Perfectly Perfect And Imperfect Markets And Monopolies Flashcards
What is the market structure?
How the market is organised
What is the spectrum of market structures?
Perfect competition - Monopolistic competition - Oligopoly - Monopoly
As you shift more towards the left of the market spectrum what happens?
There is more market power and less efficiency
How are markets characterised?
The n. firms in the market
The degree of product differentiation
Ease of entry into the market
Explain the market characteristic: The n. Firms in the market
The more firms there are the more competitive it is. This also includes the extent of competition abroad
Explain the market structure characteristic: The degree of product differentiation
The more differentiated the product is the less competitive the market is.
What type of products are sold in perfectly competitive markets?
Homogenous products
How can you differentiate a product?
What effect does this have?
Price, branding and quality, however this effects the elasticity of demand of the product
Explain the market structure characteristic: Ease of entry into a market
This is about the number of barriers and the difficulty to overcome them to enter a market
Barriers are erected to stop other companies from making profit in a market. This increases producer surplus. The higher the barriers to entry are the less competitive the market is.
What are some barriers to entry to a market?
Economies of scale
Brand loyalty
Controlling the technology
Strong reputations for existing firms
Backwards vertical integration
Why is brand loyalty a barrier to entry?
It makes demand more inelastic. It will be harder to persuade customers to buy your product
Why is backwards vertical motion a barrier to market entry?
It controls supply. This therefore means that firms can control their prices as there is no invisible hand of the market.
This makes it hard for firms to compete in price
What are the different types or barriers a firm can erect to stop competition entering a market?
Structural
Strategic
Statutory
Describe the barrier to entry types: Structural
When barriers are formed due to differences in production costs
Describe the barrier to entry types: Strategic
When firms use different pricing policies
Describe the barrier to entry types: Statutory
The use of patents protecting a franchise
What do models that consider that traditional theory consider?
All firms want to maximise profit
What is profit?
The difference between total revenue and total cost. It is the reward that entrepreneurs get if they take risks
When do firms break even?
When TR=TC
How does a profit maximised firm operate?
When they are operating at a price and quantity of production that derives the most profit whilst having the lowest costs possible
When does profit maximisation happen?
MC=MR
Marginal costs = Marginal Revenue
What is the case when MC=MR
Profit has been maximised so an increase or decrease in unit production will not be beneficial
How does a graph show profit maximisation and the break even point?
When do profits increase/decrease?
Profits increase when MR>MC
Profits decrease when MR<MC
Why may some firms choose to maximise profits?
Provided greater wages
More dividends for shareholders - which may increase investment
Retained profits are a cheap source of finance, so you don’t have to use loans
Which type of business is most likely to want to maximise profits?
Why?
PLC may have short run profit maximisation as their goal because they need to keep shareholders happy with high dividends
What can the principle- agent problem be linked to?
Asymmetric information
What is the principle- agent problem?
When the agents make decisions for the principle but they are inclined to act in their own interest rather than those of the principle
For example a manager may give himself a bonus rather than give the money to the shareholders
Why are funds being limited be a problem?
In the short run Shareholders want profit to be turned into dividends
In the long run the firm wants to improve for example giving better managers more pay to keep them
This conflicts what the firm and the shareholders want
What is the problem for a manager to sell his firm’ sells
The shareholders could gain a big portion of the shares and could get a lot of control over the firm
This is called shareholder activism
What are some objectives of firms?
Profit maximisation
Survival
Growth
Increasing their market share
Quality
Maximising sales revenue
Sales maximisation
To improve: society, the environment, being ethical, personal gains, worker welfare
Satisficing
Explain the objective of the firm: Survival?
Normally new firms
This is a short term view
This may happen when their is low global economic growth like in 2008
This may involve selling assets to get cash to pay of loans etc
Explain the objective of the firm: Growth?
May happen through taking advantage of economies of scale to lower the average cost of the firm to eventually make them more profitable.
It could happen through takeovers or mergers
Large firms may use innovation through expensive methods of R and D
This is normally a long term goal
Explain the objective of the firm: Increasing their market share?
This helps increase a firms chances of survival and this can also be achieved by maximising sales
In the short run you may make a loss but in the long run (if done correctly) you should make a profit
This is normally a long run goal
Explain the objective of the firm: Quality?
This may be done to try and increase competitiveness through a USP (quality)
This could be done through product quality or customer service quality
This could be achieved through innovation
This may be done as if the firm gains a good reputation of quality it could result in the firm being able to charge higher prices
Explain the objective of the firm: Maximising sales revenue?
This occurs when MR=0
On the graph (at Point P1O) the firm is at MR=0 so sales are maximised
Explain the objective of the firm: Sales Maximisation?
This is where a firm tries to sell as much as their good or service as possible without making a loss
This may be common in charities
On a graph this is where AC=AR
Draw and label a diagram that shows the objective of firms
When is a firm profit Satisficing?
When a firm makes just enough profit to make its shareholders happy
Why may profit satisficing happen?
A manager is more concerned about ethics and therefore makes enough profit to keep shareholders happy whilst following his ethical code
Essentially this happens when there is a divorce of ownership and control
What are the characteristics of a perfectly competitive market?
Many buyers and sellers
Sellers are price takers
Free entry and exit to the market
Perfect information
Homogeneous goods
Firms are short run profit maximisers
Factors of production are perfectly mobile
In a perfectly competitive market, how is the price decided?
Why?
By the market
Because all firms are price takers
In a perfectly competitive market, why are profits likely to be low?
Each firm has a very small market share so they can’t set their own prices
As there are many firms the price should average out to the firms break even point as firms will compete on price but since homogeneous goods are being sold the buyers will buy the lowest priced good.
If a firm is making profit due to the perfect information other firms will join and compete that profit away
In what state can supernormal profits be made?
The short run only
Can supernormal profit be made in a perfectly competitive market?
Yes but only in the short run which would only last for a couple days as other firms enter the market
Draw a diagram showing the short run equilibrium for a perfectly competitive market
The yellow box is supernormal profits
I would expect the the demand price in the industry to increase in the long term so that it is in line with the turning point of the AC curve so the firms break even
In a perfectly competitive market, explain the short run equilibrium graph
The firm is a price taker and therefore it accept the price of the industry of P1.
In the short run the firm produces Q1 (as it is assumed that they want to maximise profit)
Describe the yellow box
In a perfectly competitive market, draw a diagram showing the long run equilibrium
In a perfectly competitive market, describe the long run equilibrium graph?
Die to the supernormal profits being made in the short term more firms have entered the market and they have competed away the supernormal profits. Since there are no barriers to entry and exit they can enter the market at any time.
This causes the supply in the market to increase. Therefore the price in the market falls so the firms (who are price takers) set a lower price
The mew equilibrium at P=MC means that firms produce at a new quantity in the long run
What are the advantages of a perfectly competitive market?
In the long run there are lower prices and allocative efficiency
Since firms are producing at the bottom of the AV curve there is productive efficiency
The supernormal profits produced in the short run could increase innovation and dynamic efficiency
What are the disadvantages of a perfectly competitive market?
In the long run dynamic efficiency is limited due to no supernormal profits
There are few economies of scale
This is not applicable in real life
What are the characteristics of a monopolistic competitive market?
Imperfect competition
Forms are short run profit maximisers
Firms sell non-homogeneous goods (due to branding)
Lots of relatively close substitutes
There are a large amount of sellers and buyers who act independently
All firms have equal and small market control
Pricing competition is not used
No barriers to entry and exit
Imperfect information
Give some examples of monopolistic competition?
Hairdressers
Regional plumbers
When on a graph do firms maximise profit in the short run?
MC=MR
Draw a diagram to show what is happenings in a monopolistically competitive market in the short run
P1C1AB is an area that represents supernormal profit
In the long term in a monopolistically competitive market why do new firms enter the market?
What effect does this have?
They are attracted by the supernormal profits
This makes demand for the firms original product more elastic which shifts the AR curve to the left. A new equilibrium point in reached and supernormal profits have been competed away
Draw a diagram to show what is happenings in a monopolistically competitive market in the long run?
What are the advantages of monopolistic competition?
Firms are allocatively efficient in the long run
Consumers get a wide range of choice
This model is more realistic than the one of perfect monopolistic competition
The supernormal profits in the short run could increase dynamic efficiency
What are the disadvantages of monopolistic competition?
In the long run dynamic efficiency might be limited due to the lack of supernormal profits
Firms aren’t as efficient as perfect competition markets
There is a lot of X- inefficiency as there is little incentive to minimise costs
What are the characteristics of an oligopoly?
High barriers to entry and exit
High concentration ratio
Interdependence of firms
Product differentiation
Explain the characteristics of an Oligopoly: high barriers to entry and exit?
This makes the market less competitive
Explain the characteristics of an Oligopoly: high concentration ratio
Only a few firms own the majority of the market. This makes the market less competitive. For example the UK supermarket market is an oligopoly.
Explain the characteristics of an Oligopoly: interdependence of firms
Firms in an oligopoly are interdependent. This means that the actions of 1 firm affects another firms behaviour
Explain the characteristics of an Oligopoly: product differentiation
This may be done using methods such as branding
The more oligopolistic a market is the harsher the degree of product differentiation there will be
How can oligopoly form?
There may be a few firms who have a high market concentration
Or some firms in a market decide to act Oligopolistically
Firms that display oligopolistic behaviour might be:
Interdependent, have stable prices, collude, or have non price competition
What is the concentration ratio?
The concentration ratio of a market is the combined market share of the top few firms in the market
How do you calculate the market concentration of a market?
You add the market shares of the top few firms in a market
How does the concentration ratio effect the competition in the market?
Why?
The higher the concentration ratio the less competitive the market will be because fewer firms are supplying the bulk of the market
When does collusive behaviour happen?
When firms agree to work together on something eg fixing the price
Why is collusion bad for consumers?
It leads to a lower consumer surplus, higher prices
But greater profits for the firm colluding.
Collusion allows oligopolies to act like monopolies who can charge higher prices
Why do firms in an Oligopoly have high incentives to collude?
By making agreements they can maximise their own benefit and restrict their output to cause the market price to increase.
What is a by product of collusion?
It is anti competitive and acts as a barrier to market entry
Why is collusion most commonly found in Oligopoly markets?
Monopolies can’s collude as there is only 1 firm
Collusion is most likely ro happen when there is only a few firms. The is what an oligopoly is
Give disadvantages of collusion?
It isn’t easy to catch.
It is anti competitive
It erects high barriers to entry
It causes ineffective competition policy .
There is often consumer inertia (the tendency for consumers to buy a product from a certain brand even though there is a superior alternative option) so the market stays stable so the collusion is allowed to continue unnoticed
When does non collusive behaviour happen?
When firms are competing. This establishes a competitive Oligopoly.
When is non collusive behaviour in an oligopoly most likely to happen?
When there are several firms, on firm has a significant cost advantage, products are homogenous and the market is saturated
How do firms grow in an non collusive oligopolies market?
Taking market share from rivals
What are the 2 types of collusion?
Overt and tacit
What is overt collusion?
When collusion is a formal agreement between firms
Eg it has often been expected that Uk gas companies do overt collusion
When is overt collusion most likely?
When there are only a few dominant firms in a market (so one doesn’t refuse)
Is overt collusion legal?
Not in the UK and USA etc
What else may companies in an oligopoly collude to do?
Cut their advertising costs
What is tacit collusion?
When there is no formal agreement of collusion but it is implied
Give an example of tacit collusion?
In the UK supermarket industry
Are price wars good for firms in an oligopoly?
No
What is the difference between co-operation and collusion?
Co-operation is legal where collusion is illegal
Collusion is usually with poor intentions whilst co-operation will usually be beneficial
Collusion usually involves market variables like quantity and price where cooperation is usually to do with management etc
What does the kicked demand curve try to show?
The feature of price stability in an oligopoly
Draw a kinked demand curve?
What are the advantages of an oligopoly?
They can earn significant supernormal profits which could be reinvested in r&d which could yield positive externalities and make the firm more dynamically efficient in the long run. There could also be more invention and innovation.
Furthermore, firms are more likely to innovate when they can protect their ideas. When there are high barriers to entry then there is more protection
Higher profits could be a source of government revenue
Industry standards could improve because collaboration could improve the standards of safety etc.
Also collusion could save on duplicate r&d costs
Since oligopolies are large they can exploit economies of scale. Ao they will have lower average costs of production. This can be shown through the long run average cost curve.
Draw a graph showing supernormal profits on a graph?
What is special about a monopoly graph?
Since the firm is the sole supplier the costs and revenue curves are the same as the industry’s
P>MC in the diagram due to profit maximisation which occurs at MC = MR, so there is allocative efficiency in a monopoly
AR>AC so there are supernormal profits
What are the advantages of a monopoly?
Significant supernormal profits are made. This could be reinvested in r&d which could yield positive externalities and increase dynamic efficiency in the long run. This could result in more intention and innovation
Furthermore, firms are more likely to do this if they know that what they do will be protected from other companies (high barriers in a monopoly ensures this)
If there is a natural monopoly it may be more efficient for 1 firm to run the market because having duplicates of the same infrastructure could be inefficient
Monopolies could generate export revenue
They can exploit economies of scale to get a lower AC of production - this can be shown through the LRAC curve shown below
High profits could be a source of government profit through taxation
Draw a diagram illustrating price discrimination
Show x-inefficiency on a graph?
What is consumer surplus on a graph?
The area above the price of the good and below the demand curve
In terms of consumer surplus what does an increase in demand cause?
Show this on a graph?
An increase on consumer surplus
What is consumer surplus explain on a graph?
The area beneath the market price and above the supply curve
Draw a graph showing the area of deadweight loss and a profit maximising monopoly?
