Principles of Economics 4.2 - Firm Behaviour and Market Structures*

Question 1

What’s imperfect competition?

Answer 1

Where firms differentiate their
product in some way and so can have some influence
over price

Question 2

What’s the name for ‘where firms differentiate their
product in some way and so can have some influence
over price’?

Answer 2

Imperfect Competition

Question 3

What’s the most extreme degree of imperfect competition?

Answer 3

Monopoly

Question 4

What’s a monopoly, both in theory and in reality?

Answer 4

It’s a market structure with only one firm as the sole seller of a product and no close substitutes. In reality, firms can exercise monopoly power by being the
dominant firm in the market

Question 5

Explain what happens when a firm holds over 25% of market share

Answer 5

Firms might be investigated by regulators if they
account for over 25 per cent of market share, because
there is a risk that they have too much market power

Question 6

How much market share must a firm hold for there to be a risk that a regulator might investigate the firm?

Answer 6

25%

Question 7

What’s the saying for describing a competitive firm vs a monopoly firm to describe their relationship with prices?

Answer 7

A competitive firm is a price taker, a monopoly firm is a
price maker

Question 8

Define ‘market share’

Answer 8

The proportion of total sales in a market
accounted for by a particular firm

Question 9

What’s the name for ‘the proportion of total sales in a market
accounted for by a particular firm’?

Answer 9

Market Share

Question 10

Define ‘market power’

Answer 10

Where a firm is able to raise the price of its
product and not lose all its sales to rivals

Question 11

What’s the name for ‘where a firm is able to raise the price of its
product and not lose all its sales to rivals’?

Answer 11

Market Power

Question 12

What’s the fundamental cause of monopoly?

Answer 12

Barriers to entry

Question 13

What are the 4 sources of Barrier to entry?

Answer 13

◦ Ownership of a key resource.
◦ The government gives a single firm the exclusive right to
produce some good.
◦ Costs of production make a single producer more efficient than
a large number of producers.
◦ A firm is able to gain control of other firms in the market
and thus grow in size

Question 14

Which source of barrier to entry in reality doesn’t really cause monopolies?

Answer 14

Although exclusive ownership of a key resource is a
potential source of monopoly, in practice monopolies
rarely arise for this reason

Question 15

Explain goverment-created monopolies

Answer 15

Governments may restrict entry by giving a single firm the
exclusive right to sell a particular good in certain markets

Question 16

Give & explain 2 important examples of how government creates a monopoly to serve the public interest

Answer 16

Patent and copyright laws are two important examples of
how government creates a monopoly to serve the public
interest.
◦ Laws governing patents and copyrights have benefits and
costs.
◦ The benefits are the increased incentive for creative activity and
must be set against costs of monopoly pricing

Question 17

Explain what would be the repercussions if patents or copyright laws didn’t exist

Answer 17

Without patents, there may not be enough of an incentive for a firm to innovate or invent new products that would help the market as it takes a lot of time and money to do so and the firm would feel like it’s not worth it if as soon as they come up with the product, other firms just flood into the market and take market share, making the firms’ time and money wasted

Question 18

When’s an industry a natural monopoly?

Answer 18

When a single firm can supply a good or service to an entire market at a smaller cost than could two
or more firms

Question 19

What does it mean when a single firm can supply a good or service to an entire market at a smaller cost than could two
or more firms

Answer 19

An industry is a natural monopoly

Question 20

When does a natural monopoly occur?

Answer 20

A natural monopoly occurs when there are
economies of scale, implying that average total cost falls as the firm’s scale becomes larger

Question 21

What happens when there are
economies of scale, implying that average total cost falls as the firm’s scale becomes larger?

Answer 21

A natural monopoly occurs

Question 22

Describe the graph describing ‘Economies of Scale as a Cause of Monopoly’

Answer 22

‘Cost’ on y-axis, ‘Quantitiy of Output’ on x-axis, line in the shape of 1/x, x>0 labelled ‘Average total cost’

Question 23

Explain the development of a monopoly through external growth

Answer 23

o Many of the largest firms in the world have grown
partly through acquisition, merger or takeover of
other firms.
o Consequently, industry becomes more
concentrated.
o One effect of this is that a firm might be able to
develop monopoly power over its rivals and erect
barriers to entry to make it harder for new firms to
enter

Question 24

What’s the key difference between a monopoly and a competitive firm?

Answer 24

The key difference between a competitive firm and a monopoly is the monopoly’s ability to control price

Question 25

What are the features of a monopoly? (2)

Answer 25

◦ A monopoly faces a downward sloping demand curve which represents monopolistic control (a competitive firm’s is flat)
◦ A monopoly can increase price and not lose all its sales

Question 26

Give the 4 main comparative points between a monopoly and competitive firm

Answer 26

Monopoly
◦ Is the sole producer.
◦ Faces a downward-sloping demand curve.
◦ Is a price maker.
◦ Reduces price to increase sales.
Competitive Firm
◦ Is one of many producers.
◦ Faces a horizontal demand curve.
◦ Is a price taker.
◦ Sells as much or as little at same price.

Question 27

What’s the TR equation?

Answer 27

P x Q = TR

Question 28

What’s the AR equation?

Answer 28

TR/Q = AR = P

Question 29

What’s the MR equation?

Answer 29

dTR/dQ = MR

Question 30

How is the TR equation different for a monopoly compared to a competitive firm?

Answer 30

It’s the same

Question 31

Explain the difference between MR, AR and P in monopolies compared to competitive markets

Answer 31

In a competitive firm, P=MR=AR; whereas with a monopoly, MR becomes less than AR as the firm tries to sell more units of its product. This is because the firm MUST lower the price of ALL of its units in order to sell THAT MANY units that it’s trying to sell, making MR<AR. This is due to the downward-sloping demand curve for a monopoly.