Section 4: Market Structures Flashcards
What would a perfetly competitive market look like (6 aspects)
Infinite number of supplier and consumers
Consumers have perfect information
Producers have perfect information
Products are identical
No barriers to entry or exit
Firms are profit maximisers
In a perfetly competitive market what would every firm be with regards to price
A price taker
In a perfetly competitive market what would be the relationship with a markets demand curve and the marginal utility and why
Demand curve = marginal utility
The worth of a good to a customer decreases as quantity increases due to law of diminishing marginal utility
In a perfetly competitive market what would be the relationship with a markets supply curve and the marginal cost and why
Supply curve = Marginal cost
A producers’ marginal costs increase as quantity increases due to the law of diminishing returns
What is allocative efficiency
When a good’s price is equal to what consumers want to pay for it
Why does allocative efficency happen in a perfectly competitive market
The price mechanism ensuures that producers supply exactly what consumer demand
At what point is allocative efficiency achieved
When price is equal to marginal social cost
What is marginal social cost
The cost to a society to producing one further unit
Explain type of profit doesn’t exist in the long run in a perfectly competitive market
Supernormal profit because any short term supernormal profits attract new firms because there are no barriers to entry
Give 2 reasons why supernormal profit is competed away
When supernormal profit is made new firms are attracted to the market
This causes the supply curve to shift to the right meaning the market price falls until all excess profits have been competed away
What is the market price equal to
Average revenue
If the market price falls below average-unit what does that mean for the firms profit
The firm is making less than normal profit
In a perfectly competitive market give 3 things that happen in the short run if the firm is making less that normal profit
If the selling price is still above the firm’s average variable costs then the firm may continue to trade temporarily
If it falls below the average varaible costs then it will leave the market immediately
What is productive efficiency
Ensuring the costs of production are as low as they can be
Why does productive efficiency come about in a perfectly competitive market
It comes as a result of all firms trying to maximise their profits
What is X-efficiency
Measures how successfully a firm keeps its costs down
Give 2 things X-efficiency is caused by
Using factors of production in a wasteful way
Paying too much for the factors of production
In a perfectly competitive market what has to be assumed in order for it to have productive efficiency and give 2 reasons why
You have to assume that there are no economies of scale
In a perfectly competitive market each firm is very small since there are infinite firms so they can’t take full advantage of economies of scale
So that means that the firms may be less productively efficient than if there was one big firm
What does dynamic efficiency mean
Improving efficiency in the long run
Why does a perfectly competitive market not lead to dynamic efficiency
There is only normal profit so no risks are taken to improve efficiency in the long run
What is static efficiency
When allocative and productive efficiency are achieved at a particular point in time
Why do governments want to encourage efficiency between firms
So firms are forced to produce efficiently to reduce costs and set a price that’s fair to their customers
Give 6 policies the government can implement to encourage competition in markets
Encouraging enterprise with advice and start-up subsidies
Increase consumer knowledge to make sure comparison information is available
Introduce consumer choice and competition in public sectors by creating internal markets
Privatise and deregulate large monopolistic nationalised industries
Discourage mergers and takeovers that excessively reduce new firms competing
Encourage more international competition
What is an incumbent firm
Firms which are already in the market
In a purely monopoly market what are the barriers to entry
Total
Explain 4 ways that incumbent firms may create barriers to entry
An innovative new product patented (legally protected so the design can’t be copied) by an incumbent firm can make it very hard for an entrant to overcome
Strong branding and familiarity with the incumbent firms products can make it very hard to make them choose and entrants product instead
Incumbent firms can aggresively lower the price to drive out competition that a new entrant can’t match
The threat of a ‘price war’ can deter entrants from joining markets
Give 3 reasons why barriers of entry can be due to the nature of an industry
Some industries require high amounts of capital expenditure before a firm recieves any revenue (the cost of entering the market is huge so most firms don’t enter
If investments can’t be covered to leave a market then entering that market can be very risky and unappealing
If there is a MES of production then a smaller entrants will be operating on a higher point on the average cost curve than established firms so they will have to sell at higher prices than bigger firms
What is capital expenditure
Money spent buy a business acquiring assets
Give 3 reasons why barriers to entry can be created by government regulations
An industry requiring a license can be a barrier to entry to new firms, similarly in regulated industries firms may have to be approved by a regulator before they can operate in the industry
New factories may need planning permission before they can be built
There will also be health and safety regulations and worker conditions that firms will need to keep to
Give 2 ways new entrants may have their own advantages
Not all new entrants are small firms having to compete against bigger firms
Sometimes new entrants are large and successfull firms that wish to diversofy their products
What is a monolopy
A monopoly is a market with only one firm in it (this firm has 100% of the market share)
Give 3 reasons why monopoly power can come about
Barriers to entry preventing new competition to compete away large profits
Advertising and product differentiation - if consumers think that a product is more desirable than other products then a monopoly can be created
Few competitors in market
What type of profit will a monopolist make in long and short run
Supernormal
If a firm wants to maximise it’s profits what level of output will they be operating at
Where MC=MR
Explain the efficiency of a monopoly (2 aspects)
Their MC isn’t equal to their AC so they aren’t operating at the lowest possible point on the AC curve so monopolies arent productively efficient
The price charged by the monopoly is greater than MC so they arent’ allocatively efficient
What does it mean when a market is at equilibrium
The price and quantity point at which market supply and market demand for an item are equal (supply is equal to demand)
What is a deadweight welfare loss
The reduction in economic efficiency that happens when a market is not at equilibrium
Give 4 drawbacks of monopolies
No need to innovate or differentiate their product - they become complacent
No need to increase efficiency - x-efficiency remains high
Consumer choice is restricted
Monopsonist power can be used to exploit suppliers
What industries lead to natural monopolies
Industries where there are large fixed costs and/or their are large economies of scale
Give 2 ways a government interacts with a natural monopoly
May be reluctant to break up a natural monopoly because this may reduce efficiency
They might provide subsidies so the firm will increase its output to a point where supply meets demand
What are the 4 potential benefits of a monopoly
A monopolists large size may lead to economies of scale if diseconomies of scale is avoided (this means it can keep average costs low)
The security a monopolist has in it’s market means that it can focus on developing it’s products in the future - this can lead to dynamic efficiency
Monopolists can provide stable employment for workers
IPRs (Intellectual Property Rights) allow a form of limited monopoly that can actually be in consumers interests
Name 2 types of IPRs
Copyrights
Patents
Give 3 ways an IPR benefits a firm
Allow a firm exclusive use of their innovative ideas for a limited amount of time
During this time supernormal profit is possible
Without the protection of IPRs firms would have little incentive to risk their resources investing in innovative ideas because other firms would be able to copy those ideas
What is a monopsony
When a single buyer dominates a market
How can a monopsonist exploit it’s suppliers
Can act as a price maker since they’re the only source of income for the supplier
What is price discrimination
When a seller chargesa different prices to different customers for exactly the same product
What are the 3 conditions necessary for a firm to make use of price discrimination
The seller must have price making power - monopolies and ologopolies
The seller must be able to separate sellers into different groups based on price elasticity of demand
The seller must be able to prevent seepage
What is seepage
When customers by a product at a lower price re-selling it themselves at a higher price to customers who could have been charged more
What is consumer surplus
The difference between the actual selling price of a product and the price a consumer would have been willing to pay
What are three different types of price discrimination
First/Second/Third degree price discrimination
What is first degree price discrimination
Where each individual customer is charged the maximum they would be willing to pay
This method is unlikely because of the cost of gathering the information and the difficulty of preventing seepage
What is second degree price discrimination
Often used in wholesale markets where lower prices are charged to people who purchased large quantities
Encourages large orders
What is third degree price discrimination
When a firm charges different prices for the same product to different segments of the market
These segments could be:
- Customers of different ages
- Customers who buy at different times
- Customers who buy at different places
To maximise profit the seller would set a price at a level for both groups where MC = MR
Does price discrimination lead to allocative efficiency
The average revenue is greater than the marginal cost so price discrimination doesn’t lead to allocative efficiency because that happens when price is equal to marginal cost
What is a concentrated market
When some industries are dominated by just a few companies
How do you find the level of domination of a company in a market
Level of domination is measured by the concentration ratio
Divide the amount that the company is worth and divide it by the value of the market and multiply it by 100 to get the percentage value
Give the 2 ways to define an oligolopy
A market that’s dominated by a few firms that has high barriers to entry in which firms offer differentiated products
A market in which firms are interdependant and where firms use competitice or collusive strategies to make this interdependance work to their advantage
What are the 2 strategies that firms in an oligopolistic market can adopt
Competitive behaviour
Collusive behaviour
Explain collusive behaviour in an oligopolistic market (4 aspects)
When firms cooperate with each other especially with what prices are charged
Formal collusion involves an agreement between firms (this is usually illegal)
Informal collusion is a tacit (happens without any kind of agreement) - this is when firms know what’s in their best interests and choose to not compete as long as the other firms do the same
Some firms in a collusive oligopoly can act as price leaders and can choose to change prices and the rest will normally follow
When is competitive behaviour in an oligopolistic market more likely to happen (4 aspects)
When one firm has lower costs than the others
When theres a large number of firms in the market
When the firms produce products that are very similsar
When the barriers to entry are relatively low
When is collusive behaviour in an oligopolistic market more likely to happen (4 aspects)
When the firms have similar costs
When there are a small amount of firms
When brand loyalty means customers are less likely to switch
When barriers to entry are high
What are the 2 assumptions present in the kinked demand curve
If one firm raises its price, then the other firms will not raise thers
If one firm lowers its prices, the other firms will also lower theirs
In the kinked demand curve model what is the relationship between price and demand
When price is increased demand is elastic
When price is decreased demand is inelastic
In the kinked demand curve model why do firms that choose to decrease their products lose out
Rest of the firms will lower their prices aswell so the firm won’t gain market share and their average price will fall
What is game theory
The mathematical study of strategic interactions
What is the first-mover advantage
If two firms are deciding what output level they choose to operate at and one firm chooses to operate at a high output then it would be the in the other firms interest to operate at a low output level
What are the 4 conditions necessary for monopolistic competition
Some product differentiation due to advertising or real differences between products:
- This means the seller has some degree of price-making
power
- So each seller’s demand curve slopes downwards
- But the smaller the product differences the more price
elastic the
demand for each product will be
There are either no barriers to entry or only very low barriers to entry:
- This means that if very high supernormal profits are earned,
new entrants can join the industry easily
In monpoilistic competition when is the only time that supernormal profits can be earned and why
In the short run
The barriers to entry and the product differentiation means that supernormal profit can be made
In monpoilistic competition when is the time where exclusively normal profits are earned and give 2 reasons why
In monopolistic competition new entrants will join the industry because of the low barriers to entry
This will cause the established firm’s demand curve to shift the left until only normal profits can be earned - the demand curve meets tangentially to the AC curve so the firms isn’t operating where the AC is at it’s lowest so it is not productively efficient and the equilibrium price is greater than MC this is not allocatively efficient
Explain the 3 aspects of the process of a monopolistic competition going from resembling a monopoly to resembling a perfect competition
In the short run the barriers to entry and the product differentiation means that supernormal profit can be made
This resembles a monopoly since new entrants haven’t joined yet
This market will begin to resemble a perfect competition as new entrants enter the market and compete away the supernormal profit
What is monpololistic competition
When many companies are in the same market but the products are slightlty differentiated so they are’nt perfet substitutes
Where on the AC curve are firms operating on if they are in a monopolistic competition
They aren’t operating on the lowest point of the AC curve
Describe the difference in prices in perfect competition and monopolistic competition
The prices are higher in monopolistic competition because they have to differentiate their product causing them to have higher costs
Why do firms in monopolistic competition don’t take advantage of economies of scale
Because they have they have chosen to restrict output in order to maximise profits
What is contestability
How open a market is to new competitors
What are the 2 characteristics of a contestable market
The barriers to entry and exit are low - if excess profits are made by incumbent firms, new firms will enter
Supernormal profits can potentially be made by new firms
Give 6 things that can increase the barriers to entry
There are patents on key prooducts and production methods
Advertising by incumbent firms has already created strong brand loyalty
There’s a threat of limit pricing by the incumbent firms
Trade restrictions are present - these don’t allow foreign entrants to compete on equal terms with the incumbent firms
Incumbent firms are vertically integrated
If sunk costs are high they create barriers to exit - e.g. expensive equipment or large costs on advertising
What is a hit and run tactic
Entering a market when supernormal profits can be made and leaving when they can’t anymore
