theme 3- 3.4 market structures Flashcards
efficiency
measures how well resources are used
e.g. output relative to another factor
allocative efficiency
occurs where the price = Marginal cost of production
means that people are paying the exact amount it costs to produce the last unit
allocative efficiency (Ae) on a graph
at the point where the AR curve meets the MC curve
productive efficiency
occurs where a firm operates at the output at which average cost is lowest
i.e. the lowest point of the AC curve
effect of selling at productive efficiency
if price = AC, this is the lowest price the customer can enjoy
for consumer surplus and effective use of factors of production = optimum output
BUT v little incentive for firms to operate at Pe
dynamic efficiency
arises when a firm uses its resources more efficiently and productively over time (LONG TERM)
ways dynamic efficiency is achieved
- innovation resulting from R&D -> new products
- investment in new production processes
- investment in human capital- training
- improvements in working practises and labour relations
X-inefficiency
occurs when costs rise because there is a lack of competitive pressure in a market
can lead to organisational/managerial slack
happens in monopolies
x-inefficiency on a graph
upward shift in the average cost curve
market structures
the ways in which firms are competing
range from monopoly (no competition)
to perfect competition
perfect competition efficiency overview
productively efficient in SR? No
productively efficient in LR? Yes
allocatively efficient in SR and LR? Yes
monopolistic competition efficiency overview
not productively or allocatively efficient at any time
oligopoly efficiency overview
not productively or allocatively efficient at any time
monopoly efficiency overview
not productively or allocatively efficient at any time
assumptions of perfect competition
- many buyers and sellers that are price takers, firms have a horizontal demand curve AR = MR
- goods sold are homogeneous
- no barriers to entry/exit
- perfect knowledge of info
- all firms aim to max profits, MR = MC
short run profit maximising equilibrium (perfect competition)
market price is determined by the interaction of supply and demand
each firm is a price taker so faces a perfectly elastic demand curve
price = above average cost of production so the firm is making supernormal profit
long run profit maximising equilibrium (perfect competition)
supernormal profit acts as a signal to other firms to enter the market
-> thus supernormal profit will be competed away in the long run
new firms cause the supply curve to shift to the right and price to fall -> only make normal profit
firms making a loss in the short run
when a perfectly competitive firm is making a loss, average cost will be higher than average revenue at the profit maximising output
does the firm in perfect competition automatically shut down in the short run when it makes a loss?
no barriers to exit- makes sense to leave
has fixed costs in the short run that has to be paid- question is whether they make a bigger loss paying them or waiting for the cost to be variable- needs to look at the shut down point (where price covers AVC)- if can’t = should shut down
impact of firms leaving the industry
causes a leftward shift in the market supply curve, and therefore a decrease in industry output
this causes a rise in the market price
impact on firms remaining in the market
price will rise and their output will also
-> as there are fewer firms in the market
MC rises as MR rises
monopolistically competitive markets- overview
like perfect competition, but with differentiated products
means that firms have some price-setting power and little market power
characteristics of monopolistically competitive markets
- many buyers and sellers
- goods sold are differentiated
- firms are price makers facing a downwards sloping demand curve
- low barriers to entry and exit
- all aim to maximise profits (MR=MC)
- some brand loyalty but no strong brand names
short run profit maximising equilibrium
the demand (AR) curve is twice as steep than the MR curve
-> means the firm has some market power, some influence over price
AR is above AC, so the firm is making supernormal profit
long run profit maximising equilibrium
the supernormal profit acts as a signal to other firms to enter the industry
no barriers to entry, so all firms can enter
AC and AR curves are tangential at the profit maximising output
thus, supernormal profit will disappear and the firm will only make normal profit
oligopoly definition
when a few firms are dominating the market
characteristics of oligopoly
- high barriers to entry and exit
- high concentration ratio
- firms are interdependent
- product differentiation
- faces a downwards sloping demand curve
concentration ratio definition
the proportion of the market supplied by the largest firms in that industry
market power is most effectively measured using this
n-firm concentration ratio
measures the population of the market supplied by the largest n firms
high ratio = industry is dominated by a few firms
low ratio = the industry is very competitive
UK industries with the highest five-firm concentration ratio (CR 5) (top 5 firms with the most market share)
sugar = 99%
tobacco = 99%
confectionery = 81%
man-made fibres = 79%
soft drinks and mineral waters = 75%
reasons for collusive and non-collusive behaviour
collusive:
- enables firms to increase profits
- believe collusion will not be discovered
non-collusive:
- no trust between firms and market
- possibility of new entrants to the market
- high penalties for being found guilty of collusion
overt collusion
any form of direct contact between firms
a formal agreement is made to control the market by fixing prices, allocating customers or rigging bids for contracts
-> illegal and easier to detect
tacit collusion
can result from situations where firms act individually but jointly exercise power with other competitors
e.g. by following the market leader by raising prices
-> implicit agreement so hard for authorities to control
cartels
form of overt collusion
formal agreement between a group of producers that limit output in order to manipulate products
may also engage in collusive bidding for contracts and dividing the market between the firms involved
price leadership
in some markets the dominant firms acts to change prices and others will follow
-> because if other firms try to make changes, this could set off a price war or other sorts of retaliation
the large firm becomes the established leader
game theory
study of strategies used to make decisions
e.g. decisions on prices, levels of advertising
simple pay off matrix (prisoner’s dilemma)
2 petrol stations R and Q are on a high street
price charged is dependent on the price charged by the other
without collusion, both will end up with £80 each
if they collude, they get £100
if one breaks the collusion, they get £160
shows incentive to both collude and break it
price wars
occur when price cutting leads to retaliation and other firms cut their price
-> means original firms again want to cut prices to increase their sales
predatory pricing
involves cutting prices below the average cost of production (could also be below AVC)
short term measure only and once other firms have been forced out of the market the firm increases the price again
-> almost always illegal
limit pricing
involves cutting the price to the point that deters new entrants
may also be used to discourage incumbent firms (already in the market) from expanding
may or may not be illegal
non-price competition methods
methods used by firms to compete without changing the price:
- advertising and branding
- design and quality
- reliability
- service
- loyalty cards and free gifts
aim is to increase demand and make it less price elastic
pure monopoly definition
when only one firm is supplying a good or service
legal definition of monopoly in the UK
where a firm supplies at least 25% of the market
characteristics of monopoly
- one firm in the market
- high barriers to entry and exist
- firms face a downwards sloping demand curve
profit maximising equilibrium of a monopolist
since there are high barriers to entry, a monopolist can make supernormal profit in both the short and long term
benefits and costs of monopoly for consumers
adv:
- innovation
- lower prices as can produce at a lower average cost
disadv:
- less choice
- higher prices to maximise profit
- lower quality- no incentive to produce good quality goods
- X-inefficiency -> higher costs and prices
benefits and costs of monopoly for workers
adv:
- better job security
- higher pay/more perks as the firm can afford it
disadv:
- weak bargaining power as less easy to transfer to a diff company
- profits used to replace workers with machinery
benefits and costs of monopoly for govts
adv:
- higher tax revenue as large firms pay more corp tax
- lower unemployment as keeps jobs in the country
disadv:
- tax avoidance
- higher rate of inflation from firms raising prices
benefits and costs of monopoly for other firms e.g. suppliers
adv:
- a secure outlet for suppliers- ensures steady demand
- consistent quality- not worth a monopoly to take risks
disadv:
- exploitation- no choice over range and price of the goods
- overdependence
price discrimination
occurs when a firm with some degree of market power charges more than one price for the same good/service
easier for a monopolist as it is the only firm in the market
conditions necessary for price discrimination
- market power- must be able to set prices
- ability to separate markets
- price elasticities of demand must be diff in the diff markets- so the firm can charge diff prices
- the cost of keeping the markets separate is less than the increased profits gained from price discrimination
benefits and costs of price discrimination for consumers
adv:
- lower prices where demand is elastic
- helps consumers who would otherwise be unable to afford the product
- consumers may benefit from better quality goods and services
disadv:
- higher prices where demand is inelastic
- more unequal distribution of income
benefits and costs of price discrimination for producers
adv:
- higher revenues and profits
- enables finance for R&D
- can provide a product that would otherwise been unprofitable
- enables firm to spread demand from peak to off-peak times
disadv:
- costs may outweigh extra revenue
- may create a poor image for the company
natural monopoly
where one firm can supply the market at a lower cost than if there was more firms
has a continuously falling LRAC and MC curve
optimum size of the plant is large relative to the demand
-> room for only 1 firm to fully exploit economies of scale
e.g. electricity gen, water supply
pure monopsony definition
a firm that is the sole buyer of resources or supplies
many firms have some degree of monopsony power, so they have some control over their suppliers
benefits of monopsony
- can make more profit as suppliers can’t overcharge
- lower buying costs passed onto consumer
- higher profits can be used to invest and innovate
costs of monopsony
- suppliers can be squeezed out of business
- choice for consumers could be limited as monopsony acts as a barrier to entry
- higher profits of monopsony can result in inequality
- competition authorities may investigate monopsony firms
contestability definition
measure of the ease with which a firm can enter or exit an industry
characteristics of contestable markets
- low barriers to entry and exit
- new firms entering or leaving the market
- low sunk costs
- low supernormal profit
- low levels of collusion or other signs of oligopoly
characteristics of a low contestable market
- high barriers to entry and exit
- high sunk costs (key reason)
- high concentration ratio
sunk costs definition
unrecoverable costs i.e. can’t be recovered if a firm shuts down
3 main types of barriers to entry
- artificial (strategic) business
- natural (structural) business
- legal barriers
artificial (strategic) business
some are deliberately imposed and can be seen by regulators as illegal anti-competitive measures e.g.:
- predatory pricing
- limit pricing
- brand loyalty
- loyalty schemes
- switching costs
natural (structural) business
many barriers exist simply due to the nature of the business or the market e.g.:
- economies of scale
- high start up costs e.g. may involve specialist machinery
- ownership of key resources
legal barriers
some barriers to entry are imposed by the authorities, in case of too much competition being seen as working against the interests of the consumer e.g.:
- patents
- state-owned franchises e.g. rail network
- licenses to allow firms to operate e.g. 5G licenses
barriers to exit (sunk costs)
- advertising
- cost of closure
- specialised machinery that is unlikely to be transferable to other industries
