Theme 3 - market structures

Question 1

what is the shutdown condition, when should firms consider shutting down and why? - perfect competition

Answer 1

when AR = AVC,
- When AR = AVC, the firm is just covering its variable costs, meaning it can’t contribute anything to covering fixed costs, such as rent or machinery expenses.

• the firm earns zero economic profit,

Question 2

what is the breakeven condition - perfect competition

Answer 2

when AR = AC (normal profit)
- When AC = AR, the firm is covering all its costs (both fixed and variable) and earning zero economic profit. This means it’s not making a loss, so there is no immediate reason to shut down.
- If market conditions improve (e.g., an increase in demand), the firm could start earning positive profits.

Question 3

when should firms completely shut down - perfect competition

Answer 3

when AR < AVC
- If AR < AVC, the firm is not even covering its variable costs, meaning it’s losing money on every unit produced.
- Staying open with AR < AVC leads to a negative cash flow, making it unsustainable in the short run as the firm cannot pay for essential inputs like labor and materials.
- By shutting down, the firm avoids additional variable costs, which helps minimize losses to just fixed costs. Continuing production would increase its losses further.

Question 4

what are characteristics of a perfect competition market

Answer 4

• there are many buyers and sellers
• there are no barriers to entry or exit
• firms sell homogeneous goods, firms are price takers, they cannot set their prices
• there is perfect information between buyers and sellers
• firms are profit maximisers

Question 5

what is the long run equilibrium in perfect competition

Answer 5

when normal profit is being made. any point more than normal profit is a short run equilibrium

Question 6

why is supernormal profit only a short run equilibrium in perfect competition

Answer 6

• High profits attract new firms due to low barriers to entry and perfect information,
• New firms entering the market increases the overall supply of goods in the market, shifting the supply curve to the right.
• As supply increases, the market price falls, reducing the supernormal profits that existing firms were initially earning.
• Firms continue to enter until prices fall to the point where only normal profits are made, leaving no incentive for further firms to enter.
• In the long run, all firms earn only normal profits as the market reaches a new equilibrium with no supernormal profits remaining.

Question 7

in perfect competition, why would firms only be making subnormal profits in the short run

Answer 7

• Firms are incentivized to leave the market to avoid losses and produce elsewhere at their opportunity cost.
• Due to low barriers to exit, firms can easily exit the market, reducing the overall supply.
• As supply shifts left, the market price increases, reducing the losses faced by the remaining firms.
• Firms continue to exit until prices rise to the point where the remaining firms earn normal profits.
• In the long run, only normal profits are earned, and there is no incentive for further firms to leave.

Question 8

efficiency in a perfectly competitive market

Answer 8

allocative efficiency - SR:yes
LR: yes

productive efficiency - SR:NO LR: yes

X - efficiency is high as they are minimising waste and therefore cost

Dynamic efficiency - SR: yes
LR : no

Question 9

what are barriers to entry

Answer 9

any obstacle that stops a new firm from entering the market

Question 10

4 types of barriers to entry

Answer 10

• Legal
• Technical
• Strategic
• Brand loyalty

Question 11

examples of legal barriers to entry

Answer 11

patents - having sole ownership of something you created, no other firm can copy you, firms may not know how to stand out/compete with other firms and may not join the market

license/permits - Licenses or permits create additional costs for new firms, making it more expensive to enter the market. may be expensive/difficult to obtain, and there are a limited number

red tape - is excessive paperwork slow down the process of entering the market, discouraging potential entrants who face long waiting periods

regulations and standards - Standards and regulations impose compliance costs, requiring firms to invest in meeting specific industry criteria, which raises the cost of entry.

insurance - increase upfront costs, making it more expensive for new firms to enter the market.High premiums or limited availability of insurance can deter smaller firms or startups, reducing competition.

Question 12

examples of technical barriers to entry

Answer 12

• start up costs - High initial investment requirements (e.g., equipment, infrastructure) make it difficult for new firms to enter the market without significant capital.
• sunk costs - Irrecoverable expenses (e.g., advertising, R&D) deter entry as firms can’t recoup these costs if they fail, raising the risk for new entrants.
• economies of scale - Established firms benefit from lower average costs due to large-scale production, making it hard for new entrants to compete at the same cost level.
• natural monopolies - Markets with high fixed costs and infrastructure requirements (e.g., utilities) tend to be dominated by one large firm, discouraging new entrants due to the sheer scale of investment needed.

Question 13

what are sunk costs

Answer 13

costs that cannot be recovered if the firm were to leave the market

Question 14

examples of strategic barriers to entry

Answer 14

• predatory pricing
• temporarily lowering prices to drive competitors out of the market.
• they make it financially unviable for new entrants to compete.
• limit pricing
• Firms can use limit pricing to deter potential entrants by setting prices just low enough to make entry unprofitable.
• By maintaining a price that is lower than the average cost of potential competitors,
• heavy advertisingg
• Established firms may invest heavily in advertising to create strong brand loyalty and awareness.
• Significant advertising expenditures increase customer recognition and preference for the established brand, making it difficult for new entrants to gain market share.

Question 15

what is monopolistic competition

Answer 15

a competitive market with some aspects of a monopoly

Question 16

characteristics of a monopolistic market

Answer 16

• many buyers and sellers
• firms sell slightly differentiated goods
• firms are price makers
• price elastic demand as there are many substitutes
• low barriers to entry/exit
• non - price competition(competition based on branding,advertising etc)
• good information
• firms are profit maximisers(MR=MC)

Question 17

why, in the short run, can firms in monopolistic competitive markets, make supernormal profits

Answer 17

• Firms in monopolistic competition produce differentiated products, allowing them some control over prices rather than being price-takers.
• This differentiation enables firms to set prices above marginal costs, leading to higher revenues relative to costs.
• In the short run, firms can exploit this pricing power to generate supernormal profits

Question 18

why, in the long run, will firms not be able to make supernormal profit

Answer 18

• new firms enter the market due to low barriers to entry and good information
  -This increases competition, shifting the firm’s demand(AR) curve leftwards
• As demand falls, the firm adjusts to a point where its demand(AR) curve becomes tangential to the ATC curve.
• In the long run, the price equals ATC at the profit-maximizing output level (MR = MC), so firms earn just enough to cover their costs, resulting in normal profits only.

Question 19

comments on efficiency in a monopolistic market

Answer 19

short run - allocative efficiency is not reached as price not equal to MC
long run - allocative efficiency is not reached

long run and short run - productive efficiency is not reached as we are not on the lowest part of AC curve

lpng run - no dynamic efficiency, profits arent being made to reinvest

VERY INEFFICIENT STRUCTURE

Question 20

evaluation point for the argument that a monopolistic competitive market is inefficient

Answer 20

• There is some competition, which reduces price-setting power.
  
  • With firms facing competition from close substitutes, their ability to raise prices and exploit consumers is limited compared to a monopoly
  • The loss in consumer surplus is less severe, meaning consumers still get relatively competitive pricing.
• Perfect competition assumes homogeneous goods, but is that what consumers want?
  
  • In monopolistic competition, product differentiation caters to diverse consumer preferences, offering a variety of choices.
  • Consumer satisfaction could be higher, as many prefer differentiated products over identical ones.
• The productive inefficiency in monopolistic competition is less severe than in monopoly.
  
  • With close substitutes and competition, firms can’t afford to fully exploit economies of scale as monopolies do, preventing extreme inefficiency.
  • Productive inefficiency exists but is not as pronounced, and prices remain more competitive.
• Economies of scale can be greater than in perfect competition
  
  • Firms in monopolistic competition can reach a size that allows for some economies of scale, unlike perfectly competitive firms, which are usually too small to benefit from these efficiencies.
  • This could lead to slightly lower prices and better resource use compared to perfect competition.
• Short-run supernormal profits may encourage reinvestment, leading to dynamic efficiency.
  
  • Firms may use their short-run profits to innovate, improve products, and invest in new technologies, making the market more dynamically efficient.
  • This can benefit consumers over time through better products and services, even if there is some inefficiency in the short run.

Question 21

what is allocative efficiency

Answer 21

• where resources follow consumer demand
• where society surplus is maximised
• where net social benefit is maximised
• on a graph, it’s where D=S and where AR/P = MC

Question 22

what is productive efficiency

Answer 22

• when a firm is operating at the lowest point on their AC curve
• full exploitation of economies of scale

Question 23

what is X efficiency

Answer 23

• when a company is minimising their waste, there are no excess costs
• occurs when firm is operating on the AC curve

Question 24

what is dynamic efficiency

Answer 24

• the reinvestment of long run supernormal profit back into the business

Question 25

difference between static(allocative/productive/X) and dynamic efficiency

Answer 25

• static efficiency all occur at one specific production point
• dynamic efficiency occurs over time

Question 26

efficiencies consumer analysis

Answer 26

allocative efficiency
- resources perfectly follow consumer demand
- low prices, higher choice, maximisation of CS, high quality of production

Question 27

efficiencies consumer analysis

Answer 27

allocative efficiency
- resources perfectly follow consumer demand
- low prices, higher choice, maximisation of CS, high quality of production

productive efficiency
- increased production at lower AC
- higher profits
- lower prices and greater market share

Dynamic efficiency
- new innovative products,lower prices, high CS

X efficiency
- low prices, high Cs

Question 28

efficiency producer analysis

Answer 28

allocative efficiency
- retained or increased market share, staying ahead of rivals, increased profit

productive efficiency
- more production at lower AC
- higher profit
- increased market share, lower prices

dynamic efficiency
- long run profit maximisation
- lower costs over time
- retained or increased market share
- stay ahead of rivals

X efficiency
- lower costs, higher profit, lower prices and increased market share

Question 29

efficiency producer analysis

Answer 29

allocative efficiency
- retained or increased market share, staying ahead of rivals, increased profit

Question 30

Real-Life Examples of Perfectly Competitive Markets

Answer 30

Agricultural Markets: Markets for crops like wheat, corn, and soybeans are often used as examples of near-perfect competition. There are numerous farmers (sellers) providing standardized products, with prices determined largely by market demand rather than individual sellers.

Foreign Exchange Market: - The currency exchange market is often cited as close to perfect competition, with many buyers and sellers trading standardized currencies, freely determined by supply and demand.

Stock Market for Commodities:
- The trading of commodities like gold, silver, and crude oil in stock exchanges also approaches perfect competition due to high standardization and many participants, though slight differences can arise based on contracts.

Question 31

Real-Life Examples of Monopolistic Competitive Markets

Answer 31

Restaurants and Cafés: The food service industry exemplifies monopolistic competition. Restaurants offer differentiated products through cuisine, ambiance, location, and service, with easy entry and exit and many competitors.

Retail Clothing Stores: The fashion retail market, including both branded stores and generic clothing shops, operates in a monopolistic competitive environment, as brands differentiate themselves through style, quality, and brand image.

Beauty and Personal Care Products: Cosmetics, skincare, and personal care items are highly differentiated by branding, quality, and pricing, making the personal care industry a prime example of monopolistic competition.

Fitness Centers and Gyms: Fitness centers differentiate through facilities, classes, and location, but there are many players with relatively easy entry and exit, fitting the monopolistic competition model.