Theme 3 - market structures Flashcards

Question

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

Answer 1

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

Answer 2

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

Answer 3

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

Answer 4

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

Answer 5

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

Answer 6

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.

Answer 7

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.

Answer 8

- LOW BARRIERS TO ENTRY/EXIT - large pool of potential entrants - good information abt the market - hit and run profits

Answer 9

when new firms enter the market, snatch supernormal profits, then leave the market before firms and income can react and lower their profit margins

Answer 10

1. Lowers Barriers to Entry → More Firms Can Enter the Market → Increased Competition Technology reduces start-up costs by allowing firms to operate digitally instead of requiring physical infrastructure → This makes it easier for new firms to enter previously monopolized markets, increasing contestability → For example, e-commerce platforms reduce the need for expensive retail space, allowing small businesses to compete with larger firms → More competition forces existing firms to improve efficiency and lower prices, benefiting consumers. Example: The rise of online banking and fintech companies has challenged traditional banks by offering financial services without the need for physical branches, increasing contestability in the banking sector. 2. Reduces the Need for Large Sunk Costs → Firms Can Enter and Exit Markets More Easily → Market Becomes More Contestable New technology, such as cloud computing and software-as-a-service (SaaS), allows firms to operate without significant upfront investment in physical assets → Lower sunk costs reduce the risk of market entry, making it easier for new competitors to challenge established firms → As a result, incumbent firms face greater competitive pressure and must remain innovative and efficient to retain market share. Example: The media streaming industry became more contestable as platforms like Spotify and Netflix eliminated the need for costly distribution infrastructure (e.g., physical CDs or DVDs), allowing new entrants to emerge with lower initial investment. 3. Enhances Consumer Knowledge → Reduces Asymmetric Information → Encourages New Firms to Compete Technology improves access to market information, reducing information asymmetry between firms and consumers → Consumers can now compare prices, quality, and reviews easily, forcing firms to compete on price and service quality → New entrants can gain market share more quickly by offering better products or lower prices, making markets more contestable. Example: Price comparison websites (e.g., Skyscanner, Expedia) allow consumers to compare flights and hotels instantly, forcing firms to offer competitive pricing and reducing the power of previously dominant companies in the travel industry. 4. Creates Alternative Distribution Channels → Incumbents Lose Control of Supply Chains → Increases Contestability Technology enables new distribution models such as direct-to-consumer (D2C) sales, online platforms, and decentralized supply chains, reducing reliance on traditional distribution networks controlled by dominant firms → This allows smaller businesses to bypass intermediaries and reach customers directly, increasing competition in previously concentrated industries. Example: The rise of online marketplaces like Amazon, Etsy, and Shopify has allowed small businesses to sell products directly to customers, increasing contestability in the retail sector where large brick-and-mortar chains previously dominated. 5. Enables Disruptive Innovation → Challenges Existing Market Structures → Forces Incumbents to Adapt or Exit Technological advancements often lead to disruptive innovation, where new business models challenge traditional firms → This forces existing companies to adapt, lower prices, or risk losing market share → If dominant firms fail to keep up with technological changes, they lose their monopoly power, making the market more contestable. Example: The gig economy (e.g., Uber, Airbnb, Fiverr) has increased contestability in transportation, accommodation, and freelance work, challenging traditional taxi services, hotels, and employment agencies.

Answer 11

In a contestable market, a monopoly may choose to produce at AC = AR (breakeven) to reduce the threat of new entrants. By setting prices at the point where Average Cost (AC) equals Average Revenue (AR), the monopoly earns zero economic profit. This means that there is no room for new entrants to expect high profits by entering the market. The rationale behind this pricing decision is that in a contestable market, low barriers to entry mean that potential competitors could easily enter if they perceive an opportunity for profit. The impact of producing at AC = AR is that the monopoly reduces the incentive for other firms to enter the market. By setting prices low enough to just cover costs, the monopoly signals that it has no supernormal profits to attract new firms. This strategy serves to maintain market dominance and prevent competition from undermining its position.

Answer 12

Allocative Efficiency - In a contestable market, firms are incentivized to produce at a price where demand equals supply, leading to allocative efficiency. - This is because if a firm charges above the market equilibrium price, new entrants can enter and undercut the incumbent's price, thus encouraging the incumbent to set prices that reflect consumer preferences. - As a result, resources are allocated in a way that maximizes total welfare, ensuring that goods and services are produced at the level that consumers want, and at prices they are willing to pay. X-efficiency - In a contestable market, firms are compelled to operate efficiently, minimizing costs, as they know that any inefficiency will attract potential entrants. - Since firms face the threat of competition, there is a strong incentive to reduce waste and improve operations, thus leading to lower costs and higher efficiency in the market. - This enhances productive output without unnecessary resource use, benefiting consumers and ensuring firms remain competitive. Productive Efficiency - Firms in a contestable market are motivated to produce at the lowest cost possible, utilizing their resources effectively. - Because they have the potential to face competition at any time, which forces them to minimize costs to maintain a competitive edge. - As a result, firms are more likely to adopt best practices and new technologies that enhance their efficiency, leading to a reduction in average costs. Job Creation - In a contestable market, firms that successfully innovate/ reduce costs often expand their operations, can lead to increased demand for labor. - The entry of new firms also provides job opportunities, as competition increases and firms grow to meet demand. - This growth in market activity and employment can increase economic growth and job creation within the economy.

Answer 13

Lack of Dynamic Efficiency - In a contestable market, firms may have limited incentives to innovate over the long term, as their profits are constantly threatened by the potential entry of new firms. - Since firms can only expect normal profits, the pressure to invest in long-term research and development or technological advancements is weakened. - This can result in a lack of dynamic efficiency, where innovation and progress are slowed down, ultimately reducing the overall rate of economic growth. Cost Cutting in Dangerous Areas - To stay competitive, firms in a contestable market may cut costs in ways that negatively affect product quality or worker safety. -For example, reducing spending on safety measures or using cheaper materials to lower production costs may endanger consumers or employees. - This drive for cost reduction in a highly competitive environment can lead to undesirable side effects, such as the exploitation of workers or a decline in product safety. Creative Destruction - Contestable markets may encourage "creative destruction," where inefficient firms are driven out of business as new, more innovative competitors enter the market. - While this can lead to improvements in overall market efficiency, it may also cause significant disruption, including job losses and the collapse of long-established businesses. - Such disruption can harm communities and create short-term economic instability, especially for workers in industries that are unable to adapt to new competition. Anti-Competitive Strategies - Even in a contestable market, incumbent firms may engage in anti-competitive strategies to deter potential entrants or maintain market dominance. - These strategies may include predatory pricing, where firms temporarily lower prices below cost to drive new entrants out of the market, or collusion to prevent market entry. - These reduce the effectiveness of contestability, potentially leading to monopolistic behavior and reducing the benefits of competition for consumers.

Answer 14

Length of Contestability - If the market remains contestable for a long period, it ensures that firms continue to face the threat of competition, which encourages efficiency and lower prices. - However, if barriers to entry increase over time due to changes in market conditions, such as increasing capital requirements or regulatory hurdles, firms may be able to secure their position and reduce the level of contestability, thus undermining its benefits. Role of Technology - Technology plays a significant role in making markets more contestable by reducing entry barriers and enabling firms to operate more efficiently. - However, technology can also lead to market concentration if larger firms have the resources to dominate the use of advanced technologies, potentially limiting competition in the long run and diminishing contestability. Regulation - Regulation can have a significant impact on the contestability of a market. While regulation can reduce barriers to entry by ensuring a level playing field (such as removing anti-competitive practices), excessive regulation can increase entry costs and limit market access for new firms. - For example, strict licensing requirements or heavy tax burdens can deter new entrants, reducing the overall contestability of a market. - Therefore, the role of regulation is a delicate balance; too little can lead to anti-competitive behavior, while too much can hinder market entry and reduce contestability. Dynamic Efficiency - Dynamic efficiency refers to the ability of firms to innovate and improve their products or services over time. - While contestable markets generally encourage short-term efficiency through price competition, the pressure to maintain normal profits may limit long-term investments in innovation and technological advancement. - In some cases, firms in a contestable market may not have sufficient incentives to engage in research and development because of the constant threat of competition, which could reduce dynamic efficiency and limit long-term growth.

Answer 15

they are making supernormal profits

Answer 16

- Because of high interdependence. - Collusion, such as price-fixing agreements, reduces uncertainty and intense price competition, allowing firms to maximize profits. - High concentration ratios and barriers to entry make collusion more feasible. - For example, firms may form cartels to maintain stable prices and output levels, benefiting all parties involved

Answer 17

the ability of a business to set prices above the level that would exist in a highly competitive market

Answer 18

🏦 High sunk costs discourage new entrants → High sunk costs mean firms can't recover their investment if they exit the market → This increases the risk for potential new firms → So fewer firms are willing to enter the market → Contestability of the market decreases 🔄 Existing firms can exploit their position → With high sunk costs, incumbent firms feel secure → They may engage in limit pricing or other barriers → These practices deter new firms from entering → Market power is sustained, reducing contestability 🧱 Barrier to hit-and-run entry → In a contestable market, firms can enter and exit freely → But sunk costs make it expensive to "test the waters" → This prevents hit-and-run entry by new competitors → The threat of entry (which maintains competition) is weakened 🛑 Reduces dynamic efficiency → Less contestability leads to reduced pressure to innovate → Firms are less worried about potential new entrants → This may lead to complacency and x-inefficiency → Long-run competitiveness and innovation may fall

Answer 19

Firms are likely to price close to marginal cost. - To deter entry, incumbent firms may adopt limit pricing strategies to make the market unprofitable for new entrants. - This leads to allocative efficiency, benefiting consumers with lower prices. Increased focus on innovation. - Firms invest in product and process innovation to maintain a competitive edge and create entry barriers. - Results in dynamic efficiency and higher-quality products for consumers. Potential for hit-and-run competition. - Firms enter the market to exploit short-term profits and exit when conditions become unfavorable. - Ensures that no single firm can sustain monopoly pricing in the long run.

Answer 20

Product Variety and Consumer Choice In a monopolistic competitive market, firms offer differentiated products. This creates variety for consumers, improving consumer satisfaction and well-being. While firms might not produce at the minimum point of the average cost curve, the benefits of diversity in products may outweigh the inefficiencies associated with higher prices. Evaluation: The variety of products is a key benefit, but this also means that firms might not achieve full economies of scale, leading to higher average costs in comparison to perfectly competitive markets. Dynamism and Innovation Firms in monopolistic competition are incentivized to innovate to differentiate their products. This constant innovation leads to improvements in products and services over time. These innovations may increase overall welfare, even if firms are not producing at the lowest possible cost. Evaluation: Although innovation is a positive, the costs of innovation (e.g., advertising, research, development) may increase prices for consumers, leading to a trade-off between innovation and affordability. Lower Barriers to Entry Compared to monopolies or oligopolies, monopolistic competition typically has fewer barriers to entry. This encourages more firms to enter the market, leading to a more competitive environment. This can result in better service, lower prices, and more efficient outcomes over time as firms must constantly compete to maintain market share. Evaluation: While the lack of barriers promotes entry, the smaller scale of firms often results in less productive efficiency than in monopolies with significant economies of scale. Efficiency of Resource Allocation Monopolistic competition allocates resources more efficiently than a monopoly. Firms respond to consumer preferences, and competition forces firms to optimize their production processes and pricing strategies. Even though firms have some pricing power, their products are not unique enough to allow for total price gouging, and market forces still prevent excessive profits. Evaluation: While resources may be allocated more efficiently than in a monopoly, the lack of perfect competition means that the market is not operating at the most efficient point possible. The presence of price markups can still result in some inefficiency. Short-Run Profit Maximization vs Long-Term Efficiency In the short run, monopolistic competition allows firms to make supernormal profits. These profits provide incentives for more firms to enter the market, increasing competition and eventually driving prices down to the point where firms only make normal profit in the long run.

Answer 21

1. Low barriers to entry and exit 🔹 There are few legal or financial obstacles to starting a firm in the market ➡️ This means new entrants can join easily when profits are high ➡️ Which forces incumbent firms to price competitively and behave efficiently ➡️ Leading to outcomes that mirror those of more competitive markets (lower prices, higher allocative efficiency) 2. Access to technology and knowledge 🔹 Firms can easily access the same production technology or knowledge as existing firms ➡️ Reduces cost asymmetries between new and established firms ➡️ So new firms can be equally productive and compete effectively ➡️ Puts pressure on incumbent firms to remain innovative and efficient to survive 3. Weak brand loyalty or low sunk costs 🔹 Consumers are not highly attached to brands, and firms do not incur unrecoverable costs when entering/exiting ➡️ Makes it easier for new firms to gain market share without major upfront investment ➡️ Threat of entry disciplines current firms to operate efficiently and avoid supernormal profits ➡️ Improves dynamic and productive efficiency in the long run 4. Hit-and-run entry is possible 🔹 New firms can enter, exploit short-term profits, and exit quickly if prices fall ➡️ Means incumbent firms cannot rely on exploiting monopoly power without consequences ➡️ Encourages firms to keep prices close to average cost ➡️ Leads to lower prices and greater consumer surplus in the market

Answer 22

1. High sunk costs act as a barrier to exit If firms must make large upfront investments (e.g. in specialised equipment), → these sunk costs cannot be recovered if the firm fails and exits, → increasing the risk of market entry for potential rivals, → reducing the likelihood of new firms entering, → therefore lowering the degree of contestability. 2. Strong brand loyalty acts as a barrier to entry In some markets, consumers are loyal to existing firms due to established branding, → new firms struggle to attract customers even with lower prices, → making it hard to gain market share quickly, → which deters entry and limits competitive pressure, → meaning the market becomes less contestable. 3. Predatory or limit pricing deters entry Incumbent firms may cut prices aggressively (even below cost), → to make entry unprofitable for new firms, → causing potential entrants to be discouraged due to fear of unsustainable price wars, → limiting actual or potential competition, → reducing contestability. 4. Regulatory or legal barriers raise costs of entry Heavily regulated sectors (e.g. pharmaceuticals, banking) require licenses or approvals, → the time and cost to comply with rules increases, → which deters smaller or newer firms from entering, → creating a protection for incumbents, → and reducing market contestability. 5. Economies of scale create a cost advantage for incumbents Large firms benefit from lower average costs due to scale, → allowing them to undercut smaller entrants on price, → which means new firms cannot compete profitably, → so they are less likely to enter, → leading to low contestability in the market.