Theme 3.4 Flashcards
What is allocative efficiency?
Allocative efficiency occurs when resources are distributed to the goods and services that consumers want, maximizing utility.
It exists at P = MC, indicating that consumers pay for the value of the marginal utility they derive.
What is productive efficiency?
Productive efficiency occurs when firms produce at the lowest point on the short run or long run average cost curve, where MC = AC.
All points on the PPF curve are productively efficient.
What is dynamic efficiency?
Dynamic efficiency is when all resources are allocated efficiently over time, optimizing the rate of innovation and leading to falling long run average costs.
It is related to meeting consumer needs and wants over time.
What is x-inefficiency?
A firm is x-inefficient when it produces within the AC boundary, leading to higher costs than would occur with competition.
This can be due to organizational slack, poor management, or lack of competition.
List the characteristics of perfect competition.
• Many buyers and sellers
• Sellers are price takers
• Free entry to and exit from the market
• Perfect knowledge
• Homogeneous goods
• Firms are short run profit maximisers
• Factors of production are perfectly mobile
Price is determined by the interaction of demand and supply.
What happens to profits in a perfectly competitive market in the long run?
In the long run, firms only make normal profits as supernormal profits are competed away by new entrants.
New firms increase market supply, lowering prices.
What are the advantages of a perfectly competitive market?
• Lower price in the long run (P = MC)
• Productive efficiency (firms produce at the bottom of the AC curve)
• Short run supernormal profits may increase dynamic efficiency through investment
Allocative efficiency is achieved.
What are the disadvantages of a perfectly competitive market?
• Limited dynamic efficiency in the long run due to lack of supernormal profits
• Few or no economies of scale due to small firm size
• Assumptions rarely apply in real life
Branding and product differentiation complicate competition.
List the characteristics of monopolistically competitive markets.
• Imperfect competition
• Short run profit maximisers
• Non-homogeneous products (product differentiation)
• Large number of small buyers and sellers
• No barriers to entry or exit
• Downward sloping demand curve
• Imperfect information
Examples include hairdressers and regional plumbers.
What is the profit-maximizing equilibrium in the short run for monopolistically competitive firms?
In the short run, firms profit maximize at the point where MC = MR.
In the long run, new firms entering the market lead to only normal profits.
What are the advantages of monopolistically competitive markets?
• Allocatively inefficient (P > MC)
• Excess capacity in the market
• Wide variety of choices for consumers
• More realistic model than perfect competition
• Supernormal profits in the short run may increase dynamic efficiency through investment
Firms do not fully exploit their factors.
What are the disadvantages of monopolistically competitive markets?
• Limited dynamic efficiency in the long run
• Not as efficient as firms in perfect competition
• Firms have x-inefficiency due to little incentive to minimize costs
This inefficiency arises from the lack of competitive pressure.
List the characteristics of an oligopoly.
• High barriers to entry and exit
• High concentration ratio
• Interdependence of firms
• Product differentiation
For example, the UK supermarket industry is an oligopoly.
What is the significance of the concentration ratio in a market?
The concentration ratio measures the combined market share of the top firms; a higher ratio indicates less competition.
Fewer firms supply the bulk of the market.
What is collusive behavior in an oligopoly?
Collusive behavior occurs when firms agree to work together, setting prices or output levels to minimize competitive pressure.
This leads to higher prices and greater profits for colluding firms.
What is overt collusion?
Overt collusion is a formal agreement between firms, often illegal, where they coordinate actions like price fixing.
It is often suspected in industries like fuel.
What are the benefits of collusion?
• Improvement of industry standards
• Excess profits can be reinvested
• Savings on duplicate research and development
• Exploitation of economies of scale
This can lead to lower prices in the long run.
What are the costs of collusion?
• Loss of consumer welfare due to higher prices
• Decreased efficiency
• Reinforcement of monopoly power
• Loss of allocative efficiency
Cartels, like OPEC, exemplify collusion.
What is game theory in relation to oligopoly?
Game theory analyzes the interdependence between firms, predicting outcomes based on decisions made under uncertainty.
The Prisoner’s Dilemma illustrates this concept.
What is the Nash equilibrium?
The Nash equilibrium is the optimal strategy for all players, where no player can improve their position given the choices of others.
It highlights the instability of collusion since players may have incentives to cheat.
What is a price war?
A price war is a competitive situation where firms continuously lower prices to undercut competitors.
An example is the UK supermarket industry.
What is predatory pricing?
Predatory pricing is an illegal strategy where firms set prices below average costs to drive competitors out of the market.
In the short run, this leads to losses for the firm.
What is limit pricing?
Limit pricing involves setting low prices to deter new entrants into the market, ensuring existing firms maintain market share.
It can lead to dissatisfaction among shareholders due to lower dividends.
What are types of non-price competition?
• Improving customer service
• Special offers and promotions
• Advertising and marketing
• Brand differentiation
These strategies aim to increase brand loyalty and make demand more price inelastic.
