Theory Of The Firm

Question 1

Characteristics of perfect competition

Answer 1

Number of firms: Many small firms
Type of product: Homogeneous
Type of knowledge: Perfect knowledge about competitors
Barriers to entry/exit: None
Price setting powers: None, price is set by the market

Question 2

Short run vs Long run in perfect competition.

Answer 2

Short run: supernormal profits can be made
Long run: super normal profits attract new firms: Supply increases represented by an outward shift in the supply curve. This leads to quantity and price falling for the firm and now only normal profits are made. This is known as the LONG RUN EQUILIBRIUM .

Question 3

Is a firm in Perfect competition either productively efficient or allocatively efficient at any point?

Answer 3

Allocativley and productively efficient in the long run

Question 4

What is meant by the term “shut down point”?

Answer 4

As long as AVC Are being covered, a firm will continue to operate in the short run because the firm is still contributing to to the sunk fixed costs. If

Question 5

Characteristics of of monopolistic competition?

Answer 5

Number of firms: Many small firms
Type of product: non homogenous
Knowledge: imperfect knowledge however rival firms know when super normal profits are being made.
Barriers to entry/exit: none
Price setting powers: firms have price setting powers because they produce slightly differentiated goods.

Question 6

Short run vs long run for monopolistic competition?

Answer 6

Short run: super normal profits
Long run: super normal profits cannot be maintained do to the near perfect knowledge allowing firms to enter the market alongside low barriers to entry.
Normal profit is made. Firms do not make losses as the low barriers to exit mean they can just leave the industry.

Question 7

Is monopolistic competition allocativley efficient or productive efficient at any point?

Answer 7

NEVER

Question 8

Characteristics of a oligopoly?

Answer 8

Number of firms: A few large firms 
Type of product: non homogeneous 
Knowledge: imperfect knowledge 
Barriers to entry/exit: high 
Price setting powers: price setting power

Question 9

Define collusion

Answer 9

An agreement between two or more firms to limit competition and increase welfare gains for the firms concerned.

Question 10

Is collusion illegal?

Answer 10

Hell yeah!!

Question 11

Overt/tact collusion?

Answer 11

Overt- open collusion

Tacit- implicit co-operation where no words are said

Question 12

How can matrices be used to show collusion?

Answer 12

Collusion occurs when both firms adopt high pricing. However mistrust may develop and a firm may try to earn more profit by setting a higher price. This leads to the collusive agreement being broken.

Question 13

Characteristics of a monopoly

Answer 13

Monopoly- sole supplier of a good or service.
Type of product- unique
Knowledge- imperfect knowledge 
Barriers to entry/exit- high
Price setting power- price maker

Question 14

Short run vs Long run for a monopoly?

Answer 14

As a result of high barriers to entry monopolies can set high prices without fear of other firms entering the market. In this way profits can be maximised in the long run.

Question 15

What can the lack of competition cause in monopolies?

Answer 15

X-inefficiencies can occur because there is no incentive to maintain an edge over competitors because there are none!

Question 16

Monopolistic competition long run diagram?

Answer 16

AC curve shifts upwards and is now tangential to the AR curve

Question 17

Are monopolies either allocativly efficient or productively efficient?

Answer 17

They are neither

Question 18

What three conditions will price discrimination be successful under?

Answer 18

1)Degree of monopoly power/high barriers to entry 2)Two different markets with different PED 3)Markets can be kept separate at a cost that is lower then the gain in profits(To prevent cheaper resale)

Question 19

Evaluation to the formation of monopolies?

Answer 19

Natural monopolies: which occur in a industry that has high sunk costs and requires large levels of output to exploit economies of scale. Supernormal profits: help fund R&D and create reserves to overcome short term difficulties.
Economies of scale: may be able to take advantage of economies of scale meaning AC will be lower than a competitive firm.

Question 20

What is the definition of a contestable markets?

Answer 20

Exist in markets with low barriers to entry/exit and therefore low sunk costs. For example no one firm dominates with high brand recognition, requiring large amounts to be spent on advertising to gain marketshare.

Question 21

What is a monopsony?

Answer 21

The sole buyer in an industry. Firms could collude together to increase buying power and exploit sellers to get lower prices.

Question 22

Monopsony evaluation?

Answer 22

If a firm can get cheaper goods they could then possibly pass the cheaper price onto the consumer however firms may sometimes choose to increase their profits instead. Monopsony power may also be beneficial as it may be able to balance out monopoly power.

Question 23

What are strategies to gain market share and increase profitability?(non price competition)

Answer 23

Pricing strategies- Predatory pricing, limit pricing
Non pricing strategies- Advertising, branding(loyalty cards), packaging, customer service, quality, innovation and mergers.

Question 24

Why will oligopolies avoid price competition and instead use non price competition?

Answer 24

Price competition will lead to price wars which would offset gains of increased sales.

Question 25

What are the aims of non price strategies and what do they often mean in the short run?

Answer 25

In the short run there will be a fall in profits. The aim of non-price strategies is to increases demand and reduce the PED by reducing the number of substitutes available.