Week 3 - Markets, Advertising & competition Flashcards
What are the assumptions of monopolistic competition
- Large number of firms with minimal market power
- Free entry into market
- Products are slightly differentiated
What are the profits for firms in monopolistic markets?
Monopolistic markets & profit:
Short-run: economic profit
Long-run: Normal profit
How is profit calculated for monopolistic firms?
Profit = (PQ) - (QAC)
P = price
Q = Quantity
AC = Average cost
At what point is profit maximised on a monopolistic firm?
Step 1
First find the intersect of MR and MC
Step 2
Move directly upward to the Demand curve
What are the assumptions of an oligopoly market?
- few participants
- Strong barriers of entry
- Products are similar
- Firms decisions affect each other
What is a cartel?
When oligopolies collude to form a monopoly and maximise profit
What are the three models of oligopolies?
- Cournot Model
- Bertrand Model
- Kinked Demand model
What are the assumptions of the cournot model and how do they compete?
Assumption:
Rivals will produce at a certain quantity
Firms compete in quantities and produce a reaction function based on competitors output level
What are the assumptions of the bertrand model and how do they compete?
Assumption:
Prices are set based on the prices of competitors
Prices drop until P=MC or firm with lower MC survives
How do firms compete in the kinked demand model?
One firm drops prices and forces other firms to follow
Demand curve forms a bend
What is the minimum efficient scale and how is it expressed?
MES is the size where no significant additional economies of scale can be achieved
Expressed as total domestic product
How is MES used and when has has MES been achieved?
MES is used to gauge competition in a market
High MES = more competition
Low MES = low competition
MES is achieved when within the flattened section of LRAC curve
How is MES calculated?
If market’s MES is 6.1%, AC is 100
100/6.1 = 16
There should only be 16 firms in the market
What does it mean if MES is above 100%?
How about 50%?
Above 100%
no competition as firms cannot exploit economies of scale
Higher than 50%
Not enough room for another firm to gain full economies of scale
What is a concentration ratio and what does it mean?
Concertation ratio ranks firms in order of market share
high ratio = low competition
low ratio = high competition
How is the concentration ratio calculated and is its limitation?
calculated by the sum of market share percentage
Limitations:
If only looking at top companies, it cannot say whether each firm is taking market share from another
What is the Herfindahl-Hirschan Index and how is it calculated?
HHI is a measurement of competition in a market
Calculated by summing squares of each firms market share percentage
HHI = 0 => perfect competition
HHI = 1 => Monopoly
What is the HHI score of each market type?
Roughly
Perfect comp = <0.2
Monopolistic = 0.2
Oligopoly = 0.2 - 0.6
Monopoly = > 0.6
What are the 7 factors impeding competition?
- Economies of scale
- May not support 2+ producers - Economies of scope
- Product differentiation & Brand Loyalty
- Ownership/control of inputs
- Legal Protection
- Strategic coalition with government
- Aggressive tactics
What is the benefits of advertising?
Emphasises product differentiation
Creates barriers of entry
What are advertising’s effects on demand curves?
- Shifts curve outwards
- Makes curve less elastic (steeper)
How is advertising expenditure decided?
Last dollar spent rule:
MC = MR of spending
(advertising cost / Total revenue) = (advertising elasticity / price elasticity)
