Yr1/2 Perfect Competition, Imperfectly Competitive Markets and Monoploy Flashcards
CONTINUE FROM FLASHCARD 58
PART 1
MARKET STRUCTURES
Definition of market structures
The organisational and other characteristics of the market. Focus on the characteristics which affect the degree of competition between firms and their purchasing decisions
The conduct and behaviour of the market depends on…. (5)
- Are there dominant firms
- Is there evidence of anti-competitive behaviour
- How important is non-price competition
- Is there interdependence between firms
- Do businesses behave strategically to retain profits
Factors affecting conduct and performance (reasons why a firm can or cannot dominants linked to (1) costs and (2) the product
Costs
- entry costs
- sunk costs > money that cannot be got back if the firm leaves the market
- natural cost advantage
Product
- homogenous goods (same characteristics)
- non-homogenous goods
- strong product differentiation and brand loyalty allows firms to charge higher prices
What are some performance indicators within a market?
- Trends in real price levels overtime
- Size of business profits
- Spending on research and development
- Spending on human capital
- Productivity
- Efficiency
What are sunk costs?
Money that cant be recovered if a firm leaves the market
What is a homogenous product?
When there are no distinguishing characteristics e.g. potatoes
What is total revenue?
All the money made by a business (unit price x quantity)
What are total costs?
The sum of all the costs to a business (FC+VC)
What is average costs?
The cost per unit of producing a good (TC/TO)
What is marginal revenue?
The additional revenue generated from selling an additional unit (change in revenue / change in quantity sold)
What are marginal costs?
Additional costs incurred from making an additional unit (change in costs / change in quantity produced)
What are barriers to entry and exit?
Factors that prevent or make it difficult for new firms to enter a market
What are some barriers to entry for
(1) coffee shops
(2) pharmacist
(1)
- brand loyalties
- high rent costs
- high levels of competition
(2)
- qualifications
- high supply costs
What are the 4 types of barriers to entry?
- Structural barriers
- Strategic barriers
- Legal barriers
- Restrictive practises
Give examples of structural barriers to entry?
- economies of scale
- vertical integration
- control essential technologies / commodities
- expertise and reputation
- customer (brand) loyalty / inelastic demand / network effect
- investment
- R+D
Give examples of strategic barriers to entry?
- predatory pricing
- marketing / product differentiation / advertising
Give examples of legal barriers to entry?
- intellectual property rights
> licences, patents, copyright, trademark
Give examples of restrictive practises?
- franchises
- tariffs/quotas/trade restrictions
What are the four key barriers to exit? (And some examples)
- Asset-write-off
- plant + machinery
- stock - Sunk costs
- Potential upturn
- Closure costs
- redundancy costs
- contracts with suppliers / leases
What is customer loyalty? (In terms of barriers to entry and exit)
It means new businesses have barriers to entry as demand is inelastic for existing businesses
Therefore, there are not enough consumers to make the firm viable
- consumers have less options to substitute
Market structure factors (8)
- the number of firms in the industry
- the nature of the product produced
- the degree of monopoly power each firm has
- the degree to which the firm can influence price profit levels
- firms behaviour - pricing strategies, non-price competition, output levels
- the extent of barriers to entry + entry
- the impact on efficiency
List the type of market structures from most competitive to least competitive
Most
1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Duopoly
5. Monopoly
6. Pure monopoly
Least
PART 2
THE OBJECTIVES OF FIRMS
What are the 4 key objectives of firms? (And where are they placed on a market structures diagram)
- Profit maximisation (MC=MR)
- Revenue maximisation (MR=0)
- Sales maximisation (AC=AR)
- Efficiency
- allocative (P=MC)
- productive (AC=MC)
What is profit satisficing and give some examples of people who could be involved?
When a firm makes enough money to satisfy its influencers e.g. shareholders, employees, suppliers etc
What is revenue maximising?
Where MR=0
Prior to this point, MR is positives and therefore, adding to total revenue. However, after this point, marginal revenue is negative and total revenue decreases
What is sales maximisation?
When AC=AR
Where a firm sells as much as it can without making a loss and can only achieve ‘normal’ profit
What is allocative efficiency?
Where MC=AR (or P)
The optimal distribution of goods and services
What is productive efficiency?
When MC=AC
The turning point of AC
What are the three types of profit in terms of firm objectives?
- abnormal profit
- normal profit
- profit maximisation
What is abnormal (super) profit?
Profit over and above normal profit. Also known as super-normal profit and above-normal profit
What is normal profit?
The minimum profit a firm must make to stay in business, which is however, insufficient to attract new firms into the market
What is profit maximisation?
Occurs at the level of output which total profit is greatest
PART 3
PERFECT COMPETITION
What are the characteristics of a perfectly competitive market?
- many suppliers and consumers
- price takers
- homogenous product
- perfect substitutes
- perfect information
- no barriers to entry or exit
- abnormal profit in the SR
Examples of a perfectly competitive market (not completely perfect)
- foreign exchange
- betting
- car auctions
- street roast
What are the 5 graphs for a perfectly competitive market?
- SR - industry
- SR - firms
- LR - industry
- LR - firms
- Reason for leaving the market
What is needed for entry and exit strategies for monopolistically competitive markets?
Entry
- abnormal profits attract firms to the industry + no barriers to entry make it easy to set up
Exit
- normal profit in the LR has to be made to justify staying in the market
- in the SR, they will operate as long as the price per unit is greater than or equal to average variable costs
What does price have to equal for a firm to stay in a perfectly competitive market?
Where AC and MC meet
PART 4
MONOPOLISTIC COMPETITION
What are some examples of monopolistic competition?
- coffee shops
- hairdressers
- cereal
- shoe repairs and key makers
- night clubs + bars
- taxi companies
Definition of monopolistic competition
A market structure in which slightly differentiated products are sold by a large number of relatively small producers, and in which the barriers to new firms entering the market are low
Characteristics of monopolistic competition
- Many firms
- Many customers
- Slightly differentiated market
- Price makers (more control)
- Non-price competition : branding, advertising
- Low barriers to entry and exit
- Abnormal profit in the SR, normal in the LR
- Imperfect knowledge
What are the four types of differentiation within monopolistic competition and what do they entail?
- Physical product differentiation
- highlighting physical attributes - Marketing differentiation
- different strategies used to stand out due to competitors - Human capital differentiation
- differences in the intangible asset or quality an employee has - Differentiation through distribution
- how the product / service is sold to a consumer
What are the two graphs for monopolistic competition?
- SR
- LR
PART 5
OLIGOPOLY
Characteristics of an oligopoly?
- A few large firms have the majority market share
- Only a few firms dominate
- High barriers to entry and excit e.g. sunk costs and marketing
- Products could be highly differentiated >branding or homogenous
- Non price competition
- Price stability within the market “sticky pricing”
- Potential for collusion
- Abnormal profits > depending on the market e.g. elasticity, pricing structure, fewer firms
- High degree of interdependence between firms
Examples of markets with the oligopoly structure
- supermarkets
- banking industry
- chemical industries
- oil-petrol stations
- medical drugs
- broadcasting
- bookshops
How do you measure if a market is an oligopoly?
The concentration ratio which is the proportion of the market share accounted for by the top X number of firms
Can also be the smallest number of firms with >70% market share etc
What is game theory?
Concerned with predicting the outcome of games of strategy in which the participants (for example two or more businesses competing in the market) have incomplete information about the others’ intentions
What is nash equilibrium in terms of oligopolies?
The point where both firms set a low price and lose out
What is the dominant strategy in terms of oligopolies?
Strategy that maximises potential earnings e.g. lowering prices
What is Hotellings Model of Spatial Variation linked to oligopolies?
A model based on the assumptions that two or more firms have chosen their bounded location and are able to compete on price
Conditions for collusion in oligopolies? (7)
- Few firms which know each other well
- Not secretive about costs + production methods
- Similar production methods and average costs > change prices at the same time and by the same percentage
- Produce similar products so reach agreements on price
- One firm take the dominant role
- Significant barriers to entry so there is little fear of disruption by new firms
- Market is stable e.g. demand or production costs
Definition of tacit collusion?
Competitors agree on a strategy without communicating or writing it down
Definition of formal collusion?
A formal agreement between competitors
Collusion summary
- competitive rivals may seek to rescue uncertainty by colluding to either fix a price, a level of output or allocate customers
- by forming a cartel agreement all parities in the oligopoly can achieve a better outcome in terms of maximising profit
- bad for consumers as they have limited choice or higher prices (illegal as laws to protect consumers)
What are two examples of collusion involving the CMA?
- CMA were involved with Skyscanner (Online hotel booking system) due to the firm collaborating so certain sites had cheaper prices e.g. Expedia
- CMA fined Pharma companies Pfizer and Flynn Pharma nearly £90mn for charging excessive prices to the NHS for an anti-epilepsy drug (incr in prices by 2,600%)
PART 6
MONOPOLY AND MONOPOLY POWER
What are the characteristics of a monopoly?
- one firm - dominant
- no close substitutes
- imperfect knowledge
- high barriers to entry and exit
- price setter
- firm has > 25% of market share
Definition of a monopoly?
A market structure where one firm supplies all output in the industry and has 25% of more of the market share. Furthermore, a natural monopoly occurs where the LR average costs fall over a wide range of output levels
Examples of monopolies
- Microsoft
- Apple IOS
- National Rail
- Transport for London
- BT Openreach
What is the definition of a natural monopoly?
The long run average costs fall curve (LRAC) falls continuously over a large range of output. The result may be that there is only room in the marker for one firm to fully exploit the economies of scale that are available
What changes occur within the market due to a monopoly?
Welfare loss and a loss of the consumer surplus due to profit maximisation as an objective
- also price discrimination
What are the FAANGs?
Large monopoly firms such as Facebook, Apple, Amazon, Netflix and Google
What are the positives and negatives of a monopoly?
POS
- reinvestment into innovation
NEG
- may stop being innovative once in power
- lack of price controls
- control supply (abuse power)
- lack of choice
Evaluation points of a monopoly
- How the monopoly came to be: excellence or by pushing out competitors e.g. price
- Ethical viewpoint of the monopoly
PART 7
PRICE DISCRIMINATION
Definition of price discrimination
When the same product is priced differently to different demographics
- a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with cost
What are the two conditions needed for price discrimination to work?
- Differences in PED
- charge a higher price to the group with a lower PED (more price elastic demand) - Prevent resale/ consumer switching
- easier with services than goods
- time limited (product bought in a certain time)
- photo cards as identification
- electronic/ digital ways of protecting usage
What is first degree price discrimination? + example
- known as optimal pricing
- firm separates the market into each individual consumer and charges them the price they are willing to pay
- aims to extract the consumer surplus and turn it into extra revenue
E.g. car industry where different consumers are charged different amounts
What is second degree price discrimination? + example
Occurs when the seller prices the first block of output at a higher price than subsequent blocks of output
E.g. fast track at theme parks + peak and off peak train tickets
What is third degree price discrimination? + example
Involves charging different prices for the same product in different segments of the market
- linked directly to the consumers willingness and ability to pay for a good/service
- means that the prices charged may bear little or no relation to the cost of production
E.g. car insurance, student discount, OAP’s, children’s discount
What is a two part pricing policy? + example
A fixed fee is charged + ‘variable’ charge based on units consumed
- fixed fee may be a set up charge
- assigned to cover fixed costs of supply
E.g. taxi fares, mobile phone tariffs
What are the welfare gains for a consumer of a two-part pricing policy
- Potential for cross subsidy activities that bring wider social benefits
- Make better use of spare capacity - decr business closure
- Bringing new consumers into the market
- Use monopoly profit for research - innovation in the LR
Welfare losses and counter arguments for a two part pricing policy
- Exploitation of consumers (majority still pay) > marginal cost causing loss of allocative efficiency
- Extraction of consumer surplus
- Predatory pricing tactic barrier to entry and exit > reduced comp
- Reinforces monopoly power and dominance of existing firms > higher prices long term
PART 8
THE DYNAMICS OF COMPETITION AND COMPETITIVE MARKET PROCESSES
What is the CMA and what are there three key roles of preventing?
- competition and markets authority
- promote competition to benefit consumers (nationally + internationally)
- ensure goods and services are at the correct price and quantity
- Dividing up and sharing markets e.g. geographical divide
- Price fixing
- Abuse of dominant market strategy
Examples of CMA action
- April 2018
- co-op / Nisa tie up accepted - Oct 2018
- Merger between the retail of SSE and N power given finals clearance - Nov 2018
- CMA says $2.2 Pay-pal - iZettle merger threatens competition - Jan 2019
- CMA cleared acquisition of Pepsi Co Inc of Pipers Crisps
Ways of controlling business and encouraging competition
- Price capping (max price)
- Opening up of a market to new competition (liberalisation)
- Privatisation
- Industry regulators to protect consumers
- Forced de-mergers / business devestment in an industry
- Better info to encourage switching (substitutes)
- Tougher laws on price fixing / collusion
PART 9
CONTESTABLE AND NON-CONTESTABLE MARKETS
What is the meaning of creating a contestable market
By controlling the actions of a large business the government will create a contestable market
Through:
- imperfectly competitive markets in which firms face real and potential competition
- the threat of ‘hit and run’ entry from new rivals may be sufficient to keep the industry operating at the competitive price and output (allocative efficiency)
What are the three conditions for market contestability?
- Ability / legal rights to use the best available technology
- Legal freedom to enter a market
- Relative absence of sunk costs
Examples of high and low contestability markets
HIGH
- retail coffee stores
- budget hotels
LOW
- streamed movies on demand
- national lottery
- mail services
- web browsers
What are the 4 key ways of making markets more contestable?
- De-regulation
- reducing barriers to entry to liberalise a market (privatisation) - Tougher competition laws
- acting against predatory pricing + behaviour by existing firms / tough rules against cartels - Changing the nature of technology
- decr entry costs + prices more transparent - New business models
- challenge established players e.g. low cost airlines
Barriers to contestability
- Raising rival costs
- verticals integration gibing control over the supply chain
- import tariffs / protectionism - Reducing rivals’ revenues
- bundling
- selling spare capacity at lower prices - Cross subsidisation
- using profit in one market to cut prices in another
Evaluation points for a contestable market
- Number of firms is less relevant
- abnormal profits attracting firms + market efficiencies - Opening up a market
- competition policy reduces barriers + potential competition influences efficiency
What is privatisation?
Involves the transfer of assets or economic activity from the public to the private sector
What are the three types of privatisation?
- Denationalisation
- sale of public assets (industries, companies, local authority council houses) - Franchising
- public sector continues financial provision but for private sector production (competitive tenders are requested for contract) - Deregulation
- the removal of legal barriers to entry in a previously protected market to allow private enterprise to compete
What is the PFI linked to privatisation?
Private Finance Initiative
- important + controversial policy designed to change the model of funding
- encourages private investment to manage the deign, builds finance an operation of public infrastructure
- typical contract replayed over 30 years
Benefits and drawbacks of PFI?
BENEFITS
- improved efficiency
- lack of political interference
- shareholder pressure
- incr competition
- gov will raise revenue from the sale
DRAWBACKS
- natural monopoly now under private control
- profit motive rather than public interest
- gov losses out on potential dividends
- problems of regulating private monopolies
- fragmentation of industries
- short-termism of firms
PART 10
MARKET STRUCTURE, STATIC EFFICIENCY, DYNAMIC EFFICIENCY AND RESOURCE ALLOCATION
PART 11
CONSUMER AND PRODUCER SURPLUS
