2.11 (Market failure- Market Power)

Question 1

Define firm or business.

Answer 1

An organisation that employs factors of production to produce and sell a good or service.

Question 2

Define industry.

Answer 2

A group of one or more firms producing identical or similar products.

Question 3

Define a market structure and list the 4.

Answer 3

Describes the characteristics of market organisation that influence the behaviour of firms within an industry.

• Perfect competition
• Monopoly
• Monopolistic competition
• Oligopoly

Question 4

What are the main characteristics of market structures (4)?

Answer 4

• Ability to control price (market power).
• Number of firms in the industry.
• Level of product differentiation.
• Barriers to entry.

Question 5

What are the characteristics of perfect competition (5)?

Answer 5

• Large number of small firms.
• Identical products.
• Free entry and exit.
• Perfect (complete) competition.
• Perfect resource mobility.

Question 6

What are characteristics of a monopoly (3)?

Answer 6

• Single seller or dominant firm in the market.
• There are no close substitutes.
• There are significant barriers to entry.

Question 7

What are barriers to entry (6)?

Answer 7

• Economies of scale.
• Branding.
• IP legal barriers (patents, licenses, copyrights).
• Legal barriers (public franchises, tariffs, quotas, trade restrictions).
• Control of essential resources.
• Aggressive tactics.

Question 8

Whar are characteristics of monopolistic competition (3)?

Answer 8

• Large number of firms.
• No barriers to entry and exit.
• Product differentiation (physical, quality, location, services and product image).

Question 9

What are characteristics of oligopolies (4)?

Answer 9

• Small number of large firms.
• High barriers to entry.
• Products may be differentiated or homogeneous.
• Mutual interdependence.

Question 10

Define revenues.

Answer 10

The payments first receive when they sell goods and services they produce.

Question 11

What happens to revenue curves in perfect competition?

Answer 11

The firm is unable to control price; price is constant as output varies.

Question 12

What happens to revenue curves in monopolistic competition, oligopolies and monopolies?

Answer 12

The firm has control over price; price varies with output.

Question 13

Define short run.

Answer 13

The period of time when at least one factor of production is fixed.

Question 14

Define long run.

Answer 14

The period of time when all factors of production are variable.

Question 15

Define total cost.

Answer 15

All costs incurred by a firm.

Question 16

Define marginal cost.

Answer 16

The extra or additional cost of producing one more unit of output.

Question 17

Define average cost.

Answer 17

The cost per unit of output produced, or total cost divided by units of output.

Question 18

Define economies of scale.

Answer 18

The decreases in the average costs of production over the long run as a firm increases its outputs (resulting from increasing its inputs). EoS explains the downward-sloping portion of the LRATC curve.

Question 19

List reasons for economies of scale (5).

Answer 19

• Specialisation and division of labour.
• Managerial EoS.
• Purchasing (bulk buying) EoS.
• Financing EoS.
• Spreading costs over larger volumes of output.

Question 20

Define diseconomies of scale.

Answer 20

The increases in the average costs of production over the long run as a firm increases its outputs (resulting from increasing its inputs). DoS explains the upward-sloping portion of the LRATC curve.

Question 21

List reasons for diseconomies of scale (3).

Answer 21

• Difficulties co-ordinating and monitoring operations.
• Communication difficulties.
• Low motivation.

Question 22

Define explicit costs.

Answer 22

Payments made by a firm to outsiders to acquire resources for use in production are explicit costs.

Question 23

Define implicit costs.

Answer 23

The sacrificed income arising from the use of self-owned resources by a firm is an implicit cost.

Question 24

Define economic costs.

Answer 24

Economic costs are the sum of explicit and implicit costs, or total opportunity costs incurred by a firm for its use of resources, whether purchased or self-owned.

Question 25

Describe what happens when economic profits are positive, negative or zero.

Answer 25

• If economic profit is positive, other firms have an incentive to enter the market.
• If economic profit is zero (i.e. normal profit level), other firms have no incentive to enter or exit. When economic profit is zero, a firm is earning the same as it would if its resources were employed in the next best alternative.
• If the economic profit is negative, firms have the incentive to leave the market because their resources would be more profitable elsewhere. The amount of economic profit a firm earns is largely dependent on the degree of market competition and the time span under consideration.

Question 26

Define normal profit.

Answer 26

The minimum amount of revenue that the firm must receive so that it will keep the business running (as opposed to shutting down).

Question 27

Explain profit maximisation.

Answer 27

Approach based on the principle that profit = total revenue - total cost, where TC is the firm’s economic costs.
The firm’s profit-maximisation rule is to produce the level of output where TR - TC is as large as possible. The amount of profit made by the firm is equal to the numerical difference between TR and TC.

• Positive profit: TR > TC; the firm earns abnormal profit.
• Zero profit: TR = TC; the firm earns normal profit.
• Negative profit: TR < TC; the firm makes a loss.

Firms maximise profit or minimise losses when MR = MC.