5. Perfect competition, imperfectly competitive markets and monopoly

Question 1

What is a market structure?

Answer 1

The organisational and other characteristics of a market

Question 2

What are some important features of market structure include?

Answer 2

• The number of firms in the market
• The market share of the largest firms, which as we later explain can be measured with the use of concentration ratios
• The nature of the costs incurred by the firms in the market
• The nature of the sales revenue earned by firms in the market
• The extent to which there are barriers to entry to, and exit from, the market
• Ease of access to information about what is going on in the market
• The extent to which firms in the market undertake product differentiation and adopt
  different price-setting procedures
• The ways, if any, in which firms are affected by buyers’ behaviour in the market

Question 3

What are entry barriers?

Answer 3

Obstacles that make it difficult for a new firm to enter a market

Question 4

What are exit barriers?

Answer 4

Obstacles that make it difficult for an established firm to leave a market

Question 5

What is product differentiation?

Answer 5

The marketing of generally similar products with minor variations or the marketing of a range of different products

Question 6

What are the two main types of entry barriers making it difficult or preventing a new firm from entering a market?

Answer 6

Natural barriers and artificial (or man-made) barriers

Question 7

What is the divorce of ownership from control?

Answer 7

The owners and those who control the firm (managers) are different groups with different objectives

Question 8

What is satisficing?

Answer 8

Achieving a satisfactory outcome rather than the best possible outcome

Question 9

What is productive efficiency?

Answer 9

For the economy as a whole occurs when it is impossible to produce more of one good without producing less of another. For a firm it occurs when the average total cost of production is minimised

Question 10

What is allocative efficiency?

Answer 10

Occurs when it is impossible to improve overall economic welfare by reallocating resources between markets. In the whole economy, price must equal marginal cost (P = MC) in every market

Question 11

When does productive efficiency combine with allocative efficiency?

Answer 11

• All the firms in the market benefit from all the available economies of scale. This is unlikely because each firm produces only a tiny part of total market output. Each firm is likely to be well below minimum efficient scale (MES)
• There are perfectly competitive markets for all goods and services, including future markets, and P = MC simultaneously in each and every market. To take this point further, every firm in every market throughout the world must even if all the conditions of perfect competition could be met
• There are no externalities, negative or positive

Question 12

What is allocative inefficiency?

Answer 12

Occurs when P > MC, in which case too little of a good is produced and consumed, and when P < MC, in which case too much of a good is produced and consumed

Question 13

What do firms do in a perfect competition short-run equilibrium?

Answer 13

Firms make abnormal or supernormal profits

Question 14

What happens in a perfect competition short-run equilibrium?

Answer 14

The entry of new firms has brought the price down until surviving firms make normal profits only

Question 15

What is a monopoly?

Answer 15

One firm only in a market

Question 16

What is monopoly power (market power)?

Answer 16

The ability of a monopoly to raise and maintain price above the level that would prevail under perfect competition. Market power can also be exercised, usually to a lesser degree, by firms in oligopoly and monopolistic competition

Question 17

What are natural barriers?

Answer 17

Barriers to market entry caused by geography.

For example, if one firm has control of a resource essential for a certain industry, other firms are unable to complete in the industry

Question 18

What are sunk costs?

Answer 18

Costs that have already been incurred and cannot be recovered

Question 19

What are artificial barriers (strategic barriers)?

Answer 19

‘Man-made’ barriers to market entry, e.g. patent protection

Question 20

What type of curve does a monopoly face?

Answer 20

A downward-sloping demand curve (the market demand curve), which is the monopoly’s average revenue (AR) curve

Question 21

What are the possible advantages of a monopoly?

Answer 21

• Monopolies can gain the benefits of economies of scale. Economies of scale are shown by a falling long-run average cost curve
• Monopoly profit can be used to finance Research & Development with the result that monopolies can be dynamically efficient

Question 22

What are the possible disadvantages of a monopoly?

Answer 22

It may lead to productive and allocative inefficiency and the latter results in resource misallocation

Question 23

How does Monopolistic competition resemble perfect competition?

Answer 23

In that abnormal profits can be made in the short run but not in the long run

Question 24

How does Monopolistic competition resemble monopoly?

Answer 24

Each firm faces a downward-sloping demand curve (and AR curve)

Question 25

How are firms in imperfectly competitive markets, both in monopolistic competition and in oligopoly, are likely to undertake various forms of non-price competition?

Question 26

What is Monopolistic competition?

Answer 26

‘Imperfect competition among the many’

Question 27

What is a concentration ratio?

Answer 27

Measures the market share (percentage of the total market) of the biggest firms in the market.

For example, a five-firm concentration ratio measures the aggregate market share of the largest five firms

Question 28

What is market conduct?

Answer 28

The pricing and marketing policies pursued by firms. This is also known as market behaviour, but is not to be confused with market performance, which refers to the end results of these policies

Question 29

What is a cartel?

Answer 29

A collusive agreement by firms, usually to fix prices. Sometimes there is also an agreement to restrict output and to deter the entry of new firms

Question 30

What are the possible advantages of oligopoly?

Answer 30

• Just like a monopoly, firms benefit from economies of scale in oligopoly, which means they can become more dynamically efficient and can pass on cost cuts as low prices to consumers
• Provided that there is a degree of competition, oligopolies continuously innovate and develop new and better products

Question 31

What are the possible disadvantages of oligopoly?

Answer 31

• Just like monopoly, oligopolies restrict output and raise prices (and profit), compared to a more competitive market. Firms may sacrifice, content with an easy life
• Collusive oligopoly in the form of a cartel is a bad form of market structure, combining the disadvantages monopoly (high prices, productive and allocative inefficiency, and lack of choice) with few if any of the benefits

Question 32

What is price leadership?

Answer 32

The setting of prices in a market, usually by a dominant firm, which is then followed by other firms in the same market

Question 33

What is a price agreement?

Answer 33

An agreement between a firm, similar firms, suppliers or customers regarding the pricing of a good or service

Question 34

What is a price war?

Answer 34

Occurs when rival firms continuously lower prices to undercut each other

Question 35

What is price discrimination?

Answer 35

Charging different prices to different customers for the same product or service, with the prices based on different willingness to pay

Question 36

What are the conditions for there to be successful price discrimination?

Answer 36

• It must be possible to identify different groups of customers or sub-markets for the product
• At any particular price, the different groups of customers must have different price elasticities of demand
• The markets must be separated to prevent seepage

Question 37

What is a contestable market?

Answer 37

A market in which the potential exists for new firms to enter the market. A perfectly contestable market has no entry or exit barriers and no entry or exit barriers and no sunk costs, and both incumbent firms and new entrants have access to the same level of technology

Question 38

What is hit-and-run competition?

Answer 38

Occurs when a new entrant can ‘hit’ the market, make profits and then ‘run’, given that there are no or low barriers to exit

Question 39

In a contestable market theory, what is monopoly power dependent on?

Answer 39

The ease or difficulty with which new firms may enter the market

Question 40

What is static efficiency?

Answer 40

Efficiency (e.g. productive and allocative efficiency) at a particular point in time

Question 41

What is dynamic efficiency?

Answer 41

Improvements in productive efficiency occurring over time

Question 42

What is consumer surplus?

Answer 42

A measure of the economic welfare enjoyed by consumers: surplus utility received over and above the price paid for a good

Question 43

What is producer surplus?

Answer 43

A measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept