Week 3 - Markets, Advertising & competition

Question 1

What are the assumptions of monopolistic competition

Answer 1

1. Large number of firms with minimal market power
2. Free entry into market
3. Products are slightly differentiated

Question 2

What are the profits for firms in monopolistic markets?

Answer 2

Monopolistic markets & profit:

Short-run: economic profit
Long-run: Normal profit

Question 3

How is profit calculated for monopolistic firms?

Answer 3

Profit = (PQ) - (QAC)

P = price
Q = Quantity
AC = Average cost

Question 4

At what point is profit maximised on a monopolistic firm?

Answer 4

Step 1
First find the intersect of MR and MC

Step 2
Move directly upward to the Demand curve

Question 5

What are the assumptions of an oligopoly market?

Answer 5

1. few participants
2. Strong barriers of entry
3. Products are similar
4. Firms decisions affect each other

Question 6

What is a cartel?

Answer 6

When oligopolies collude to form a monopoly and maximise profit

Question 7

What are the three models of oligopolies?

Answer 7

1. Cournot Model
2. Bertrand Model
3. Kinked Demand model

Question 8

What are the assumptions of the cournot model and how do they compete?

Answer 8

Assumption:
Rivals will produce at a certain quantity

Firms compete in quantities and produce a reaction function based on competitors output level

Question 9

What are the assumptions of the bertrand model and how do they compete?

Answer 9

Assumption:
Prices are set based on the prices of competitors

Prices drop until P=MC or firm with lower MC survives

Question 10

How do firms compete in the kinked demand model?

Answer 10

One firm drops prices and forces other firms to follow

Demand curve forms a bend

Question 11

What is the minimum efficient scale and how is it expressed?

Answer 11

MES is the size where no significant additional economies of scale can be achieved

Expressed as total domestic product

Question 12

How is MES used and when has has MES been achieved?

Answer 12

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

Question 13

How is MES calculated?

Answer 13

If market’s MES is 6.1%, AC is 100

100/6.1 = 16

There should only be 16 firms in the market

Question 14

What does it mean if MES is above 100%?
How about 50%?

Answer 14

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

Question 15

What is a concentration ratio and what does it mean?

Answer 15

Concertation ratio ranks firms in order of market share

high ratio = low competition
low ratio = high competition

Question 16

How is the concentration ratio calculated and is its limitation?

Answer 16

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

Question 17

What is the Herfindahl-Hirschan Index and how is it calculated?

Answer 17

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

Question 18

What is the HHI score of each market type?

Answer 18

Roughly
Perfect comp = <0.2
Monopolistic = 0.2
Oligopoly = 0.2 - 0.6
Monopoly = > 0.6

Question 19

What are the 7 factors impeding competition?

Answer 19

1. Economies of scale
   - May not support 2+ producers
2. Economies of scope
3. Product differentiation & Brand Loyalty
4. Ownership/control of inputs
5. Legal Protection
6. Strategic coalition with government
7. Aggressive tactics

Question 20

What is the benefits of advertising?

Answer 20

Emphasises product differentiation

Creates barriers of entry

Question 21

What are advertising’s effects on demand curves?

Answer 21

1. Shifts curve outwards
2. Makes curve less elastic (steeper)

Question 22

How is advertising expenditure decided?

Answer 22

Last dollar spent rule:

MC = MR of spending

(advertising cost / Total revenue) = (advertising elasticity / price elasticity)