3.4 Flashcards
(90 cards)
1
Q
What is allocative efficiency?
A
Allocative efficiency is the optimal distribution of goods in an economy that meets the needs and wants of society.
2
Q
When does allocative efficiency occur?
A
P = MC (AR = MC) , S = D
3
Q
What are characteristics of allocative efficiency?
A
1- Resources follow consumer demand
2- Society surplus is maximised
3- Net social benefit is maximised
4
Q
What is productive efficiency?
A
Productive efficiency is the ability of a firm to produce goods or services at the lowest possible cost. It implies that resources are being used efficiently to minimize production costs. This is where the AC curve is the lowest.
5
Q
When does productive effiency occur?
A
When MC = AC
When AC is lowest
6
Q
What is Dynamic efficiency?
A
Dynamic efficiency refers to the ability of an economy to innovate and adapt over time. It involves the long-term competitiveness and growth potential of an economy. Dynamic efficiency is linked to innovation, technological progress, and the ability to adapt to changing circumstances.
7
Q
How can Dynamic efficiency be achieved?
A
1- Innovation, resulting from research research and development that leads to the development of new products.
2- Investment into new production processes
3- Investments in human capital through training
4- Improvements in working practices and labour relations.
8
Q
What is X-Efficiency?
A
It is production with no waste, as a result production will be on the ac curve.
9
Q
What is X-Inefficiency? and what causes it?
A
X-inefficiency occurs when a firm is not operating at its lowest possible cost, even in the absence of competitive pressures. This inefficiency can arise due to factors such as poor management, lack of motivation, or the absence of competition. X-inefficiency can persist in markets where firms have market power.
10
Q
What does X-Inefficiency do to the AC curve?
A
Results in an upwards shift of the AC curve
11
Q
What is the likelihood of a firm achieving allocative efficiency in the short run?
A
Firms are likely to be allocatively efficient. In the short run.
12
Q
What is the likely-hood of firms achieving allocative efficiency in the long run?
A
Firms can be allocatively efficient in the long run.
13
Q
What is the likely-hood of firms achieving productive efficiency in a perfectly competitive market?
A
Firms may not be productively efficient in the short run because they could be producing at higher average costs due to fixed factors and short-term constraints. However, in the long run firms are likely to be productively efficienta
14
Q
Are firms productively and allocatively efficient in monopolistic competition?
A
In this market structure, firms may not achieve allocative efficiency because they have some degree of market power, but they compete on product differentiation. Productive efficiency may not be fully realized either, as firms may operate at less than minimum average cost due to product differentiation.
15
Q
Are firms productively and allocatively efficient in an oligopoly?
A
In an oligopoly, there is typically and under allocation of resources, making oligopolies both productively and allocatively inefficient.
16
Q
Are firms productively and allocatively efficient in a monopoly?
A
Monopolies often lead to allocative inefficiency because they can set prices above marginal cost, resulting in deadweight loss. However, a monopoly can be productively efficient if it operates at the minimum point of its average cost curve.
17
Q
What is the impact of allocative efficiency on consumers?
A
1- Consumers get what they want in the quantity they want it in as resources follow consumer demand.
2- Low prices
3- Maximisation of consumer surplus
4- High Choice
5- High quality of production
18
Q
What is the impact of allocative efficiency on producers?
A
1- It is a way to retain or increase their market share: When a firm allocatively produces what consumers want at the right price, customer satisfaction increases.This helps the firm attract and retain more customers, gaining market share over competitors that aren’t as aligned with consumer demand.
2- They can stay ahead of rivals: Firms that consistently meet demand efficiently are seen as more responsive and competitive. This builds a reputation for reliability and value, helping them outperform less efficient rivals.
3- Increase profits: Allocative efficiency ensures that resources aren’t wasted on unwanted products. Producing only what’s most demanded maximises sales and revenue while keeping costs in check, boosting overall profitability.
19
Q
What is the impact of productive efficiency on consumers?
A
1- Lower AC may be passed on to consumers resulting in lower prices.
2- Low prices means a high consumer surplus.
20
Q
What is the impact of productive efficiency on producers?
A
1- Increased production at lower costs
2- Increased profits
3- Lower prices allow firms to stay ahead of rivals and increase market share.
21
Q
What is the impact of dynamic efficiency on consumers?
A
1- Due to reinvestment and increased R&D there may be new innovative products.
2- Lower prices over time
3- High consumer surplus
22
Q
What is the impact of dynamic efficiency on producers?
A
1- Long run profit maximisation
2- Lowers costs over time
3- Retain/increase market share
4- Stay ahead of rivals
23
Q
What is the impact of X-Efficiency on consumers?
A
1- Low prices
2- High consumer surplus
24
Q
What is the impact of X-Efficiency on producers?
A
1- Lower costs
2- Higher profit
3- Lower prices and higher market share.
25
What are the characteristics of perfect competition?
1- Many buyers and sellers
2- Buyers and sellers are price takers and face a horizontal demand curve.
3- The goods sold are homogenous
4- There are no barriers to entry or exit
5- There is perfect information
6- All firms aim to maximise profits
26
Illustrate the profit maximising equilibrium within a perfectly competitive market in the short and long run.
Short run:
market price is determined by supply and demand. Each firm has a horizontal demand curve as they are price takers. Price is greater than AC thus firms make supernormal profits.
Long Run:
New entry of firms into the industry causes the market supply curve to shift to the right and decreases price. The individual firm now has a lower price. Firms will now only make normal profit where AC = AR.
27
Can firms make supernormal profit in the long run?
No. This is because firms will make supernormal profit in the short-run which will attract competitors to enter the industry. Thus causing the firm to make normal profit. (can be described with costs and revenues diagram)
28
What are the characteristics of Monopolistic competition?
1- Many buyers and sellers: There are numerous firms in the market, each producing slightly differentiated products. These differences can be based on branding, quality, design, or other factors.
2- Product Differentiation: Each firm produces a product that is similar but not identical to the products of its competitors. This product differentiation allows firms to have some control over the price they charge.
3- Low barriers to entry or exit: Firms can enter or exit the market relatively easily. There are no significant barriers to entry, such as high start-up costs or government regulations.
4- Non-Price Competition: Firms engage in non-price competition to attract customers. This includes advertising, product design, branding, and customer service.
5- Since firms have a downward sloping demand curve and are price makers, they can raise their price without losing all of their customers. This is because firms have some degree of price
setting power.
6- All firms aim to maximise profits, MR = Mc
29
Illustrate the profit maximising equilibrium in the short and long run in monopolistic competition.
Short run:
The firm has some market power and influence over price. AR is above AC meaning the firm is making supernormal profit.
long run:
Firm only earns normal profits as the average costs touches the AR curve. Meaning the price = cost.
30
Explain whether Monopolistically Competitive firms can profit maximise in the long-run, and why?
In the long run firms will make normal profit. This is because in monopolistic competition there are low barriers to entry thus when firms see supernormal profits they will enter the market. Increased competition shifts existing firms' demand curves leftward, making them more elastic.
This continues until only normal profit is made (AR = AC)
31
What are the characteristics of an Oligopoly?
1- High Barriers to Entry and Exit: Oligopolistic markets often have significant barriers that prevent new firms from entering the industry or existing firms from easily exiting. These barriers can include high capital requirements, economies of scale, patents, and government regulations.
2- High Concentration Ratio: Oligopolies are characterized by a small number of large firms dominating the market. The concentration ratio measures the market share held by the largest firms in the industry, and in oligopolistic markets, this ratio is typically high.
3- Product Differentiation: Oligopolistic firms often engage in product differentiation to distinguish their offerings from competitors. This can include branding, quality variations, and advertising to create brand loyalty.
4- Interdependence of firms: Firms are interdependent in an oligopoly. This means the actions of one firm affects the behaviour of another firm.
5- Firms face downwards sloping demand curve.
32
Define a concentration ration
The n-firm concentration ratio measures the combined market share of the largest n firms in an industry. It is calculated by summing the market shares of these firms.
33
What does a high concentration ratio indicate?
A highly concentrated industry with few firms.
34
What does a low concentration ratio indicate?
A more competitive industry with a greater number of smaller firms.
35
What is collusive behaviour? What is the most common type? and what is the effect on consumers?
Collusive behaviour in an oligopoly refers to when the firms within the oligopoly engage in cooperative agreements or actions to limit competition and increase their collective profits. This collusion can take various forms, but the most common type is price-fixing, where firms agree to set prices at a certain level or to coordinate their pricing strategies. Collusion typically involves some level of cooperation and communication among the oligopoly's members. It can lead to higher prices for consumers, reduced output, and decreased overall market efficiency. Collusive behaviour is generally illegal in many countries and is subject to antitrust laws and regulations aimed at promoting fair competition and protecting consumers' interests.
36
What are the reasons for collusive behaviour?
1- Maintaining High Prices: Firms in an oligopoly may collude to set high prices and limit competition, increasing their profits collectively
2- Stability: Collusion can provide market stability, reducing uncertainty for firms and consumers.
3- Avoiding Price Wars: Collusion helps firms avoid destructive price wars
4- Firms do not believe that their collusion will be discovered by the regulator.
37
What are the reasons for non collusive behaviour?
1- No trust between firms in the market
2- Possibility of new entrants in the market
3- legal reasons: If there are high penalties for being found guilty of collusion.
4- Differences in Objectives: Firms may have differing goals and incentives that make collusion difficult.
38
What is Overt collusion?
It is any form of direct contact between firms. There is a formal agreement (written or verbal) among firms to control the market by fixing prices, allocating customers or rigging bids for contracts. It is illegal.
39
What is Tacit collusion?
Where firms act individually but jointly exercise market power with other competitors, for example, by following the market leader in raising prices. It is an implicit (unspoken) agreement with nothing in writing. It is illegal but very hard for the competition authorities to control.
40
What is a cartel?
It is a formal agreement between a group of producers that limit output in order manipulate prices. It is a form of overt collusion. A cartel involves firms acting as a monopoly through an agreement.
41
What is price leadership?
Where the dominant firm changes prices and others will follow. This is because if other firms try to make changes, it could set off a price war. The large firm becomes the established leader.
42
What is Game theory?
It is the study of strategies used to make decisions.
43
What is a pay off matrix?
A simple two-firm, two-outcome model.
44
What is the prisoners dilemma?
The prisoner's dilemma is a classic game theory scenario where two rational players, in this case, two firms, make decisions that result in suboptimal outcomes. In an oligopolistic context, if both firms choose to compete aggressively, they may trigger a price war and both suffer lower profits. However, if both firms collude and set high prices, they both earn higher profits. The dilemma arises because each firm has an incentive to betray the collusion agreement to gain a larger share of the profits, but if both firms do this, they both end up worse off.
45
What are types of price competition? (and explain each)
1- Price wars: These occur when price cutting leads to retaliation and other firms cut prices, meaning the original firms again want to cut prices to increase their sales.
2- Predatory pricing: This involves cutting prices below the average costs of production. It is a short term measure only, and once other firms have been forced out of the market the firms will raise their prices up again. This is almost always illegal.
3- Limit pricing: This involves cutting the price to the point that that deters new entrants from entering the market. It may also deter firms that are in the market from expanding. This may or may not be illegal.
46
What are types of non-price competition?
1- Product Differentiation: Firms emphasize the unique qualities and features of their products through branding, quality, design, or advertising.
2- Advertising and Marketing: Firms engage in extensive advertising and marketing campaigns to create brand loyalty and awareness.
3- Innovation: Competing through the development of new products, technologies, or processes.
4- Customer Service: Offering exceptional customer service and support as a competitive advantage
5- Distribution Channels: Establishing efficient distribution networks to reach customers faster and more conveniently.
47
What is a pure monopoly?
When there is only one firm supplying a good or service.
48
What is a legal monopoly?
A firm that supplies at least 25% of the market.
49
What are the characteristics of a monopoly?
1- Single seller: In a monopoly, there is only one firm or seller that dominates the entire market, with no close substitutes for its product.
2-High Barriers to Entry: Monopolies often maintain their dominant position due to high barriers to entry, which can include factors like patents, economies of scale, control over essential resources, and government regulations.
3- Price Maker: A monopoly has the power to set the price of its product, and it faces a downward-sloping demand curve. It can choose the price and quantity of output to maximize its profits.
50
Where is the profit maximising equilibrium for a monopoly?
When MR = MC, the firm makes supernormal profits in the short and long run.
51
Illustrate the profit maximising equilibrium for a monopoly.
A diagram of a monopoly market typically shows the demand curve, marginal revenue curve, and marginal cost curve. The monopolist's profit-maximizing point is where MC intersects MR. The price is found on the demand curve corresponding to the quantity produced. Any difference between price and average total cost represents the monopolist's profit.
52
What is a stakeholder?
Any person or group that has vested interest in a firm. These include consumers, suppliers, owners, the government and other firms already supplying the market.
53
What are the benefits of a monopoly for consumers?
1- Innovation: a monopoly may use its profits to develop new and better products
2- Lower prices: A monopoly may be able to produce at lower average costs than firms competing in the same industry.
54
What are the costs of a monopoly for consumers?
1- Less choice: Large firms keep to the brands that make the most profit.
2- Higher prices: monopolies can restrict supply and raise prices to maximise their profits.
3- Lower quality: Firms with no competition might not have the incentive to produce high quality goods.
4- X-inefficiency: results in higher costs for the business and higher costs for consumers.
55
What are the benefits of a monopoly for workers?
1- Better Job security: facing no competition, monopolies are likely to have a steady demand for their goods and services.
2- Higher pay/perks for workers: higher profits might mean that the firm can afford to pay higher wages to its workers.
56
What are the drawbacks of a monopoly for workers?
1- Weaker bargaining power
2- Profits may be used to replace workers with machinery
57
What are the benefits of a monopoly for the government
1- Higher Tax Revenue: large firms pay higher rates of corporation tax. The more profits the monopoly makes, the more the firm will pay in tax.
2-Lower unemployment: monopolies might have many competitors outside the country. Monopoly power helps keep workers within the country.
58
What are the drawbacks of a monopoly for the government?
1- Tax avoidance: monopolies may find ways to avoid paying tax.
2- Higher rate of inflation: without competition monopolies might raise prices. This could lead to an inflationary wage-price spiral.
59
What are the benefits of a monopoly for producers?
1- A secure outlet for suppliers: a monopoly producer can ensure steady demand of goods
2- Benefits complementary goods suppliers
60
What are the drawbacks of a monopoly for producers?
1- Exploitation
2- Overdependence
61
What is price discrimination?
A pricing strategy in which a seller prices the same product differently across markets based on what each markets buyers are willing to pay.
62
What are the conditions necessary for price descrimination?
1- Market power: the firm must be able to set prices (it will be facing a downwards sloping demand curve)
2- Ability to separate markets: the firm must be able to identify different submarkets and be able to keep them separate.
3- Price elasticities of demand must be different in the different markets: so that the firm can charge different prices in different submarkets.
4- The cost of keeping the markets separate is less than the increased profits gained from price discrimination.
63
Illustrate price discrimination in 3 different markets
Market A: Relatively inelastic demand with a high price. Horizontal AC = MC.
Market B: Elastic demand with low price.
Horizontal AC = MC.
Combined Market: Downwards sloping MR and AR curve with Horizontal AC = MC curve
(ac = mc curve stays the same across all 3 graphs.)
64
How does diagrammatic analysis price discrimination show that Price discrimination leads to an increase of supernormal profits?
Supernormal profit in market A + Supernormal profit in market B is greater than the supernormal profit in the combined market.
65
What are the benefits of price discrimination for consumers?
1- Lower prices (higher consumer surplus) for those in the market where demand is elastic.
2- Consumers may benefit from better quality goods and services.
66
What are the drawbacks of price discrimination for consumers?
1- Higher prices (and lower consumer surplus) for those in the market where demand is inelastic.
2- Creates a more unequal distribution of income: consumers pay higher prices while shareholders gain higher dividends.
67
What is waste with x-Inefficiency?
A firm is wasting resources if it’s not getting the maximum output for the input used, even though it could with better effort or organisation.
68
What are the benefits of price discrimination for producers?
1- Higher revenues and profits
2- Enables firms to finance research and investment.
3- May enable a firm to provide a product or service that would be unprofitable without price discrimination.
69
What are the drawbacks of price discrimination for producers?
1- Costs involved in preventing seepage between markets might outweigh extra revenue gained from price discrimination.
2- Might create a poor image of the company.
70
What is a real example of price discrimination?
An example of price discrimination would be the cost of movie tickets. Prices at one theatre are different for children, adults, and seniors
71
Explain what a natural monopoly is and how it arises?
A natural monopoly is a type of monopoly that arises due to unique circumstances where high start-up costs and significant economies of scale lead to only one firm being able to efficiently provide the service in a certain territory. As a result one large business can supply the the entire market at a lower long run average cost contrasted with multiple providers.
72
What industries are regarded as natural monopolies
Electricity generation, water supply and telecommunications.
73
What is a monopsony?
It's a firm that is the sole buyer of a good or service. This means that the buyer has a lot of power over the price that they pay for the good or service
74
What is an example of a monopsony?
Farmers selling their produce to a single (or few) buying market is a common example of monopsony.
The NHS is the main buyer of Doctors and Nurses within the uk.
75
What are the characteristics and conditions for a monopsony to operate?
1- Single Buyer: A monopsony is characterized by a single dominant buyer in a particular market or industry. This buyer has substantial market power and controls a significant share of the total demand for a specific product or labor.
2-Limited Substitute Buyers: A key condition for a monopsony to exist is the absence of readily available substitute buyers for the goods or services it purchases. This limits the options for sellers to find alternative customers.
3- Price Maker: The monopsonist has the ability to set the price it is willing to pay for the goods or services it buys. It can do so because sellers have limited alternatives, and the monopsonist's demand significantly affects market prices.
4- Downward-Sloping Supply Curve: The supply curve facing the monopsonist is downward-sloping, meaning that sellers are willing to provide more goods or services at lower prices. This gives the monopsonist the power to negotiate lower prices with suppliers.
5- Barriers to Entry: In some cases, barriers to entry or factors that discourage new buyers from entering the market may contribute to the existence of a monopsony. These barriers could include regulatory restrictions, high start-up costs, or economies of scale that favour larger buyers.
76
What are the benefits of a monopsony?
1- Power in buying means the firm can make more profits, as suppliers cannot overcharge.
2- Lower buying costs might be passed on to the consumer in lower retail prices.
3- Higher profits of a monopsony can be used to invest and innovate.
77
What are the drawbacks of a monopsony?
1- Suppliers can be squeezed out of business: A monopsony can squeeze suppliers out of business by using its buying power to force them to accept very low prices, often below sustainable levels
2- Choice for consumers could be limited as monopsony acts as a barrier to entry for new firms as it controls access to key inputs
3- Higher profits of monopsony can result in inequality.
78
What are the costs to firms of a monopsony?
Monopsony power allows the buyer to negotiate lower prices for inputs, benefiting the firm by reducing production costs.
However, if the monopsony exploits its market power excessively, it can harm suppliers, potentially leading to reduced supply, lower product quality, or the exit of smaller suppliers from the market.
79
What are the benefits to consumers of a monopsony?
Consumers may benefit from lower prices for the final goods or services produced by the monopsony, as lower input costs can translate into lower prices for consumers.
However, if the monopsony drives suppliers out of business or reduces the quality of inputs, it could result in limited product variety and potentially higher prices in the long run.
80
What are the benefits to employees of a monopsony?
Employees may benefit from a monopsony's presence if it offers competitive wages and working conditions due to its ability to negotiate lower input costs.
However, in cases where the monopsony uses its power to depress wages, it can lead to lower incomes and reduced job opportunities for workers.
81
What are the benefits to suppliers of a monopsony?
Suppliers may benefit from the stability and reliability of a monopsony as a consistent buyer.
However, they may face pressure to accept lower prices, reduced profit margins, and less bargaining power
82
Define contestability
A measure of the ease with which firms can enter or exit an industry.
83
What are features of a contestable market?
1- Low barriers to entry or exit
2- New firms entering or leaving the market.
3- Low sunk costs
4- low levels of supernormal profits
5- low levels of collusion or other signs of oligopoly
84
What are sunk costs?
Sunk costs are unrecoverable costs, ie costs that cannot be recovered if the firm closes down.
85
What are features of an industry that has a low degree of contestability?
1- There are high barriers to entry and exit
2- There are high sunk costs (barriers to exit) . Any costs that cannot be recouped if the firm leaves the industry reduce contestability.
3- A high concentration ratio.
86
What are Implications of contestable markets for the behaviour of firms?
If markets are contestable, firms are more likely to be allocatively efficient. In the long run, firms operate at the bottom of the average cost curve. This makes them
productively efficient.
The threat of new entrants affects firms just as much as existing competitors. Due to the low barriers to entry which provide easy access to the market, firms are wary of new entrants entering the market, taking
supernormal profits, and then leaving.
Markets which are highly contestable are akin to a perfectly competitive market. This is because existing firms act as though there is a lot of competition.
There could be supernormal profits in the short run and only normal profits in the
long run. In the short run, new firms can enter and take advantage of the supernormal profits. However, in practice, firms can only earn normal profits in the
short run. This is because it is the only way to prevent potential competition. Without supernormal profits, there is no incentive for new firms to enter, even if barriers to entry and exit are low
87
What are barriers to entry?
Barriers to entry are any obstacles that prevent a firm from setting up or extending its reach in new markets.
88
What are the 3 types of barriers to entry?
(explain each with examples)
1- Artificial (strategic) barriers: deliberately imposed barriers
-Predatory pricing
-limit pricing
-Brand loyalty
-Loyalty schemes
-Switching costs.
2- Natural (structural) barriers: barriers that exist due to the nature of the business or the market.
-Economies of scale
-High start-up costs, this may involve
specialist machinery.
- Ownership of key resources
3- Legal barriers: some barriers to entry are imposed by the authorities, in cases where too much competition might be seen as working against the interest of the consumer.
-Patents
-State owned franchises, such as the rail
network
-Licences to allow firms to operate, such
as 5G licences
89
What are barriers to exit?
Barriers to exit are obstacles that make it difficult or costly for a firm to leave an industry. Can be referred to as sunk costs which are the costs associated with a decision to leave a market / industry
90
What are 4 examples of Sunk costs?
1- Advertising: These are costs that have been incurred by the firm in promoting its products that cannot be recovered if the firm exits the market.
2- Costs of closure: These could include redundancy costs, loans and costs of terminating contracts early.
3- Specialised machinery: it is unlikely that this could be transferrable to other industries, so it would be a barrier to exit.
4- Lost goodwill with customers
