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MIcroeconomics (2) > 3.4 Market Structures > Flashcards

3.4 Market Structures Flashcards

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1
Q

What is perfect competition?

A

An idealized market condition where sellers compete to offer the best prices and large sellers have no advantage

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2
Q

What are the 5 characteristics of perfect competition?

A

- Price takers: prices determined by interaction of supply/demand (cannot be influenced by firms)
- Many buyers and sellers: no one firm or customer can influence the market
- No barriers to entry/exit: firms can start-up or leave the industry with ease (increases competition)
- Perfect information (consumers know about prices/quality, producers know about prices/costs + tech)
- Homogenous products

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3
Q

In the short-run where do firms in perfect competition profit maximise?

A

Where MC=MR

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4
Q

How are firms in perfect competition both productively and allocatively efficient?

A
  • Productively efficient: produce where MC=AC (produce at bottom of AC curve)
  • Allocatively efficient: produce where P=MC
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5
Q

What are 2 advantages and 3 disadvantages of perfect competition?

A
  • Lower prices (numerous firms producing similar goods), consumer surplus
  • Productive and Allocative Efficiency
  • Lack of economies of scale (many small firms, each with small market share + there is freedom of entry)
  • Reduced Consumer Choice: although there is a wide range of firms, there is a lack of product differentiation/variety, may lead to lower quality
  • No incentive for innovation due to lack of SNP, investment may be a waste as rivals can easily copy new features/technology, dynamic efficiency decreases
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6
Q

What is a monopoly?

A

A market structure characterised by a single seller which dominates the market

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7
Q

What are 4 characteristics of a monopoly?

A

- One firm
- Non-homogenous goods (each firm selling a unique good)
- Price maker (firm sets its own price)
- High barriers to entry/exit (e.g start-up costs, regulation)

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8
Q

What is productive efficiency?

A

The ability of a firm to produce goods or services at the lowest possible cost (MC=AC)

= lowest point on the AC curve

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9
Q

What is allocative efficiency?

A

When the cost of producing the good is well matched to how much a consumer is willing to pay for it (MC=P)

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10
Q

Where is productive efficiency on a perfect competition diagram and why?

A
  • MC=AC
  • At this point, average costs are minimized and no wastage of resources (lowest point on curve)
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11
Q

Where is allocative efficiency on a perfect competition diagram and why?

A
  • P=MC
  • At this point, consumers and sellers gain the maximum benefit and there is no excess supply/demand (welfare is maximised)
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12
Q

What is the difference between a pure and natural monopoly?

A
  • Pure monopoly: where one firm is the sole seller of a good in a market
  • Natural monopoly: when one large business can supply the entire market at a lower long-run average cost
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13
Q

Why is the MR downward sloping on a monopoly diagram?

A

If a monopoly wants to increase sales, it has to lower the price of its units

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14
Q

What are 2 advantages and disadvantages of monopolies?

A
  • Price/output stability: market under control of one firm stabilises variables + reduces potential supply surplus = reliable prices for consumers
  • Firms can maximise economies of scale, increasing efficiency
  • Lack of choice for consumers
  • Firms have less incentive to innovate (lack of competition)
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15
Q

Describe whether a monopoly is allocatively and productively efficient

A
  • A monopoly is productively inefficient, since they don’t produce at MC=AC
  • A monopoly is allocatively inefficient as P>MC
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16
Q

What is monopolistic competition?

A

A form of imperfect competition that combines elements of both monopoly and perfect competition

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17
Q

What are the 3 conditions of monopolistic competition?

A

- Many buyers and sellers (no buyer/seller has price making power)
- No barriers to entry/exit (new firms can enter when SNP is made)
- Differentiated goods (products in the industry are close but not perfect substitutes)
- Price makers
- Elastic demand (consumers easily switch if prices rise)
- Non-price competition

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18
Q

What is the effect of no barriers to entry on monopolistic competition?

A
  • In the long-run, as firms are making SNP more firms will be incentivised to enter the market
  • This causes demand for the individual firm to decrease, so AR and MR curves shift to the left
  • There is a loss of SNP for the individual firm (due to competition)
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19
Q

Why is the AR curve for monopolistic competition more elastic in the LR?

A
  • If the price for the good sold rises too high, consumers will switch to one of the many close differentiated substitutes (new competitors join the market)
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20
Q

Describe whether monopolistic competition is productively and allocatively efficient

A

- Productively inefficient: firms don’t produce at the minimum point of their average cost curve
- Allocatively inefficient: firms set prices above their marginal costs (P > MC) = have pricing power

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21
Q

What is an oligopoly?

A

A market structure in which a few large firms dominate the industry

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22
Q

What is a concentration ratio?

A

The percentage of the total market that a particular number of firms have

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23
Q

What is the formula for percentage of market share?

A

total sales of n firms / total size of market x 100

n (number of firms) : total market share

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24
Q

What is collusion?

A

The collaboration between firms in order to gain a competitive advantage in the market

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25
What is the benefits of collusion to firms?
- Reduces uncertainty of firms - Firms can maximise industry profits
26
What are the 4 conditions of an oligopoly?
- Product differentiation - Interdependence - Few sellers/firms - Barriers to entry/exit
27
What is non-collusive behaviour?
When firms compete with each other to gain market share but do not engage in explicit collusion/coordination
28
Describe the kinked demand curve
Displays a different elasticity for higher and lower prices. 1. If a firm increases its prices, other firms will not follow as their comparatively lower price makes them more competitive (elastic demand curve: prices of competitors lower so demand is lost) 2. If a firm lowers its price, other firms will do the same as they want to remain competitive (inelastic demand curve: little difference in price of competitors so less change in demand)
29
What is the difference between overt and tacit collusion?
**- Overt collusion:** when firms formally agree to cooperate and set prices or output level e.g cartels **- Tacit collusion:** when firms coordinate their actions without formally communicating/reaching an agreement
30
What is does the kinked demand model (oligopoly) suggest about price?
- Prices tend to be stable - Firms are hesitant to change prices due to the fear of retaliation from competitors - means that rise/fall of costs or demand has no impact on price/output
31
What are 4 favourable conditions for collusion?
- High market concentration (few firms dominate) - Firms produce similar products - Similar costs/production methods - There is a dominant firm (others are happy to follow)
32
What is price leadership?
In an oligopoly: When one firm has advantages due to its size or costs and becomes the price leader. This firm sets the price, and other firms in the industry follow its pricing strategy (determines the price level for the entire market) (form of tacit collusion)
33
What is barometric price leadership?
When a particular firm is better at identifying a change in the market conditions/prices and other firms decide to follow their lead
34
What is game theory?
Different strategies a firm may choose depending on how they think their rivals will behave
35
What are the 3 types of price competition?
- Price wars - Limit pricing - Predatory pricing
36
What are price wars?
A type of price competition, which involves firms constantly cutting their prices below their competitors
37
Describe the method of limit pricing
- To prevent new entrants, firms will set prices low - Price set high enough to make normal profit but low enough to discourage other firms from joining
38
Describe the method of predatory pricing
- Existing firm will set a low price to undercut new entrants - Other firms are unable to make a profit, so leave market - Existing firm will then raise their prices back up
39
What is a contestable market?
When there is freedom of entry and exit into a market and the absence of sunk costs (open to actual/potential competition)
40
What are sunk costs?
A cost that has already been incurred and cannot be recovered
41
Why is the long-run outcome in contestable markets only normal profit?
Incumbent firms are disciplined to maintain competitive prices as there is the threat of competition from new entrants (so charge at the limit price/normal profit)
42
What is the difference between maximax and maximin policies?
- Maximax policy: when firms select a strategy with the best possible outcome - Maximin policy: when firms select a strategy where the worst possible outcome is the least bad
43
What is the nash equilibrium?
Where optimal outcome is when there is no incentive for players to deviate from their initial strategy (everyone playing at best possible response), rational, lasts in the long-term
44
What are 3 characteristics of a contestable market?
- Perfect knowledge (firms aware of abnormal profits) - Freedom of entry and exit - Low product loyalty
45
What is a cartel?
When two or more firms agree to control the supply of goods/services to reduce competition and drive up prices
46
What are 2 features of a cartel?
- Price-fixing (anti-competitive agreement to sell at a fixed price) - Small number of firms (easier to reach/enforce agreements)
47
Describe the effect of price wars on firms?
- Drives prices down to level where firms are making losses - In the short term, firms will continue to produce if their AVC is below AR - in the long run, they will leave the market and prices will rise (as supply falls)
48
What is price discrimination?
When a firm charges different prices to different people for the same good/service (with the same cost of production)
49
What are 2 benefits and costs of price discrimination?
- Firms can increase profits (encourages research/development, efficiency) - Uses spare capacity (e.g last minute tickets sold cheaper, efficiency) - Consumers lose consumer surplus (have to pay higher prices) - Arbitrage opportunity (reselling a good at a different price) - Anti-competitive: charging consumers lower prices could drive out competitors = monopoly power
50
What is the aim of price discrimination?
- Monopolist wants to turn consumer surplus into SNP - Different consumers willing/able to pay different prices - Firm makes each consumer pay the maximum amount they are willing
51
What are 4 conditions needed for price discrimination?
- **Market can be separated into clear groups:** identify different PED's, (requires accurate information) - **Price making ability** (degree of control over price of good e.g due to monopoly power, brand loyalty, barriers to entry) - **Preventing resale** (prevent consumers from buying and selling at a higher price e.g adult using a child's ticket)
52
What is X-efficiency?
When a firm lacks the incentive to control costs (results in AC being higher than usual)
53
What is dynamic efficiency?
The optimal rate of innovation/investment to improve production processes and reduce average cost
54
Draw: Monopoly diagram
55
Draw: Perfect competition (short-run) diagram
56
Draw: Perfect competition (long-run) diagram
57
Draw: Monopolistic competition (short-run) diagram
Y-axis = Revenue + Costs X-axis = output
58
Draw: Loss on perfect competition diagram
59
What are 3 types of non-price competition?
- Advertising/brand loyalty - After-sales service - Unique selling point (differentiated products)
60
Draw: Third degree price discrimination
61
What are 3 characteristics of a monopsony?
- Price Maker: ability to set the price it's willing to pay for the goods/services it buys - Limited substitute buyers - Barriers to entry e.g start-up costs
62
What is 2 costs and one benefit of monopsonies to consumers?
- Higher Prices due to reduced competition (can suppress the prices they pay suppliers + lower input cost may not be passed onto consumers) - Limited Choices due to reduced competition (suppliers may be forced out the market) - Lower prices for final good (lower input costs = lower prices)
63
What are one cost and benefit of monopsonies to suppliers?
- Reduced negotiating power (lack alternatives so have little leverage to negotiate better prices/conditions) - Benefit from the stability/reliability of a monopsony as a consistent buyer (more clarity when making long-term decisions, long-term profitability/stability)
64
What is a monopsony?
A market condition where there is a single buyer
65
Draw: Monopolistic competition (long-run) diagram
Y-axis = Revenue + Costs X-axis = output AR, MR MC, AC (lowest point touches the AR curve)
66
EVAL for monopoly
- Depends on the objectives - Firm may be looking to maximise social welfare or satisficing (acceptable level of profit) - Because if Pmax = workers feel unfairly compensated + consumers ripped off = reflect badly on the firm’s image/hence future sales - May lead to dynamic efficiency: firms earning above SNP, can invest profits into business to provide better quality/cheaper goods
67
What is an example of a contestable market?
- The online retail industry (relatively easy and low-cost)
68
EVAL for perfect competition
- A theoretical concept, does not exist in the real world (e.g impossible to achieve no barriers to entry/exit, perfect information)
69
Why does MC intersect with AC at its lowest point?
- when the MC of producing an additional unit is equal to the AC, the AC is neither increasing nor decreasing
70
What are 2 examples of a perfectly competitive market?
- International commodity/agricultural markets e.g wheat, corn (many farmers selling the same good, same information) - Foreign exchange markets (currency determined by supply/demand=price takers)
71
What is an example of a monopolistic market?
- Fast food industry (many sellers differentiated through menu/brand image=not perfect substitutes)
72
EVAL for kinked demand
- Depends on firm objectives: may not seek to profit maximises, but instead increase market share (so willing to cut prices even with inelastic demand) - Depends on individual firm: some may have strong brand loyalty (may have ability to increase prices without demand being elastic)
73
What is second degree price discrimination?
- Involves charging different prices for different quantities of the same good e.g quantity discounts (offering lower prices for larger purchases, encouraging customers to buy more)
74
What is first degree price discrimination?
- The producer charges each consumer the highest price they are prepared to pay (to extract maximum profit + consumer surplus)
75
How do monopsonies profit maximise?
Firms can afford to pay MRP (where the cost of hiring is equal to revenue earned). However, they abuse their power as sole buyer to maximise profit and pay less than the MRP
76
What are 2 drawbacks of monopsonies for workers?
- Limit worker choice - Lower wages create exploitation
77
What is 'hit and run' competition in contestable markets?
- New firms quickly enter a market - Enter a market where there firms making temporary SNP - Take advantage of short-term profits, and then exits without facing costs (made achievable due to low sunk costs)
78
EVAL for natural monopoly
- Depends on government intervention: government can regulate natural monopolies e.g OFWAT (water) to prevent high prices/limit market power
79
Why is competition undesirable for a natural monopoly?
- Results in a wasteful duplication of resources (allocatively inefficient) - Existing/established firm already has economies of scale advantages, competition makes it harder for one firm to exploit EOS (productively inefficient)
80
EVAL for collusion
- Incentive to cheat on collusive agreement (+ charge lower prices), means that collusion does not last in the long-term (HOWEVER may result in no benefit if consumers loyal to competitor)

MIcroeconomics (2) (5 decks)

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