3.4 Market Structures

Question 1

What is efficiency

Answer 1

Efficiency can be used to judge how well the market allocated resources, and the relationship between scarce inputs and outputs.

Question 2

Allocative efficiency

Answer 2

Achieved when resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised. It will occur when the value to society from consumption is equal to the marginal cost of production, where MC=AC

Question 3

Productive efficiency

Answer 3

A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product. The minimum resources are used to produce the max output.

This can only exist if firms produce at the bottom of the AC curve where MC=AC.

Question 4

Dynamic efficiency

Answer 4

Achieved when resources are allocated efficiently over time. Concerned with investment, which brings new products and new production techniques.

When SNP is reinvested into RND

Question 5

X-inefficiency

Answer 5

If a firm fails to minimise its AC at a given level of output, it is x-inefficient and there is organisational slack.

Question 6

Characteristics of perfect competition markets

Answer 6

• many buyers and sellers
• freedom of entry and exit from the industry
• perfect knowledge
• homogenous goods

Question 7

Profits in perfect competition markets

Answer 7

In the short run, firms can make normal profit, supernormal profit or a loss

In the long run firms can only make normal profits

Question 8

Pricing strategy in perfect competition

Answer 8

Profit maximisation at MC=MR

Question 9

Efficiency in perfect competition

Answer 9

Productively efficient since they produce where MC=AC

Allocatively efficient as they produce where P=MC

Not dynamic efficient

Question 10

Characteristics of monopolistic competition

Answer 10

• large number of buyers and sellers
• no barriers to entry or exit
• differentiated, non homogenous goods
• firms have some price setting power

Question 11

Profits in monopolistic comp

Answer 11

In the short run, can make supernormal, normal, or losses

In the long run, can only make normal profits

Question 12

Pricing strategy in monopolistic competition

Answer 12

Short run profit maximisers producing at MC=MR

Question 13

Limitations for firms in monopolistic competition

Answer 13

Information may be imperfect so firms will not enter the market as predicted as they are unaware of the abnormal profits

Question 14

Efficiency in monopolistic competition

Answer 14

Since can only make normal profit in the long run, AC=AR and since they profit maximise, MC=MR. Therefore, they will not be allocatively or productively efficiently

Likely to be dynamically efficient as differentiated products.

Question 15

Characteristics of oligopoly

Answer 15

• few firms dominate the market
• differentiated products
• high concentration ratio
• firms interdependent (actions of one directly effects other)
• barriers to entry

Question 16

Kinked demand curve

Answer 16

If a firm raises its price, competitors won’t as they’ll be comparatively lower

If a firm lowers its prices, competitors will lower as they’ll be comparatively more expensive

Therefore, assume price starts at p1 (at the kink)
Above p1 is elastic and below p1 it’s inelastic

Result is a kink in demand.

Question 17

N firm concentration ratios

Answer 17

Measures the percentage of the total market that a particular number of firms have.

3 firm shows the market share held by biggest 3 firms
4 for the biggest 4 firms.

Question 18

N firm concentration ratio equation

Answer 18

Total sales of n firms
—————————— X100
Total size of the market

Question 19

What is collusion

Answer 19

When firms make collective agreements that reduce competition

Question 20

Benefits for firms to collide and when does it work best

Answer 20

They could maximise industry profits by keeping higher prices

Reduce the uncertainty firms face and reduces fear of engaging in competitive price cutting or advertising

Works best when there are a few firms which are all well known to eachother, not secretive about costs and production methods and they are similar

Question 21

What is overt collusion

Answer 21

When there is a formal agreement between firms

Question 22

What is tacit collusion

Answer 22

No formal agreement

Question 23

What is a cartel

Answer 23

A formal collusive agreement is called a cartel, a group of firms which enter into an agreement to mutually set prices.
Rules laid out in a formal document

Question 24

How could a cartel operate

Answer 24

Agree on a price for goods and the compete freely using non-price competition to maximise their market share

Agree to divide up the market according to present market share of each business

Question 25

What is price leadership

Answer 25

Where one firm has advantages due to its size or costs and becomes the dominant firm. Other firms will tend to follow this because they would be fearful of taking on the firm in a price war

Question 26

What is game theory

Answer 26

Explores the reactions of one player to changes in strategy by another player, the aim is to examine the best strategy a firm can adopt for each assumption about its rivals behaviour and it provides insight into interdependent decision making that occurs in competitive markets

Question 27

What is the maximin game theory policy

Answer 27

Where the firm works out the strategy where the worst possible outcome is the least bad

Question 28

What is the minimax policy in game theory

Answer 28

Involves the firm working out the policy with the best possible outcome

Question 29

What is dominant strategy

Answer 29

A situation where one player has a superior tactic regardless of how the other players act If the maximin and minimax strategies end up with the same solution, this is the dominant strategy However, are not common irl.

Question 30

What is Nash equilibrium

Answer 30

Where neither player is able to improve their position and has optimised their outcome based on other players expected decision.

Question 31

What are price wars Example

Answer 31

Occur in markets where non-price competition is weak, where goods have weak brands and consumers are price conscious, also occur when it is difficult to collude Will drive price down to levels where firms are frequently making losses Lowers industry profits Supermarkets with firms desperately trying to lower orices

Question 32

What is predatory pricing

Answer 32

Occurs when an established firm is threatened by a new entrant or if one firm feels that another is gaining too much market share The firm will set such a low price that other firms are unable to make a profit and so will be driven out of the market The existing firm will then put their prices back up This is illegal

Question 33

What is limit pricing

Answer 33

In order to prevent new entrant, firms will set low prices. They need to be high enough to make at least a normal profit but low enough to discourage any other firm entering market Mainly used in contestable markets

Question 34

What is cost plus pricing

Answer 34

Where firms simply work out their average costs and add a percentage increase, which determines the level of profit they make

Question 35

Market-led pricing

Answer 35

Firms can set prices simply by looking at prices charged by competition they price their goods close to other firms. Problem is that there is no consideration of costs

Question 36

What is price skimming

Answer 36

When a product is initially launched, firms set very high prices to cover RND costs and keep demand at manageable levels. Mainly used by tech firms

Question 37

What is penetration pricing

Answer 37

When product first introduced, firm will set prices low to encourage people lot use it for the first time. When they come back for another, price is higher

Question 38

Types of non-price competition

Answer 38

Advertising - creates an awareness of the company and can persuade customer to purchase Loyalty cards - encourage repeat purchases by rewarding customer for their loyalty Branding - successful brand can help increase loyalty and repeat purchases for a business Quality - firm known for good quality can charge higher prices Customer service Product development

Question 39

Efficiencies in oligopolies

Answer 39

Statically inefficient; not productively or allocatively efficient Likely to be dynamically efficient Able to exploit economies of scale.

Question 40

What is a pure monopoly with a close example

Answer 40

Where one firm is the sole seller of a product in the market Google, 88% of the market

Question 41

Legal monopoly threshold Example

Answer 41

25% or more market share is classed as a legal monopoly. Tesco is a legal monopoly as it has 28% of the market.

Question 42

What is price discrimination Examples

Answer 42

When monopolists charge different prices to different people for the same good or service Different times of the day, peak vs off peak train times

Question 43

How can a monopoly ensure price discrimination can occur

Answer 43

The firm must be able to clearly separate the market into groups of buyers, they must have different elasticities of enemies, must be able to control supply and prevent buyers in the expensive market buying in the cheap

Question 44

Benefits of price discrimination

Answer 44

Firms benefit as increase profits Those in elastic market fins as they can play a lower price

Question 45

Drawback of price discrimination

Answer 45

Consumers lose some of their consumer surplus to the producers and some consumers have to pay a higher price

Question 46

Natural monopolies Examples

Answer 46

In these industries, the economies of scale are so large that even a single producer is not able to exploit all of them An industry where it makes sense to only have one firm National grid, water, railways

Question 47

Why do natural monopolies exist

Answer 47

It would be pointless to encourage competition since it would raise average costs for the industry Tend to be found in industries with very high fixed costs

Question 48

Benefits of monopolies for the monopoly firm

Answer 48

• Make huge profits • supernormal profits mean firms will have finance for investments and build reserves to overcome difficulties • monopoly firms can compete against large overseas corporations • maximise economies of scale

Question 49

Costs of monopolies on firms

Answer 49

Firms may not always choose to profit maximise because of x-inefficiencies, sales or revenue maximisation. Lack of competition may means firms become complacent

Question 50

Costs and benefits of monopolies on employees

Answer 50

Will employ fewer workers as produce at lower outputs However, the inefficiency of monopolies may means employees get paid more etc…

Question 51

Cost/benefit of monopolies on suppliers

Answer 51

The impact of a monopolist will depend on the extent to which the monopolist is also a monopsonist.

Question 52

Benefits of monopolies consumers

Answer 52

• Natural, consumers tend to be better off than if there was competition • when firms enjoy economies of scale, more efficient and customers will enjoy higher consumer surplus • monopolists may produce an increased range of goods or services • price discrimination benefits some consumers

Question 53

Monopolies efficiencies

Answer 53

Productively inefficient as don’t produce at MC=AC Not allocatively efficient as P>MC Dynamic efficient

Question 54

Characteristics of monopsony

Answer 54

• Only one buyer in the market • other than one buyer, it has the same characteristics as monopolies

Question 55

Example of a monopsony

Answer 55

NHS, who pay less for cancer drugs than a number of other high-income countries

Question 56

Prices in monopsony

Answer 56

The firm will pay the supplier the lowest possible price to minimise their costs and make the most of their position as the only buyer. This enables them to maximise their profit

Question 57

Benefits of monopsony for the buying firm

Answer 57

Gains higher profits by being able to buy at lower prices Achieve purchasing economies of scale, lowering costs and profits.

Question 58

Benefits of monopsonies for consumers

Answer 58

May Gain from lower prices as reduced costs are passed on. May act as a counterweight to monopolists

Question 59

Costs of monopsonies for consumers

Answer 59

Fall in supply if the firm buys less Fall in quality as prices are driven down

Question 60

Cost and benefit of monopsonies on employees

Answer 60

Benefit: may pay higher wages Costs: supplier will sell less goods so employ less people

Question 61

Cost of monopsonies for suppliers

Answer 61

Will lose out as they will receive lower prices.

Question 62

What is a contestable market

Answer 62

A contestable market is one with a high threat of new entrants, which keeps firms producing at a competitive level.

Question 63

Characteristics of contestable markets

Answer 63

• Perfect knowledge • freedom of entry and exit • relative absence of sunk costs • firms will have the best technology available. • low product loyalty

Question 64

Examples of contestable markets

Answer 64

Taxi industry with the intro of Uber, hotel market with Airbnb

Question 65

Implications of contestable markets

Answer 65

• Limit pricing, reduces incentive for firms to enter the market • firms will only be able to make normal profits • likely to be productive and allocatively efficient

Question 66

Barrie’s to entry and exit

Answer 66

• legal barriers making it difficult to enter. For example, patents and exclusive rights to production. • marketing barriers from high amounts of brand loyalty for other firms as a result of great advertising from other firms. • the pricing decisions of incumbent firms. For example, predatory pricing. • start up costs and high sunk costs as a result • economies of scale of others may make it hard to enter • barriers to exit like costs to write off assets, pay leases and make workers redundant

Question 67

What is a sunk cost

Answer 67

A sunk cost is a fixed cost that a business cannot recover if it leaves for industry. It included property.