3.4 Market Structures

Question 1

What is allocative efficiency?

Answer 1

It is when production is at the point which maximizes social welfare, P=MC

Question 2

What is productive efficiency?

Answer 2

It is when a firm is able to produce at the lowest average cost. MC=AC or the lowest point of the AC curve.

Question 3

What is dynamic efficiency?

Answer 3

It is the long term reinvestment of supernormal profits into innovation and research.

Question 4

What is X-Inefficiency?

Answer 4

This is when a firm does not minimize its costs due to a lack of incentive and competition

Question 5

What are the characteristics of a perfectly competitive market?

Answer 5

Many buyers and sellers
Homogenous Goods
Perfect Knowledge
No barriers to entry or exit
Firms are price takers
Firms are profit maximizers

Question 6

Why can firms in perfect competition make supernormal profit in the short run but not in the long run?

Answer 6

If firms are making profit, then other firms will know as there is perfect knowledge, as all firms are profit maximizers they will enter the market as there are no barrier to entry or exit and thus the new firms will shift the supply (cost curves) up until there is no profit being made in the industry.

Question 7

What efficiency is present in a perfectly competitive market?

Answer 7

They are statically efficient (allocative and productive) but not dynamically efficient as they do not earn supernormal profit in the long run, so they cannot reinvest.

Question 8

What are characteristics of firms in a monopolistically market?

Answer 8

Many firms
No barriers to entry or exit
Slightly differentiated goods
Some degree of price setting power
Perfect

Question 9

Why are the revenue curves in a monopolistic market downward sloping?

Answer 9

As goods are somewhat differentiated, in the short run the firm with the best profit will have price setting power, thus demand will not be perfectly elastic

Question 10

What efficiencies are present in a monopolistic market?

Answer 10

Firms are not statically efficient but they are likely to be dynamically efficient. This is because by being dynamically efficient they will be able to earn short term super normal profit

Question 11

What is an oligopoly?

Answer 11

This is where a few firms control most of the market share in an industry

Question 12

What are the characteristics of an oligopoly?

Answer 12

Differentiated goods
Interdependence
Barriers to entry
high concentration ratio

Question 13

Why is there a kink in the demand curve for oligopolies?

Answer 13

Oligopolies have a kink in their demand curve because when price is set at a certain point, if a firm was to increase its prices, they would be less price competitive so they would get outcompete so the proportional change in price will be smaller than the change in quantity demand, so the curve is elastic above the set price. But below this point, when a firm reduces its price, other firms will follow so there will be a minimal rise in QD therefore the proportional change in price will be larger than the change in QD so the demand curve is inelastic beyond this point. This explains why prices remain stable in an oligopoly.

Question 14

What is the n-firm concentration ratio?

Answer 14

It is the percentage of market share the ‘n’ largest firms in an industry own.

Question 15

What is collusion?

Answer 15

This is when firms make agreements to reduce competition. When there is no collision it is a competitive oligopoly.

Question 16

Why do firms wish to collude and why may some firms not collude?

Answer 16

Rather than being competitive, if firms come together and collude, they can maximise industry profits. In addition, it reduces uncertainty for firms as they know that they dont need to engage in price wars. Some firms may not wish to collude as collusion is illegal and if they have a unique business idea that sets them apart, they have a non price competitiveness over other firms, so they have no incentive to collude.

Question 17

When does collusion work well?

Answer 17

Few firms
Stable market
Similar costs structures
Similar products
One distinct leader
High barriers to entry

Question 18

What is the difference between overt and tacit collusion?

Answer 18

Overt collusion is when firms come to a formal agreement(cartel) , but tacit is when it is implied and there is no formal agreement.

Question 19

How do cartels work?

Answer 19

Firms have the option of making agreements on price, or dividing up the market, however the more successful a cartel gets, the more tempting it is to cheat and break the cartels structure as large supernormal profits can be made by doing this.

Question 20

What are the two ways tacit cartels work?

Answer 20

Price leadership and Barometric firm price leadership.

Question 21

What is price leadership?

Answer 21

This is when there is one dominant firm, due to size or costs. in an industry that every other firm follows the dominant firm, as they do not wish to engage in price wars with this firm because they will loose.

Question 22

What is barometric firm price leadership?

Answer 22

This is when one firm has a good ability to predict and track market trends so any decisions they make, other firms make as well.

Question 23

What economic theory supports non collusive oligopolies?

Answer 23

Game theory

Question 24

What is the Nash Equilibrium?

Answer 24

This is when both firms are in a better position than if they were to choose a different strategy but they could be in a better position if the other firm would change their strategy. This means neither firm has an incentive to change strategies and therefore prices remain stable.

Question 25

What types of price competition exist?

Answer 25

Price wars Predatory Pricing Limit Pricing

Question 26

What is a price war?

Answer 26

This occurs when non price competition is low and collusion is also difficult. Therefore firms frequently undercut each other.

Question 27

What is predatory pricing?

Answer 27

This is when an incumbent firm sets their price deliberately lower than their costs to drive new firms out of the market, after which they will raise their prices. This is illegal and only works if the firm is large enough to sustain losses.

Question 28

What is limit pricing?

Answer 28

This is when firms set their prices low, at a point between them making at least normal profit and a point where new firms are not able to set their prices at this level.

Question 29

What are some non price factors?

Answer 29

Advertising Brand Image Loyalty Cards Product Development Customer Service Quality

Question 30

What efficiencies are present in an oligopoly?

Answer 30

Firms are likely to be statically inefficient but dynamically efficient

Question 31

What is a monopoly?

Answer 31

A pure monopoly is when there is one sole seller of a good in an industry. A legal monopoly has at least 25% market share.

Question 32

What are the characteristics of monopolies?

Answer 32

One firm has over 25% market share High barriers to entry.

Question 33

What is third degree price discrimination?

Answer 33

This is when a firm is able to divide a markets based on varying elasticities and charging different prices to different segments to maximize profit.

Question 34

What are the costs and benefits of price discrimination?

Answer 34

Firms earn more profit Consumers in the elastic market pay lower prices Reduce inequality as without it they may not be able to afford the good or service It reduces some consumer surplus

Question 35

What is a natural monopoly?

Answer 35

A natural monopoly is one in which the economies of scale in an industry are so large that not even one firm can fully exploit them

Question 36

What kind of efficiencies are present in a natural monopoly?

Answer 36

Not static but dynamic is possible if the firms want to reinvest

Question 37

What are the cost and benefits of a natural monopoly on the firm?

Answer 37

They will have large amounts of profit They will be able to exploit economies of scale and therefore have lower costs Their size will allow them to be competitive overseas They have supernormal profit for investment which can get them out of any short term financial struggles However, the lack of competition may cause them to be X-inefficient

Question 38

What are the costs and benefits of a natural monopoly on consumers?

Answer 38

The efficiency gains from economies of scale can get passed onto the consumer so they can benefit from lower prices Through price discrimination consumers may get a wider range of goods and services A natural monopoly is also better than if there was competition in some markets because if there was only one firm Price discrimination can also allow for the survival of some products (business class flights pay for economy class) However, if there is a lack of competition X-Inefficiencies can also be passed onto the consumer

Question 39

What is the Williamson Trade-Off?

Answer 39

This is when switching from a perfect competition to a monopoly on the graph leads to a fall in consumers surplus as monopolies produce less which causes a deadweight loss. Also, as monopolies are X-inefficient their costs will rise further causing a further fall in consumer surplus.

Question 40

What is creative destruction?

Answer 40

This is the process of new production methods which have arisen from innovation leading to old and obsolete methods not being used anymore.

Question 41

What is a monopsony?

Answer 41

This is when there is one sole buyer in a market or industry

Question 42

What are the costs and benefits of a monopsony on firms?

Answer 42

The firms can get higher profits therefore reinvest these additional profits laters on They can achieve purchasing economies of scale

Question 43

What are the costs and benefits of a monopsony on consumers?

Answer 43

They can benefit from lower prices Monopsony power can outweigh any monopoly power present There can be a fall in supply as the monopsony may not need to buy as much There can also be a fall in quality as prices are driven down

Question 44

What is a contestability?

Answer 44

The degree to which new firms can enter a firm and compete with incumbent firms whilst having access to the same factors of production that incumbent firms have and face no sunk costs.

Question 45

What are characteristics of contestable markets?

Answer 45

No brand loyalty No collusion and all firms short run profit maximise Perfect Knowledge No barriers to entry or exit No sunk costs

Question 46

What are 6 barriers to entry/exit?

Answer 46

Sunk costs Legal barriers Marketing Barriers Pricing decisions of big firms Economies of scale The cost of writing off assets/making workers redundant

Question 47

What is a sunk cost?

Answer 47

It is a fixed cost the business cannot recover if they wish to leave the market