3.4 Market Structures (2)

Question 1

What is economic efficiency ?

Answer 1

• making optimal use of scarce resources to help satisfy changing wants + needs (how well scarce resources are allocated)

Question 2

What is allocative efficiency ?

Answer 2

• occurs when the value that consumers place on a good/service (reflected in the price they are willing and able to pay) = the cost of the factor resources used up in production
• when demand = supply ie. P (AR) = MC

Question 3

What is productive efficiency ?

Answer 3

• occurs when firms max production + min costs ➡️ exploiting all economies of scale
• min point on AC curve (AC = MC)
• firm on their production possibility frontier

Question 4

What is dynamic efficiency ?

Answer 4

• when businesses supplying a market successfully meets changing needs + wants over time ➡️ linked to innovation/invention
• occurs when a a firm reinvests their supernormal profits ➡️ lower unit costs
  (AC curve shift downwards)

Question 5

What is x-inefficiency ?

Answer 5

• firms being wasteful for lower costs - any point on AC curve
• a lack of real competition may give a monopolist a weak incentive to invest in new ideas or consider consumer welfare (AC increases)

Question 6

What is innovation ?

Answer 6

putting a new idea into action ie. ‘the commercially successful exploitation of ideas’
- product innovation: changes to the characteristics + performance of a good/service
- process innovation: changes to the way production takes place/is organised OR changes in business models + pricing strategies

Question 7

What is deadweight loss of welfare ?

Answer 7

• the loss in producer + consumer surplus due to an inefficient level of production eg. from market or govt failure

Question 8

What is Pareto optimality ?

Answer 8

• not possible to bargain or trade in a way that everyone is at least as well off as they were before and at least one person is better off
• exists if there is both allocative efficiency + productive efficiency

Question 9

What is perfect competition ?

Answer 9

• market structure whose assumptions are strong, therefore unlikely to exist in the
  vast majority of real-world markets
• some insights from studying a world of perfect competition ➡️ comparing/contrasting with imperfectly competitive markets
• eg. small bakeries in a large city, small scale wheat rowers, sporting bets, fruit seller in a big street market

Question 10

Characteristics of perfect competition ?

Answer 10

• many sellers (highly competitive)
• identical costs
• identical/homogenous products
• no entry/exit barriers
• perfect knowledge of market (same access to info)
• firms are price takers (little/no choice in price as firms producing identical products)
• normal profits in LR (but SR loses OR supernormal profits are possible)
• profit maximisation assumed as key objective of firms + consumers assumed to maximise utility

Question 11

SR profit maximisation in PC ?

Answer 11

• market price is set by the interaction of market S&D
• each individual firm is a price taker in a perfectly competitive market
• the ruling market price becomes the AR + MR curve for the firm
• average revenue equals marginal revenue at every level of output
• assume that the aim of each firm is to find a profit-maximising output
• can also makes losses in SR (if ruling market price is less than average costs)

Question 12

When may a firm consider shutting down production (PC) ?

Answer 12

• in SR, a business will continue to supply products if revenue covers variable costs ie. revenue = AR x Q
• VC are costs that vary directly w/output eg. raw materials, component parts & employees paid an hourly wage
• providing that price per unit (AR) > average variable cost (AVC), then a contribution is being made to cover some fixed (overhead) cost
• as a result the firm would be better off continuing production if we assume that FC are lost if a shutdown decision is made
• but, if there is a fall in demand & price drops below AVC, then a firm might decide to shutdown production to minimise their losses
• this is because not enough revenue is being generated & total losses suffered would be
  higher if production continued

Question 13

LR profit maximisation in PC ?

Answer 13

• produce at quantity where MR = MC
• Supernormal profits in SR encourages entry of new firms into market by profit motive
• causes an outward shift in supply, forcing down the ruling market price until price = LRAC
• at this point, each firm is making normal profit where P (AR) = AC
• no further incentive for movement of firms in/out of market so LR equilibrium in established where price = AC at output where MR = MC ➡️ all firms making normal profit (P = AC)
  ie. new firms enter market (no barriers) and will increase supply ➡️ price drops (profit competed away)

Question 14

Economic efficiency in perfect competition ?

Answer 14

• ✅ allocative (both in SR & LR as price = MC)
• ✅ productive (attained in LR, output is at lowest point of AC)
• ❌ dynamic (LR no as lack of supernormal profits but SR possibly)

Question 15

Why are competitive markets good for economic efficiency ?

Answer 15

1. lower prices (many competing firms) XED will be high ➡️ consumers prepared to switch to most competitively priced products
2. low barriers to entry: entry of new firms ➡️ competition + ensures prices kept low
3. lower total profits + profit margins than monopoly
4. greater entrepreneurial activity ➡️ for comp to be improved + sustained there needs to be genuine desire to innovate/invent to drive markets
5. competition ensures firms move towards productive efficiency + avoid X-inefficiency
6. threat of comp ➡️ faster rate of technological diffusion (firms need to be responsive to changing needs of consumers ie. dynamic efficiency)

Question 16

Evaluating assumptions of PC model ?

Answer 16

• ❌ most firms have some amount of price-setting power (price makers)
• ❌ dominance in real world markets of differentiated/branded products
• ❌ highly complex products (always info gaps facing consumers)
• ❌ impossible to avoid search costs even w/spread of digital/web tech
• ❌ patents, control of intellectual property, control of key inputs all ignored by model
• ❌ rare for entry/exit to be costless
• ❌ model assumes there are no externalities - in reality often 3rd party effects of every market

Question 17

Pros & cons of PC market structure ?

Answer 17

• ✅ consumers not exploited by firms (eg. higher prices)
• ✅ equality: products are the same (consumers able to buy the same product)
• ✅ no ‘wasted’ costs in terms of advertising etc
• ❌ consumers face lack of choice + cannot necessarily find a product that perfectly meets their needs
• ❌ firms are unlikely to be able to grown large enough to benefit of economies of scale

Question 18

What is monopolistic competition ?

Answer 18

• form of imperfect comp, can be found in many real-world markets eg. coffee shops in busy town centre or local hairdressers
• similar to PC but more realistic as products are differentiated (means businesses have some control over their products ie. price setting power - AR curve slopes downwards)

Question 19

Characteristic of Monopolistic competition ?

Answer 19

• imperfect comp
• large no. of sellers & buyers ➡️ concentration ratio low
• perfect info
• selling similar/differentiated products
• low barriers to entry/exit ➡️ allows firms to respond to profit signals
• firms have price making powers (downward sloping demand curve) - BUT little
• economic profit/loss in SR
• normal profits in LR
• firms aim to max profits + consumers aim to max utility
• productive + allocatively inefficient

Question 20

SR profit maximising in monopolistic competition ?

Answer 20

• supernormal profit/loses in SR

Question 21

LR profit maximising in monopolistic competition ?

Answer 21

• new firms attracted by SR economic profit so enter the market (no barriers to entry/exit)
• this reduces demand for original firm as some consumers buy products from new/alternative firms
• demand falls so price falls (curve becomes slightly more elastic) + MR will shift inwards
• only normal profits made in LR equilibrium ie. AR = AC

Question 22

Economic efficiency in LR monopolistic competition ?

Answer 22

• ❌ allocatively efficient: prices above MC
• ❌ productively efficient: saturation of the market meaning businesses unable to exploit fully internal economies of scale causing LR average costs to be higher
• ✅❌ dynamic: LR no but SR possibly + associated w/extensive consumer choice & innovation but lower profit margins
• ✅ ❌ x-inefficiency
• heavy spending on marketing & advertising- wasteful & inefficient use of scarce resources ?
• social costs of packaging & negative externalities from packaging

Question 23

What is an oligopoly ?

Answer 23

• imperfectly competitive market with a high level of market concentration (rule of thumb an oligopoly exists when the top 5 firms in market account for more than 60% of market sales ie. C5 concentration ratio > 60%)

Question 24

Characteristic of an oligopoly ?

Answer 24

• industry dominated by few large firms
• high entry/exit barriers
• high concentration ratio
• interdependence of firms (firms affected by how other firms set prices & output) affect strategic decisions
• differentiated products (similar not identical) ie. brands
• dominant firms can enjoy economic profits (prices tend to be quite stable/often avoid price comp)
• use non-price competition
• change in ATC doesn’t necessarily change output

Question 25

What is meant by concentration ratio ?

Answer 25

• measure the combined market share of the top ‘n’ firms int he industry
• value of ‘n’ is often 5 but may be 3 or any other small no.
• add market share of top ‘n’ firms
• 5-firm c ratio > 60% = oligopoly

Question 26

What is meant by strategic interdependence ?

Answer 26

• oligopolies are interdependent thus strategy becomes very important ➡️ must try to anticipate rivals responses to changes in price/non-price strategies
• one firm’s output + price decisions are influenced by the likely behaviour of competition ie. decisions of one firm influences that of another
• because there are few sellers, each firm is likely to be aware of the actions of others
• causes oligopolistic industries to be at risk of tactic or explicit collusion can lead to allegations of anti-competitive behaviour
• always high level of uncertainty

Question 27

What are the key decisions that oligopolies need to make ?

Answer 27

• whether to compete or collude with rivals
• whether to use price comp or not
• whether to leave prices alone & us non-price comp

Question 28

What is non-collusive behaviour in an oligopoly ?

Answer 28

• firms don’t work together, instead they compete w/each other in terms of price/non-price comp
• all business behaviour in oligopolies is strategic + will depend on the key objective of the business (maintaining a satisfactory rate of profitability, protecting market share, growing user base, reacting to decisions of rivals)

Question 29

Non-price competition in an oligopoly ?

Answer 29

key aspect in oligopoly especially when prices are rigid between competing suppliers

• better quality customer service eg. good after sales service
• long opening hours eg. 24/7
• discounts of product upgrades
• developing brand loyalty through advertising or promotions (reduces XED + allows firms to charge higher prices)
• exclusivity/loyalty schemes
• advertising + branding
• innovation
• environmental impact (ethical?)
• variation in design, style, service, quality of product
• contractual relationship w/suppliers eg. apple has singed exclusive distribution agreements (O2 for the iphone - gives apple 10% of sales from phone calls + data transfers)

Question 30

Why is branding important for oligopolies ?

Answer 30

• significant feature of non-collusive comp, especially in oligopoly where building + maintaining market share is often a dominant business objective

Question 31

Types of price competition in oligopolies ?

Answer 31

• prices tend to be quite stable BUT may chose to compete on price:
• price wars: firms repeatedly cut their prices over time ➡️ may lead to SR increases in sales & revenue but not in LR commercial interests of a business
• predatory pricing: occurs when a firm deliberately tries to push prices low enough to force rivals out of the market ➡️ often started by the biggest firm as they are the most dominant (know they will win or less risk if they don’t as have the most cash reserves) ➡️ bigger market share = move towards monopoly
• limit pricing: the incumbent firm sets a low price + a high output so that entrants cannot make a profit at that price ➡️ best achieved by selling at a price just below ATC of potential entrants ➡️ this signal to potential entrants that profits are impossible to make ➡️ reduces new entrants + less chance of a firm joining & becoming dominant

Question 32

Who are the winners and losers of price wars ?

Answer 32

winners:
- regular consumers (will see an increase in consumer surplus)
- managers (sales revenue will increase if demand is price elastic - may lead to higher sales bonuses)

losers:
- shareholders (if prolonged price war leads to lower profits)
- suppliers (may get squeezed if a firm uses monopsony power to lower the prices of their supplies)
- smaller firms (may not be able to absorb possible losses from an intense price war)
- the govt (lower profits = decline in corporation tax revenues

Question 33

What are the 1st and 2nd mover advantages ?

Answer 33

• the advantages of going first or going second
• sometimes it pays to go first because a firm can generate head-start profits
• 2nd mover advantage occurs when it pays to wait & see what new strategies are launched by rivals and then try to improve on them or find ways to undermine them

Question 34

Why are not all competitive oligopolies bad ?

Answer 34

• can achieve high levels of efficiency
• can still offer high quality, competitive prices etc

Question 35

When is competition more likely in oligopolies ?

Answer 35

• one firm has lower costs than the others
• there is a large no. of big firms in the market ➡️ makes it difficult to see what others are doing
• firms produce very similar products
• entry barriers are low

Question 36

What is collusive behaviour in oligopolies ?

Answer 36

form of anti-competitive behaviour often refers to businesses working together to agree to jointly set prices high and/or restrict output

• horizontal (same stage of production)
• vertical (different stages of production)
• explicit v tactical collusion (ie. open v quiet collusion)

Question 37

What are the key aims of business collusion in an oligopoly ?

Answer 37

1. maximise joint profits
2. lowers costs of competition eg. wasteful marketing wars
3. reduces uncertainty + higher profits increase producer surplus/ shareholder value ➡️ higher prices

Question 38

When is collusion more likely to occur in an oligopoly ?

Answer 38

• firms have similar costs
• few large firms in market ➡️ easier to see what others are doing
• lots of brand loyalty exists (consumers less likely to buy from competitors)
• entry barriers are high

Question 39

What are the legal forms of business collusion ?

Answer 39

not all instances of collusive behaviour deemed illegal by EU Competition Authorities

1. if agreements contribute to improving the production or distribution of goods OR to promote technical progress in a market’
2. development of improved industry standard of production + safety which benefit the consumer
3. info sharing designed to give better info to consumers
4. research joint ventures + know-how agreements which seek to promote innovative + inventive behaviour (R&D)

Question 40

What is formal collusion ?

Answer 40

• firms have actively agreed to collude (known as a cartel) ➡️ usually illegal
• desire to achieve joint profit maximisation or prevent price/revenue instability
• price fixing represents attempt by suppliers to control supply + fix price at a level close to level expected from a monopoly
• to collude on price, producers need some control over market supply + have strong price-making powers

Question 41

Conditions when price-fixing cartels are likely to occur in an oligopoly ?

Answer 41

1. ineffective industry regulators ➡️ regulatory failure
2. penalties for collusion are low relative to gain in profits (fines don’t act as a proper deterrent
3. few firms in the market + price inelastic demand (PED<1) ➡️ higher prices lead to increased revenues
4. participating firms have a high % of total sales (allows them to control market supply)
5. firms can communicate well + trust each other (helped by having similar strategic objectives)
6. products are standardised + output within the cartel is easily measurable so that supply can be controlled
7. brands are strong (consumers will not switch demand when collusion raises prices)
8. there are other strong barriers that prevent consumers from switching to other products/alternatives

Question 42

Why do many price-fixing cartels eventually break down ?

Answer 42

1. enforcement problems: cartel aims to restrict production to max total profits BUT each seller finds it profitable to expand their production ➡️ other firms not part of cartel may sell under cartel price (increased sales)
2. falling market demand eg. recession: creates excess capacity in market ➡️ puts downward pressure on profits + cash flow in cartel
3. successful entry of non-cartel firms: undermines a cartel’s control of the market
4. exposure of price-fixing by whistle-blowing firms ie, firms engaged in cartel pass on info to the competition authorities in hope of more lenient treatment from regulators

Question 43

What is informal collusion ?

Answer 43

• a tactic where firms observe one another + decide that it’s best for them not to compete on price (as long as the others do the same)

Question 44

Collusions and economic efficiency/social welfare ?

Answer 44

• UK Competition and Market Authority (CMA) believes that cartels are damaging to economic efficiency + economic welfare
• argue that cartels are a major barrier to comp + can lead to significantly increased prices & reduction of output, inefficiency, innovation + choice (all harmful to consumers)
• penalties for UK business found engaged in price-fixing cartels + other forms of anti-competitive behaviour: fines of up to 10% of their turnover (breach of competition law) + can face up to 5 years of imprisonment, unlimited fines, directors disqualification up to 15 years + potential confiscation of assets (convicted of a cartel offence)

Question 45

Costs of collusive behaviour in oligopolies ?

Answer 45

• ❌ damages consumer welfare: higher price/lost consumer surplus, loss of allocative efficiency, has a regressive impact (hits lower income families)
• ❌ absence of competition hits efficiency: X-inefficiencies leads to higher unit costs, less incentive to innovate (loss of dynamic efficiency), output quotas penalise firms who want to expand)
• ❌ reinforces the cartel’s monopoly powers: harder for new businesses to enter the market ➡️ reduced market contestability
• ❌ higher prices (ensure economic profit) + lower output

Question 46

Potential benefits of collusive behaviour in oligopolies ?

Answer 46

• ✅ general industry standards can bring social benefits
• ✅ fairer prices for producer cooperatives in lower/middle income developing counties: competing more effectively w/powerful corporations who have monopsony power ➡️ may help in reducing extreme income poverty
• ✅ profits have value - how are they used: R&D leading to dynamic efficiency, higher waged for employees (increased consumption)

Question 47

Why are not all collusive oligopolies bad ?

Answer 47

• they’re unlikely to last long/temporary (sooner someone will cheat + try to get first move advantage)
• formal collusion is quite unlikely as it’s illegal
• if firms aren’t competing on price then they are likely to be competing strongly in non-price ways ➡️ should lead to improvements in products + quality (dynamic efficiency)
• firms are unlikely to increase prices too high (would encourage new entrants to the market)

Question 48

What is game theory ?

Answer 48

• used to model the actual behaviour of businesses in concentrated markets
• the study of how people & businesses behave in strategic situations (i.e. when they consider
  the effect of other people’s responses to their own actions)

Question 49

What is the prisoner’s dilemma ?

Answer 49

• a game that illustrates why it’s difficult to cooperate, even when in the best interest of both parties
• both players are assumed to select their own dominant strategies for personal gain
• eventually, they reach an equilibrium in which they are both worse off than they would have been, if they could both agree to select an alternative (non-dominant) strategy

Question 50

Key game theory concepts ?

Answer 50

• cooperative outcome: an equilibrium in a game where the players agree to cooperate
• dominant strategy: where a single strategy is best for a player regardless of what strategy other players in the game decide to use
• nash equilibrium: any situation where all participants in a game are pursuing their best possible strategy given the strategies of all of the other participants
• tacit collusion: where firms undertake actions that are likely to minimise a competitive response eg. avoiding price-cutting OR
  firms may end up raising prices but without ever having discussed it or reached a formal
  collusive agreement
• whistle blowing: when one or more agents in a collusive agreement report it to the authorities
• zero sum game: an economic transaction in which whatever is gained by one party must be lost by the other

Question 51

What is the relevance of game theory ?

Answer 51

• relevant to analysing business decision making when there are relatively few firms
• standard game theory assumes rational agents are looking to maximise their own self-interest
• more complex game theory reveals that people businesses can develop co-operative and/or collaborative behaviours eg. the rise of joint ventures/altruism
• 🔔 Key evaluation point for the exam: Game theory can over-simplify complex decisions, and when there are more than 2 rival firms in a market the degree of complexity increases - many firms fall back on rules of
  thumb when making decisions on price, advertising budgets, production levels & much else beside

Question 52

When does a monopoly occur ?

Answer 52

• pure monopoly: occurs when there is only one firm in the industry ie. 100%
• dominant monopoly: has more than 40% market share
• legal/working monopoly: occurs if a firm has more than 25% of the market share eg. British gas
• natural monopoly: occurs when the most efficient number of firms in an industry in one eg. provision of rail network

Question 53

What are the charcteristics of a monopoly ?

Answer 53

• a single supplier that dominates the entire market (or very low levels of competition)
• price maker ➡️ downward sloping demand curve (AR)
• high barriers to entry/exit (preventing new firms entering the market to compete)
• product differentiation & advertising ➡️ more desirable = higher price
• economic profit can be made in both SR & LR
• allocative & productively inefficient
• due to the low levels of comp: consumers have little choice, price usually higher than it would be in a competitive market, qnty supplied is lower than in a competitive market, little pressure to innovate/ launch new products/ offer excellent customer service
• aim to maximise profit ie. operate where MR=MC

Question 54

Profit maximisation for a monopolist ?

Answer 54

• has price setting power because they face a downward sloping demand curve
• if AR is falling, MR will be below ➡️ in order to sell an additional unit, a firm is assumed to lower the price of all units sold & not just the marginal unit sold

Question 55

What is a natural monopoly ?

Answer 55

• occurs when a large business can supply a market at a lower price than smaller ones
• a situation in which there cannot be more than one efficient provider of a good ➡️ industry where the min efficient scale is a large share of market demand

Question 56

How is a natural monopoly different from other industries ?

Answer 56

• A natural monopoly is a special case where one large business can supply the entire market at a lower unit cost than with multiple providers
• This is because of the nature of costs in a natural monopoly industry. Typically there are very high fixed costs and low marginal costs.
• eg. the supply of water or electricity to houses and businesses involves building a big network infrastructure
• As a result, fixed costs are enormous but the marginal cost of adding an extra user is very low
• Therefore, the average total cost will continue to fall as extra users are added to the network. This is an internal economy of scale.
• This means that long run average cost (LRAC) may fall across all ranges of output. Only one firm might reach the minimum efficient scale.

Question 57

How might a monopoly be beneficial ?

Answer 57

• large size allows for economies of scale (if able to avoid diseconomies of scale then AC will fall)
• potentially dynamic efficient eg. R&D (secure in market + expects to make a profit ➡️ long term view + invest in new products, innovation + invention
• when a market is dominated by a few large firms they may still compete with each other on price, quality + service
• intellectual property rights (copyrights/patents) can be in consumers interest (firm can protect its idea so is willing to spend money on designing new products)
• monopolies may choose to be efficient
• international competition

Question 58

What is price discrimination ?

Answer 58

• when businesses charged different consumers different prices for the same good/service
• several types of discrimination BUT focus on 3rd degree (charging different prices to groups of consumers segmented by price elasticity of demand, income, age, sex)

Question 59

What are the aims of price discrimination ?

Answer 59

• increase TR (turning consumer surplus into producer surplus)
• increase total profits (providing marginal profit from selling to customers is positive)
• generate cash flow (especially during a recession)
• increase market share + build consumer loyalty
• to more more efficient use of a firm’s spare capacity
• to reduce the amount of waste + cut costs of keeping products in stock/storage

Question 60

Examples of price discrimination ?

Answer 60

• mobile phone contracts/tariffs
• taxi fares at peak times of the day
• cinema ticket prices
• hairdresser discounts
• educational bursaries
• student/retirement prices

Question 61

What conditions are required for third-degree price discrimination ?

Answer 61

• firms have sufficient monopoly (market) power ie. price making powers
• identifying different market segments i.e. groups of consumers with different PEDs
• ability to separate different groups (requires information / sufficient market intelligence on the purchasing behaviour of consumers)
• ability to prevent re-sale (arbitrage) ➡️ no secondary markets where arbitrage can take place at intermediate prices e.g. limiting sales, age-restrictions, compulsory use of ID cards

Question 62

What are the possible disadvantages of price discrimination ?

Answer 62

• ❌ higher prices for some consumers ➡️ leading to a loss of consumer surplus + reduction in allocative
  efficiency (if P>MC; the consumer surplus is reallocated into producer surplus (i.e. profit))
• ❌ can increase regional inequality if some consumers can only access goods/services at higher prices
• ❌ may be an increase in transaction costs or administration costs for businesses (have to ensure
  that the market is sub-divided + consumers in each group are kept separate e.g. checking ID documents
  for age / status etc. This can possibly reduce profit)
• ❌ groupings of consumers isn’t perfect e.g. relatively well-off adults taking night-school courses may have a student card + be able to access student discounts, despite being able to pay the normal adult price)
• ❌ additional profits earned may allow incumbent firms to adopt anti-
  competitive practices e.g. predatory pricing, higher entry barriers through more spending on advertising etc ➡️ can entrench the firm’s dominant market position + cause even higher prices in the future

Question 63

What are possible advantages of price discrimination ?

Answer 63

• ✅ lower prices for some groups of consumers, who might not otherwise be able to afford the good/service in
  question, therefore widening market access
• ✅ more profits for the business can result in higher dividends for shareholders + a positive wealth effect
• ✅ more profits can lead to reinvestment / business growth as well as R&D
• ✅ businesses can make better use of spare capacity, increasing demand in quieter times and reducing
  overcrowding/excess demand at leak times

Question 64

Price discrimination evaluation points ?

Answer 64

• impact depends on the extent to which price discrimination is used
• impact depends on how businesses choose to use profits
• it is very difficult in practice to agree on a ‘fair price’ – it is a matter of perspective

Question 65

Economic efficiency in a monopoly ?

Answer 65

• standard case against monopoly is that it is leads to a loss of economic efficiency which can then cause reductions in the welfare of consumers affected
• ❌ allocative
• ❌ productive (profit max instead)
• ✅ dynamic (make profit but may not reinvest)
• ✅ X-inefficient

Question 66

Evaluating monopoly power ?

Answer 66

• natural monopoly (might be more productively efficient to have a monopoly supplier)
• competition in the supply chain – possible to introduce competition at different stages of the supply chain
  e.g. via competitive tendering, franchises
• “In theory …. But in practice”: Best to judge a monopoly on a case by case basis using an evidence-based
  approach to how a monopoly actually behaves in the market. This is a really powerful evaluation tool!
• contestability – the threat of entry into a market can be a powerful influence on firms with monopoly power
• definition of the market – a business might have monopoly power in the domestic market but face significant
  international competition

Question 67

What is a monopsony ?

Answer 67

• a monopsony has buying or bargaining power in their market (can exploit their bargaining power with a supplier to negotiate lower prices)
• the reduced cost of purchasing inputs increases their profit margins
• eg. NHS, education, defence, Amazon, food manufactures, increasingly supermarkets

Question 68

What are the characteristics of a monopsony ?

Answer 68

• market with a single dominant buyer (ie. sole employer or buyer)
• significant buying power + bargaining power
• might abuse their market power
• profit maximise where MCL = MRP
• assume many sellers of the product/labour
• price/wage maker so can drive down prices/wages
• tends to be bad for workers + suppliers
• tends to be good for consumers

Question 69

Benefits of monopsonies to firms ?

Answer 69

• ✅ allows bigger firms to achieve purchasing economies of scale leading to lower LRAC
• ✅ lower purchase costs bring about higher profits + increased returns for shareholders
• ✅ the extra profit might be used to find capital investment or R&D

Question 70

Impact of monopsonies on consumers ?

Answer 70

• ✅ lower prices ➡️ increase consumer surplus e.g. supermarkets negotiate better prices from manufacturers that are then passed on to consumers BUT monopsony may not pass on benefit to consumers
• ✅ improved value for money eg. the NHS can use its bargaining power to cut the prices of drugs used in treatments (cost savings allow for more treatments within the NHS budget)
• ❌ less choice
• ❌ poorer quality products (due to suppliers needing to save money)

Question 71

Impact of monopsonies on suppliers ?

Answer 71

• ❌ lower prices + less revenue
• ❌ less economic profit ➡️
• ❌ less finance to reinvest
• ❌ might be forced out of business or need to change markets
• ❌ may need to find new business to sell goods to
• ❌ may need to make cutbacks or produce less quality due to £

Question 71

Impact of monopsonies on employees of monopsony ?

Answer 71

• ❌ lower wages
• ❌ less workers employed = more work
• ❌ less choice of employers + alternative job opportunities

Question 71

Impact of monopsonies on employees of supplier ?

Answer 71

• ❌ potential wage cuts (decline in profits)
• ❌ potential job losses
• ❌ potential poorer working conditions due to less £ being received

Question 72

What are contestable markets ?

Answer 72

• a market where there is freedom of entry/exit (low barriers) allowing new suppliers to come into a market + provide fresh competition to established businesses
• entry/exit must be costless

Question 73

How is the behaviour of firms determined by the potential for competition ?

Answer 73

• lower prices
• innovation + brand differentiation
• more likely to reinvest profits
• manage risks more carefully
• better quality

Question 74

What are the characteristics of contestable markets ?

Answer 74

• no/low of sunk costs (costs that cannot be recovered if a firm decides to leave an industry eg. asset write-offs, closure costs (redundancy pay, penalty costs on leasing) loss of business reputation)
• no significance to the no. of firms in the market
• susceptible to hit and run tactics
• low/no barriers to entry/exit
• low consumer loyalty
• little regulations
• easy access to tech
• perfect info
• easy access to raw materials + skilled labour
• a pool of businesses willing to enter the market
• no LR supernormal profits
• LR economic efficiency
• allocative + productively efficiency