Chapter 3 Market Failure Flashcards
The levels of competitiveness within s market will be influenced by the structure of the market which is often determined by the following:
The number of firms – this may look at the total number of firms and also whether any particular firms have a large share of the market
- The products degree of homogeneity (similarity) – in other words the products can either be virtually identical or highly differentiated
- The ease with which new firms enter (or leave) the market – in some markets there may be natural or artificial barriers to entry which would restrict competition
- The way firms may compete – they may compete purely on price or rely heavily on advertising and product differentiation
What are the 4 basic market structures?
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Define perfect competition
- A Market structure where there are: many buyers and sellers, homogenous products, freedom of entry and exit to the market, perfect information and where producers seek to maximise profit while consumers seek to maximize utility e.g. victoria market
Factors of a perfect market
There are many buyers and sellers in the market – this means that each party involved in a transaction is a price taker as they have no ability to influence the market price that is determined through the forces of demand & supply
• The goods offered by suppliers are homogenous – meaning they are virtually identical and easily suitable, encouraging competitors to offer the lowest price possible
• Firms can enter & exit the market freely – thus there are few barriers such as government restrictions licenses or high set up costs. Also a lack of artificial barriers set up by firms
• Freedom to enter the market ensures that if a good increases in popularity and profit making opportunities exist new entrants will put pressure on existing suppliers to maintain low prices or potentially lower further.
• All buyers and sellers operate with perfect information – they are able to access and therefore compare all prices and can search the availability of resources, thus economic agents make informed rational decisions based on the info
• All resource are mobile and can be moved easily to where they can be used in there most profitable manner
• Each party aims to maximize there wellbeing – suppliers = profit, consumers = utility
Define monopolistic competition
An industry that is also highly competitive, with many similarities to perfect competition, but products are differentiated rather than homogenous
e.g small businesses – gardening, plumbing, hairdressing & motor mechanics
Factors of a monopolistic competition
Like perfect market – large number of buyers and sellers who are well informed about the products that are available
• It is easy for firms to enter and exist the market and there are a few or no restrictions on firms wishing to compete in such a market
• Sellers in this market will engage in product differentiation – they will try to make their product different to the competition in some way, despite their products being similar in nature
How may monopolistically competitive firms try to differentiate their products
Physical = Offering different size, colors and tastes, textures and quality
e.g. takeaway stores
Location = Firms will want to minimize the time and distance needed for consumers to acquire the product – location is usually where the firms believes they will maximize their exposure to potential customers – and therefore enhance the ability for potential sales.
Services = Firms may deliver a range of services to their customers with products e.g. loyalty cards
Image (branding) = Firms in a monopolistic competitive market will try to create an image or lifestyle that is associated with their product so that customers develop brand loyalty
Define oligopoly
An industry where a few (very large) firms tend to dominate the industry in terms of market share and volumes sold and there is limited competition
Factors of an oligopoly
An oligopoly may actually include a large number of firms however the structure of the market could be that only a small number (perhaps 2) of the dominate firms have a large market share, while a large number of firms have very little market power.
• Any change in price strategy will tend to have a significant impact upon sales because the price elasticity of demand will be high
• Large setup costs makes it hard for firms to enter the market – thereby act as barriers to enter
• In oligopolistic industries there is always a tendency to engage in practices that minimize price competition (collusion or cartel behavior)
• When there is a high degree of product differentiation in an oligopolistic industry there are a range of factors that the firms take into account when developing strategies. If they develop strong brand loyalty or a quality product, then customers may be less sensitive to price changes.
• Usually the most significant barrier to entry for any new firm wishing to enter an oligopolistic market is the need to achieve economies of scale – also would only be able to attract a small market (setups costs $^)
• One barrier for new entrants to the industry is the difficulty consumers face when switching their banking custom (e.g. loans) from one bank to another – there are sizable financial and transaction costs that effectively prevent many customers from taking their business to another bank
Define monopoly
An industry or market that is dominated by one seller of a product and the product does not have a close substitute.
What is the main reason why monopolists exist?
Is prohibitive barriers to entry which make it impossible for new entrants to enter the market
the barrier to entry may be the result of any of the reasons explained below:
1. The monopolist owning the key resources
- Government giving the monopolist the exclusive right to produce a product – in many cases gov’t may grant one person or a firm exclusive right to manufacture and sell some good or service in order to encourage entrepreneurism and innovation. Patent and copy right laws create monopolies
- The cost of producing the product it so high that it is more efficient to have one producer than having a large number of firms producing it. – A natural monopoly may arise when a single firm can supply a good or service to a market cheaper than two or more firms could.
E.g. Aus post has bee granted legal monopoly to post letters by the gov’t
Define monopsony
A market situation where there is a single buyer for a product
Define market structure
The way different industries are organized in terms of numbers and type of buyers and sellers and the conditions under which they exchange. Market structures range from ones that are highly competitive (e.g. perfect competition) to ones that are highly uncompetitive or highly concentrated (e.g. monopoly)
Explain prefect competition - achieving allocative efficiency and productive efficiency
The producer will generally be supplying the product at a price covering the opportunity cost – at this price the level of output will provide the producer with normal profits that is sufficient to justify a continue a market presence.
• Allocative efficiency is more likely to be achieved in a competitive market as resources will tend to be directed to where they benefit consumers the most and excessive economic profits (or above ‘normal profits’) will generally not be made in long term
• Competitive markets will tend to promote productive or technical efficiency – where the cheapest cost of production is achieved
• A ‘very competitive market’ will contain highly mobile resources and it will therefore be easy to enter or exist markets as demand and supply changes
• If the market is going to be competitive it needs full info and resources will be redirected quickly in response to the change in price signals
• In a perfect market – businesses will make things in the most efficient way, businesses will make things that meet the needs + wants of consumers, business will make the right quantity of things that consumers desire, resources will go to those who value them most.
Explain monopoly’s impact on social welfare
A monopolist will generally be able to choose the quantity it supplies to the market after analyzing of it’s demand curve.
- Will be able to maximize profits through choosing a point on the demand curve where profits are highest
- If the demand for a product is price inelastic then it will be in the monopolists interest to set a price higher until price elasticity of demand is equal to 1 – this will ensure that revenue and profits are maximized
- The outcome in a monopoly market will generally be beneficial to society if the monopolist is in pursuit of a profit – a monopolist may choose to restrict output resulting in the market price to rise.
Define market failure
When an unregulated market is unable to allocate resources effectively or where resources are allocated in such away that national living standards or welfare is not maximized, resulting in a over allocation of resources to the production of some goods and services and an under allocation of others.
Explain private goods
Are those which are excludable and rival in consumption
e.g. as one person increases consumption of water from the given bottle, it reduces the amount available for other consumers by the same amount
most goods in the market are private – you don’t get it until you pay for it and once consumed it cannot be consumed by anyone else
Explain public goods
Are both non-excludable and non-rival (non-depletable e.g coal) in consumption. A person who does not pay for the good cannot be excluded from consuming it and one persons consumption does not lesson another’s ability to consume the product
The existence of public goods leads to the ‘free rider problem’
Define “free rider”
A an economic agent who receives the benefit from public-goods but does not pay for it
Explain the problem of ‘free riders’
The existence of free riders means the market will tend to under-allocate resources to those goods where the producer cannot charge all end-users
• Capitalists looking for profit making ventures would be reluctant to enter an industry where they would not charge their customers for at least the opportunity cost of producing the product – as a result producers will choose to allocate scarce resources elsewhere – meaning society miss out on the opportunity to consume this product, meaning there is an under allocation of resources to it’s production
E.g Aus’t gov’t pays for the defence of Australians – consequently the market is operated freely and resources are under allocated leading to an inefficient allocation of resources (either too small or too big)
Government intervention (public goods)
The Gov’t will intervene in those market where it deems the provisions of public goods important – the government will provide defence using the revenue derived from a range of sources including taxes
