7.6: Different market structures Flashcards
1
Q
Define perfect competition
A
A market with a large number of small firms
2
Q
Characteristics
A
- many buyers and sellers in the market with perfect knowledge
- firms are price takers
- homogenous products
- free exit and entry into the market
- has any influence on the market price
3
Q
Why are profits likely to be lower in a competitive market then a market with a few large firms?
A
- A firm in a competitive market has a small market share, so their market power is small.
- If firms make a profit, new firms will enter the market, due to low barriers to entry, as the market looks profitable.
- New firms increase supply in market which lowers average price, hence, existing firms’ profits will lessen.
4
Q
Advantages of perfectly competitive firms
A
- In the long run, P (AR) = MC, so firms are allocatively efficient
- Firms produce at the lowest point on AC curve, so they’re productive efficient
- Supernormal profits earned in the short-run can make firms increase their dynamic efficiency through investment and innovation
5
Q
Disadvantages of perfectly competitive firms
A
- In long-run, there’s lack of dynamic efficiency as supernormal profits aren’t made
- Pollution = lot’s of firms competing –> more production –> more consumption –> pollution in market
- In reality, this is a theory and realistically there’s no perfect information
- Lack of variety of good (all homogenous)
6
Q
Define monopoly
A
A single firm dominating the market
7
Q
Characteristics of a monopoly
A
- a single seller
- no close substitutes
- high barriers to entry
- price maker
8
Q
State the factors that a monopoly is influenced by
A
- barriers to entry (high BTE make it easy to obtain monopoly power)
- number of competitors
- advertising
- degree of product differentiation
9
Q
Explain barriers to entry: Economies of scale
A
- firms grow = lower AC
- existing large firms have cost advantage over new firms, which helps maintain their monopoly power
- deters new firms from entering the market as they’re not able to compete with existing firms
10
Q
Barriers to entry: Limit pricing
A
This is when existing monopoly firms set the price of their goods below the COP of new entrants to ensure they won’t enter the market profitably
11
Q
Barriers to entry: Sunk costs
A
If unrecoverable costs are high (like advertising), this will deter new entrants into market as they’re unable to compete
12
Q
Barriers to entry: Set-up costs
A
The cost for new entrants to enter the market is expensive, so it’s unlikely the new firm will enter the market
13
Q
Barriers to entry: Brand loyalty
A
If consumers are loyal to one brand (the monopoly), it’s hard for new entrants to gain market share
14
Q
The number of competitors
A
Few number of firms –> high barriers to entry –> new entrants gain less market share
15
Q
Advertising
A
Advertising creates customer loyalty –> makes the demand price inelastic –> creates high barriers to entry for new firms
16
Q
Degree of product differentiation
A
- The more differentiated a product is, the easier it is to gain market share
- More unique product is –> monopoly firm faces less competitors
17
Q
Advantages of a monopoly
A
- Supernormal profits can be used to invest in research and development to make the firm more dynamically efficient in long run (more innovation)
- Benefit from EOS when firm is large and AC is low. Producers benefit with supernormal profits and consumers benefit from low prices
- Increase in international competitiveness (more capital-intensive tech, invest better quality, firm can compete internationally with making investments from supernormal profits)
18
Q
Disadvantages of a monopoly
A
- Monopolies exploit consumers by charging them high prices. This means the good is under-consumed and consumer’s needs are not met. This allocatice inefficiency is a market failure where P (AR) > MC
- DOS can occur when overtime monopoly firms become too big and AC rises which makes the firm difficult to manage
- Monopolies have no incentive to become more efficient as they have few or no competitors, so COP is high
19
Q
Define natural monopoly
A
This is an industry that is most efficient where only one firm produces a good or service rather than several firms
20
Q
Evaluation for monopolies
A
- Depends on whether market is contestable (contestable market faces threat of entry, so this creates incentive for firms to keep prices low)
- Depends on management (large monopolies have successful management
- Depends on government regulation (if govt threatens price discrimination, this reduces excess of some monopolies)
- Depends on industry
- Depends on environmental factors (a monopoly that restricts output, reduces its environmental impact as it reduces consumption)
21
Q
Define monopolistic competition
A
Many firms selling differentiated (heterogeneous) products
22
Q
Characteristics of monopolistic competition
A
- many buyers and sellers
- few barriers to entry and exit
- consumers face wide variety of choice of differentiated products
(heterogenous) - each firm has slight monopoly power (it controls its own brand through non-price competition)
- price maker
23
Q
Advantages of monopolistic competition
A
- Consumers get a wide variety of differentiated products
- Prices are lower, output is higher than monopoly
- High competition encourages firms to keep cost down and provide high quality products
- Supernormal profits made in short-run can increase dynamic efficiency in firms through innovation/investment
- Model of monopolistic competition is more realistic than perfect competition as its still an imperfectly competitive firm and buyers and sellers have imperfect information
24
Q
Disadvantages of monopolistic competition
A
- Price is higher and output is lower than in perfect competition
- Dynamic efficiency will be limited due to lack of supernormal profits in long run
- Firms are not as efficient as those in a perfectly competitive market as they have x-inefficiency, which means they have little incentive to minimise costs
25
Define oligopolistic markets
A few large firms dominate the market and they are mutually interdependent
26
Characteristics of oligopolies
- market dominated by few large firms
- firms are mutually interdependent (firms must decide their market strategy to compete with close rivals)
- high barriers to entry and exit
- products are both differentiated and undifferentiated
- price rigidity (prices don't change that much/often)
27
Describe what is collusion
- Oligopolistic firms work together to set high prices in the market
- Collusion leads to lower consumer surplus, higher prices, and SNP profits which allows oligopolies to act like monopolies and maximise their joint profits
- Collusion is beneficial for firms, not consumers as prices are set high
- Firms have strong incentive to collude as they maximise their benefits, restrict output, and cause market prices to increase which deters new entrants as it's an anti-competitive practice
- Collusion is more likely to happen when there are few firms, they face similar costs, high barriers to entry, and it's not easy to be caught (as it's illegal)
28
Describe a non-collusive market
- Establishes a competitive oligopoly
- Occurs when there's several firms
- Occurs when firms are competing
- Homogenous products
- One firm has a cost advantage
- Market is saturated
- Firms grow by taking market share from rival firms
29
Describe formal collusion
- A collusion where firms formally agree to come together to collude and set high prices in the market
- This can be cartels
- E.g: OPEC is a cartel
30
Describe tacit collusion
- This is when firms make an informal agreement to come together without speaking to their rivals
- This is done to avoid government regulators (as it's an illegal practice)
31
Describe cartels
- This is where two or more firms come together and agree to control prices
- E.g: OPEC is a famous cartel
- Cartel's objective is to lead to high prices for consumers and restrict output
- Some cartels choose to divide the market up, so firms agree to not compete in each others markets
32
Describe price leadership
- Where one firm sets the price in the market and other firms follow
- Usually, it's the dominant firm in the market that sets the price
- Firms are often forced to follow and change the price, otherwise they risk losing a significant amount of market share
- This explains why there's price stability in oligopolies as firms don't want to lose market share if they don't follow the price change
- The price leader is the one to judge the prevailing market conditions and decide
33
Describe price war
- This is where firms in the market set prices way below that of their rivals
- Rival firms also start lowering their prices and this occurs into a back and fourth price war between firms decreasing their prices
- This is done in order to deter new entrants out of the market
- In the short-run, firms will not be maximising profits and instead will be making a loss
34
Describe non-price competition
- Firms aim to increase brand loyalty which makes demand more price inelastic
- E.g: Advertising, marketing, offering special features
- Advertising and marketing makes firms more known to consumers which attracts them and increases demand
- But, it's difficult to know what the effect of increased advertising spending will be as it may be ineffective for firms who can incur large sunk costs which are unrecoverable
- Brand loyalty --> price inelastic --> attracting and keeping firms --> higher market share
35
Describe barriers to entry
- Firms may have high barriers to entry in order to drive out competitors in the market and gain higher market share
- This prevents new entrants from entering the market profitably
- Increases producer surplus
36
Advantages of oligopoly firms
- Earns SNP --> invest in R&D --> yields positive externalities --> dynamically efficient in long-run --> increase in innovation
- firms are more likely to invest when their ideas are protected --> market has high barriers to entry
- Large oligopolies experience EOS, so their AC falls
37
Disadvantages of oligopolies
- Collusion results in a loss of consumer welfare as prices are set high and output is restricted, so less consumer surplus
- Collusion reinforces monopoly power --> makes it harder for new firms to enter the market --> less competition --> decreases efficiency --> increase AC of production
