Economics Stage 4 Flashcards
Monopolistic Competition, Oligopoly and Market Regulation. (40 cards)
What is the Market Structure of the Monopolistic Competition?
- Monopolistic competition is a market structure where:
▪ A large number of buyers and sellers are present (i.e. limited market power).
▪ Barriers to entry and exit are low (i.e. only normal profits are made in the long-run).
▪ Firms can differentiate their products (i.e. products are heterogenous).
▪ Firms compete on quality, price, and marketing.
What is Product Differentiation in Monopolistic Competition?
- Firms in a monopolistic competition market have the ability to alter their products to make them different to the products offered by their competitors.
- A common approach is through branding.
- Brands can be purely symbolic (e.g. fashion labels) or attempt to communicate a non-visible feature (e.g. organic or fair trade).
What 3 ways does Product Differentiation occur?
- This product differentiation allows firms to compete in three different ways:
▪ Quality Competition– firms may develop high quality products (e.g. more durable, reliable, and with better customer support).
▪ Price Competition– a firm producing a lower quality good may sell that product at a lower price than the market price.
▪ Marketing Competition– a firm producing a higher quality good may conduct marketing activities and alter its packaging to bring this to the attention of
consumers.
How can Price Differentiation be observed?
- An example of a monopolistic competition
market structure is that of prepared foods. - Retailers stock a large range of crisps that are
differentiated based on:
▪ Branding– Walkers and Kettle
▪ Ingredients– flavour
▪ Variation– crinkle cut and pringle
▪ Size– 35g and 150g
▪ Price– premium and basic
- This allows the market for prepared foods to
display high levels of product differentiation
How does Short-Run affect a Monopolistic Competition?
- Assume a firm in a monopolistic competition
market introduces a new product variant. - Initially, they are the sole provider of this new
product variant. - As a result of this, in the short-run the situation
facing the firm is much the same as a monopoly.
How does Short-Run affect Monopolistic Competition?
- As there are low barriers to entry in monopolistic
competition, the short-run economic profit
attracts new entrants. - These new entrants mean that the firm’s demand
curve reduces and shifts to the left with a
corresponding shift in the MR curve.
This is done until all economic profit has been competed away.
How does Monopolistic Competition benefit an economy?
- If products are changed to improve their
features then the development cost incurred
could represent a good investment.
▪ Firm earns economic profit in the short-run.
▪ Consumers get better and higher variety goods. Is product differentiation a good thing?
- If products are changed to improve their
features then the development cost incurred
could represent a good investment.
▪ Firm earns economic profit in the short-run.
▪ Consumers get better and higher variety goods.
- What about if a firm simply invests in
advertising to create the illusion of a superior
product?
▪ The fixed costs of the firm increases which also
increases its average total costs.
▪ If a firm can sell more due to advertising, it
could lower its ATC.
How does a Monopolistic Competition damage the Economy?
- The capacity output of a firm is where the ATC is at
its lowest point. - An interpretation of this is that monopolistic
competition markets are generally inefficient. - These markets could be producing products at
lower average prices if there was no product
differentiation. - However, consumers value variety and uniqueness.
What is an Oligopoly Market?
- Oligopoly is a market structure where there are a few firms present.
- The products these firms sell can be homogenous or heterogenous.
- These small number of firms are linked in terms of their decision making.
- The price setting behaviour of a firm depends on their expectations regarding how their competitors will respond.
- There are broadly two traditional approaches to understanding the operation of oligopoly markets:
▪ Kinked-Demand Curve Model
▪ Dominant Firm Model
What is a Kinked Demand Curve?
A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices.
- A firm is considering changing the price it charges but is conscious of the responses of its competitors.
- Firms in an oligopolistic market are encouraged not to change their prices– prices are stable.
- Firms in oligopolistic markets participate in non-price competition such as quality improvements and branding.
What is a Dominant Firm Graph?
- Occurs when there is a large difference present in the size (i.e. level of output) of one of the firms within the oligopolistic market.
- The larger firm will likely have a significant cost advantage over its competitors.
- This is due to economies of scale, with the dominant firm operating at a lower point on the Long Run Average Cost Curve.
- In this situation:
▪ The dominant firm has the capability to set the market price for the product (i.e. they are the price leader).
▪ The competitors follow the price set by the dominant firm (i.e. they are price takers).
What is the role of the Government?
- The duty of Government is to protect the interest of its citizens.
- Governments often intervene if they believe market failure is present.
- Market failure occurs when resources are not being efficiently allocated.
- This may occur in instances of:
▪ Public good provision
▪ Monopoly market control
▪ Market collusion
- Markets can be regulated in order to mitigate the effects of these three scenarios.
- Regulation involves the enforcement of rules by the government on such things as prices, standards, and market conditions.
What is a Public Good?
- A public good is classified as a good that is:
▪ Non-Rivalrous – the consumption of the good be one consumer does not restrict consumption of the good by other consumers.
▪ Non-Excludable – it is not possible/practical for a producer to restrict the access of a good.
- Examples of public goods are street lights, ground water, and GPS systems.
- Due to these unique features of public goods it is difficult for firms to make a profit from providing them.
What is the Free Rider Problem?
- A Free rider is a person who consumes a good without paying for it.
- This occurs because of two reasons:
▪ The non-payment by the free rider, by itself, does affect the provision of the good.
▪ The producer of the good finds it difficult to identify free riders and make them pay.
- For example GPS systems are public goods because a private firm would not be able to restrict access to their service.
- As a result of this, goods which suffer from free riders often must be provided by the government rather than private firms.
What is the Tragedy of the Commons?
- This is a situation where a good, which is finite in nature (i.e. rivalrous), is made freely available for consumption (i.e. non-excludable).
- Consumers act in their own self interest which might be counter to the collective interest of all consumers.
- As no consumer has to pay to access the good, there is an incentive to expand consumption.
- If consumption exceeds the carrying capacity then the good will deteriorate.
- This concept was initially developed to describe the situation of open grazing of animals on public land.
- Examples are now present in different areas, notably human use of the:
▪ World Atmosphere
▪ Ground Water
How does the World Atmosphere affect Economics?
- Mankind makes use of the world’s atmosphere as an
environmental sink for waste products such as global and local air pollutants. - This is often classified in economics as a negative
externality. - Negative externalities are present when the cost imposed through an economic action not accounted for.
- To overcome this , governments respond in various ways:
▪ Diplomacy – binding international commitments to reduce emissions.
▪ Regulation – standards on emissions producing activities.
▪ Markets – creation of markets for pollutants.
What is Ground Water?
- Consumers sink wells into the water table to tap aquifers.
- As there is no usage charge, no incentive exists to make efficient use of the resource.
- This can promote over consumption, whereby extraction exceeds recharge.
- To overcome this , governments respond in various ways:
▪ Markets – assign property rights to the ground water.
▪ Regulation – monitor and restrict consumption through licenses.
What are Regulators?
- Overseers of public interest in different economic sectors or to manage particular activates/resources, governments establish regulators:
- Regulators are bodies that are responsible for monitoring activities, developing
and enforcing rules, and investigating questionable practices. - Example of a regulators in the UK are:
▪ Office of Road and Rail – which regulates rail and road sectors of the UK (i.e. a monopoly market).
▪ Office of Gas and Electricity Markets - which regulates the electricity and gas sectors of the UK (i.e. an oligopolistic market).
What is Monopoly Regulation?
- Monopolies can occur when one firm can supply the market at a lower cost than multiple firms (i.e. LRAC declines at all levels of output).
- Monopolies are capable of achieving economic profit in the long run due to high barriers to entry.
- This economic profit reduces the consumer surplus that would be received in an analogous perfectly competitive market.
- Regulators often intervene in such markets through price regulation.
- This can take the form of:
▪ Average Cost Pricing – where monopolies are required to set their prices where ATC = D (i.e. normal profits are received).
▪ Marginal Cost Pricing – where monopolies are required to set their prices where MC = D (i.e. economic loss is incurred).
What is Oligopoly Collusion?
- When there are few firms in the market, an incentive exists for them to communicate in order to fix the market.
- This market fix usual represents an agreement to sell a specific quantity of product or charge a specific price.
- Such action is referred to as market collusion and is a form of anti-competitive behaviour.
- By acting in such a way, firms can form cartels and develop a situation whereby the market acts as a monopoly.
- This provides the cartel with the opportunity to make economic profit equivalent to a monopoly.
What is Oligopoly Regulation?
- Cartels often control the market through output agreements, where each partner produces a specific quantity.
- These quantities are selected to maximise the economic profit that can be achieved across the partners.
- Governments can intervene by requiring firms operating in an oligopolistic market to produce set output quotas.
- These output quotas are selected to achieve an improved outcome for the consumer.
- Governments can also make collusion an illegal practice and levy fines when it is proven to have occurred.
What is Regulatory Capture?
- Monopoly regulation requires the regulator to have accurate information regarding a monopoly’s costs.
- This might be difficult to achieve if managers within the monopoly either:
▪ Inflate the costs – spend more on production than is necessary.
▪ Mask the costs – fudge the numbers or make them difficult to unpack.
- To overcome this, there is often close working between regulators and monopolies with transfers of personnel.
- This can lead to situations where game keepers become poachers.
What are the 4 types of Market Structure?
- Perfect Competition: many buyers and sellers of a homogenous good, few barriers to entry or exit of the market, and perfect information is present about
the market. - Monopoly: one large firm dominates the supply of a product and barriers to entry and exit are high.
- Monopolistic Competition: many buyers and sellers of a heterogenous good and firms differentiate their products to develop short-run monopolies for variants.
- Oligopoly: a small number of firms supply the market and firms tend to apply non-price competition strategies such as quality and marketing.
Why is Macroeconomics studied?
- Macroeconomics represents the study of large scale economic systems.
- This type of study increased in prominence due to:
▪ The greater level of inter-dependence resulting from economic specialisation.
▪ The occurrence of economic depressions and the resulting implications for society.
- Economists began to study the national economic systems to understand:
▪ How they operate– what are the main components.
▪ How they can be measured– what are the key indicators.
▪ How they are linked– the occurrence of international trade.
▪ How they can be controlled– the application of government economic policy.
