Efficiency and market structures .2. Flashcards
(46 cards)
market structure definition
characteristics of a market with determine the firms behaviour
what are all the types of markets
- perfect competition
- monopolistic competition / contestable markets
- oligopily
- monopoly
characteristics of perfect competition
- perfect knowledge
- low barriers to entry
- many buyers and sellers
- homologous products
- price takers
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BUYERS HAVE TO SELL AT THE MARKET PRICE BECAUSE DEMAND IS PERFECTLY ELASTIC, NO DEMAND IF PRICE IS SET ABOVE MARKET PRICE, normal profit
short run profit diagrams in perfect competition
- draw supply demand diagram to the left
- trace MR,D,AR curve from left diagram at equilibrium price across to 2nd diagram on the right
- on the 2nd diagram (right) draw AR and MR , then add the AC
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IF THE AC IS BELLOW = SUPERNORMAL PROFIT
IF THE AC IS ABOVE = SUBNORMAL PROFIT
IF AC IS ON THE LINE = NORMAL PROFIT
long run profit diagrams in perfect competition
if firms are making supernormal profit then firms will enter the market (attracted by profits). This will shift the supply to the right (increase) and reduce the price, so in the LONG RUN ALL FIRMS MAKE NORMAL PROFIT. VICE VERSA
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to show this in a diagram, its the same as the short run but then you need to shift the market price up or down and trace it along to the left diagram and shift the left diagrams supply curve according
why might loss making firms be able to continue production in the short run ?
- take out a loan
- run down retained profits (savings)
- they ask suppliers to paylater
why might loss making firms want to continue production in the short run ?
- in the hopes that they will make supernormal profit in the long run
how do you show shut down points in a diagram
SHORT RUN : (only variable costs must be covered)
- MC, ATC, AVC and MR AR D
- Demand is above AVC but bellow ATC showing a loss in the short run but because AVC are covered the firm can continue production.
- the firm will only shutdown if the AVC exceeds demand /price
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LONG RUN : (all costs must be covered)
- same diagram but the demand/price is equal to AVC
- a firm will shut down if the AVC is greater than demand/AR/MR in the long run
evaluation of model of perfect competition
CRITICISM
- unrealistic because there is never a situation where everyone has perfect knowledge
- not all products are homogeneous
- most markets have barriers to entry
- LACK of supernormal profits in the LR means no reinvestment = no change in dynaic efficiency
DEFENCE
- firms must set low prices and connot exploit consumers
allocative efficiency
allocative efficiency is acheived when the value consumers place on a good or servie equals the cost of the resources used up in production
AR (P) value to consumers = MC cost to producers
productive efficiency
achieved when the output is produced at at minimum average total cost.
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where MC=AC
dynamic efficiency (oligopoly and monopoly)
firms reinvest their supernormal profits in research and development which push down long run average costs, improve quality of goods and services produced. SHOWN on LRAC diagram shifting downwards to LRAC2
X-efficiency / X-efficiency
X-inefficiency occurs when a firm has little incentive to reinvest and control costs due to large profits being earned and a lack of competition. This causes the actual cost to be highert than necessary.
MORE LIKELY WITH MONOPOLIES (protected by high barriers to entry) e.g. overpaying workers, waste , paying more for materials, poor organisation ‘slack’
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X-efficiency more likely to occur in perfectly competitive or contestable markets. Firms must operate on the AC curve to survive as they only make normal profits.
SHOWN BY COST/REVENUE DIAGRAM, 2 AC CURVES (1 curve is actual productivity and 2 is potential productivity)
Barriers to entry
factors which make it difficult or impossible for firms to enter an industry and compete with existing producers.
EXAMPLES:
- patents = giving the firm legal protection to produce a patented product (provides monopoly power in a market and prevents other firms)
- Licences or qualifications
- ownership/control of factors of production
- advertising or marketing developing consumer loyalty making entry for firms to be successful more expensive
- research and development (costs already pushed down and product quality better)
- presence of sunk costs = costs that cannot be recovered after being spent
- high startup costs
Barriers to exit
obsticles to firms leaving the market
e.g.
- sunk costs = costs that cannot be recovered when firms leave e.g. advertising, machinery
- reputation damage = loss of faith in the brand and management team
monopoly
one firm dominant in a market, one firm supplies all without facing cometition due to high barriers to entry
what are the 2 types of monopoly power
legal/working monopoly 25%
dominant monopoly 40%
characteristics of monopoly
unique products , price makers , high barries to entry
what are the degrees of monopoly
PURE monopoly - one firm only = SWR, Southern water
monopoly POWER - the ability to influence the market, set prices = tesco, apple, coca cola
NATURAL monopoly - high start up costs, there is substancial economies of scale = national grid, water
monopoly power
when a firm is able to influence the market price by setting prices charged e.g. tesco, apple
difference between monopoly diagram making a loss and supernormal profit
subnormal profit the average cost is above the AR/MR/D, supernormal profit the average cost is bellow the AR/MR/D
allocative inefficiency
when there is incorrect allocation of resources, price is greater than MC=AR causing a welfare loss.
what are the costs of monopolies
- higher prices and lower output (due to monopoly power)
- because firms are protected by high barriers to entry and lack of competition leading to X-inefficiency (producing at actual AC), less incentive to push down LRAC so less reinvestment
- welfare loss = inefficient allocation of resources
- less consumer choice (consumers forced to buy from the monopoly)
what are the benefits of monopolies
- supernormal profit can be reinvested in research and development to become dynamically efficient and push down the LRAC (cheaper goods) and produce better quality products for consumers. DEPTH = economies of scale and make them more competitive on a global scale
- supernormal profits can be used to cross subsidies other products they produce which are making a loss, this benefits their consumers. e.g. Royal Mail charges the same price for first class stamps in rural areas as urban areas
