Market Structures

Question 1

What is allocative efficiency

Answer 1

Allocative efficiency occurs when resources are distributed to the goods and services that consumers want

Question 2

What is productive efficiency

Answer 2

This is when firms produce at the lowest point on the short run or long run average cost curve

Question 3

What dynamic efficiency

Answer 3

This is when all resources are allocated efficiently over time, and the rate of innovation is at the optimum level, which leads to falling long run average costs

Question 4

What is X-inefficiency

Answer 4

A firm is x-inefficient when it is producing within the AC boundary. Costs are higher than they would be with competition in the market

Question 5

List characteristics of perfect competition

Answer 5

• Many buyers and sellers
• Sellers are price takers
• Free entry to and exit from the market
• Perfect knowledge
• Homogeneous goods
• Firms are short run profit maximisers
• Factors of production are perfectly mobile

Question 6

List some advantages of perfectly competitive market

Answer 6

• In the long run, there is a lower price.
  P =MC, so there is allocative efficiency
• Since firms produce at the bottom of
  the AC curve, there is productive efficiency
• The supernormal profits produced in
  the short run might increase dynamic efficiency through investment

Question 7

List some disadvantages of perfectly competitive market

Answer 7

• In the long run, dynamic efficiency
  might be limited due to the lack of supernormal profits
• Since firms are small, there are few or no economies of scale
• The assumptions of the model rarely apply in real life. In reality, branding, product differentiation, adverts and positive and negative externalities, mean that competition is imperfect

Question 8

What are some characteristics of monopolistically competitive markets

Answer 8

• A monopolistically competitive market has imperfect competition. Firms are short run profit maximisers
• Firms sell non-homogeneous products
• There are no barriers to entry to and exit from the market
• Imperfect information

Question 9

What are some advantages of monopolistically competitive markets

Answer 9

• Firms are allocatively inefficient in the short and long run (P > MC)
• Since firms do not fully exploit their factors, there is excess capacity in the market
• Consumers get a wide variety of choice
• The model of monopolistic competition is more realistic than perfect competition
• The supernormal profits produced in the short run might increase dynamic efficiency through investment

Question 10

What are some disadvantages of monopolistically competitive markets

Answer 10

• In the long run, dynamic efficiency might be limited due to the lack of supernormal profits
• Firms are not as efficient as those in a perfectly competitive market

Question 11

What are some characteristics of an oligopoly

Answer 11

• High barriers to entry and exit
• High concentration ratio: In an oligopoly, only a few firms supply the majority of the market
• Interdependence of firms: actions of one firm affect another firm’s behaviour
• Product differentiation

Question 12

What is collusive behaviour

Answer 12

Collusive behaviour is when firms agree to work together on something, this is illegal

Question 13

What can collusion lead to

Answer 13

Collusion leads to a lower consumer surplus, higher prices and greater profits for the firms colluding

Question 14

When is collusion likely to happen

Answer 14

Collusion is more likely to happen where there are only a few firms, they face similar costs, there are high entry barriers, it is not easy to be caught and there is an ineffective competition policy

Question 15

What is overt collusion

Answer 15

When a formal agreement is made between firms

Question 16

What are some costs of collusion

Answer 16

• There is a loss of consumer welfare, since prices are raised and output is reduced
• The absence of competition means efficiency falls. This increases the average cost of production
• It reinforces the monopoly power of existing firms and makes it hard for new firms to enter
• A lower quantity supplied leads to a loss of allocative efficiency

Question 17

What are some benefits of collusion

Answer 17

• Industry standards could improve. This is especially true in the pharmaceutical industry and for car safety technology
• Excess profits could be used for investment, which might improve efficiency in the long run
• It saves on duplicate research and development
• By increasing their size, firms can exploit economies of scale, which will lead to lower prices

Question 18

What is a cartel

Answer 18

A group of two or more firms which have agreed to control prices, limit output, or prevent entrance of new firms

Question 19

What is price leadership

Answer 19

Price leadership is when one firm changes their prices and other firms follow

Question 20

What is game theory

Answer 20

Game theory is related to the concept of interdependence between firms in an oligopoly

Question 21

State and explain types of price competition

Answer 21

• Price wars: Involves firms constantly cutting their prices below that of its competitors
• Predatory pricing: Predatory pricing is illegal. It involves firms setting low prices to drive out firms
  already in the industry
• Limit pricing: This is not necessarily illegal. Low prices discourage the entry of other firms, so there are low profits

Question 22

What is non-price competition

Answer 22

These aim to increase the loyalty to a brand, which makes demand for a good more price inelastic

Question 23

What are some types of non-price competition

Answer 23

• Special offers: Buy one get one free, free gifts, or loyalty cards, might be used to attract consumers and increase demand
• Advertising and marketing might be used to make their brand more known and influence consumer preferences

Question 24

name some characteristics of a monopoly

Answer 24

• Profit maximisation: A monopolist earns supernormal profits in both the short run and the
  long run
• Sole seller
• High barriers to entry
• Price maker

Question 25

What factors influence monopoly power

Answer 25

- Barriers to entry: The higher the barriers to entry, the easier it is for firms to maintain monopoly power - Economies of scale: As firms grow larger, the average cost of production falls because of economies of scale allows for a cost advantage over new entrants - Limit pricing: This involves the existing firm setting the price of their good below the production costs of new entrants - Owning a resource: Early entrants to a market can establish their monopoly power by gaining control of a resource - Sunk costs: If unrecoverable costs, such as advertising, are high in an industry, then new firms will be deterred from entering the market - Brand loyalty: If consumers are very loyal to a brand, which can be increased with advertising, it is difficult for new firms to gain market share

Question 26

What is cross subsidisation

Answer 26

A situation in which one group of customers or clients is charged a higher price for a product or service in order to subsidise a lower price for another group.

Question 27

What are some costs of a monopoly for consumers

Answer 27

Usually, price discrimination results in a loss of consumer surplus. Since P > MC, there is a loss of allocative efficiency. It strengthens the monopoly power of firms, which could result in higher prices in the long run for consumers

Question 28

What are some costs of a monopoly for producers

Answer 28

If it is used as a predatory pricing method, the firm could face investigation by the Competition and Markets Authority. It might cost the firm to divide the market, which limits the benefits they could gain

Question 29

What are some benefits for consumers as a result of a monopoly

Answer 29

- Consumers could benefit from a net welfare gain as a result of cross subsidisation, if they receive a lower price - Some consumers, who were previously excluded by high prices, might now be able to benefit from the good or service

Question 30

What are some benefits for producers as a result of a monopoly

Answer 30

- Producers make better use of spare capacity - The higher supernormal profits, which result from price discrimination, could help stimulate investment - If more profits are made in one market, a different market which makes losses could be cross subsidised, especially if it yields social benefits.

Question 31

What is a natural monopoly

Answer 31

A natural monopoly arises when there are high fixed costs, usually in the form of infrastructure

Question 32

What are some characteristics of a monopsony

Answer 32

- A monopsony is a single buyer in a market - It is assumed that monopsonists are profit maximisers - A firm with monopsony power is able to negotiate lower prices, because their suppliers have nowhere else to sell to - Firms with monopsony power are able to set the market price

Question 33

What are some costs of a monopsony to firms, consumers, employees and suppliers

Answer 33

- It is the monopsony power of supermarkets that has led to many farmers losing profits - Employees are likely to lose out with lower wages e.g. coal miners could be easily exploited due to little choice of employer - Workers might become unproductive if wages are low

Question 34

What are some benefits of a monopsony to firms, consumers, employees and suppliers

Answer 34

- The NHS has monopsony power when buying drugs from pharmaceutical companies. They are able to negotiate lower prices for the drugs - By lowering the price paid to suppliers, consumers might receive lower prices