Market Structures

Question 1

What is allocative efficiency ?

Answer 1

occurs when resources are allocated in a way that maximizes overall societal welfare or utility. In a perfectly competitive market it occurs when P=MC . This means that market is producing the quantity of the good that maximizes consumer and producer surplus.

Question 2

What is productive efficiency ?

Answer 2

achieved when a firm or an economy produces goods and services at the lowest possible cost. Resources are being used efficiently to minimize production costs. In competitive markets, productive efficiency is realized when AC=MC.

Question 3

What is dynamic efficiency ?

Answer 3

refers to the ability of an economy to innovate and adapt over time. Involves the long-term competitiveness and growth potential of an economy. Linked to innovation, technological progress, and the ability to adapt to changing circumstances.

Question 4

What is X-inefficiency ?

Answer 4

occurs when a firm is not operating at its lowest possible cost, even in the absence of competitive pressures. This inefficiency can arise due to factors such as poor management, lack of motivation, or the absence of competition.

Question 5

Efficiency/Inefficiency in a perfectly competitive market:

Answer 5

Allocative and productive efficiency are typically achieved because firms are price takers and have no market power. Resources are allocated efficiently, and firms produce at minimum cost.

Question 6

Efficiency/Inefficiency in a monopoly market:

Answer 6

Allocative inefficiency because they can set prices above marginal cost, resulting in deadweight loss. However, a monopoly can be productively efficient if it operates at the minimum point of its average cost curve.

Question 7

Efficiency/Inefficiency in a monopolistic market:

Answer 7

Firms may not achieve allocative efficiency because they have some degree of market power, but they compete on product differentiation. Productive efficiency may not be fully realized either, as firms may operate at less than minimum average cost due to product differentiation.

Question 8

Efficiency/inefficiency in an oligopoly:

Answer 8

They engage in price competition, leading to allocative inefficiency. However, they may invest in research and development, contributing to dynamic efficiency. Whether productive efficiency is achieved depends on the specific industry.

Question 9

Efficiency/inefficiency in Mixed or Regulated Markets:

Answer 9

Governments may intervene to promote allocative and productive efficiency through regulations, subsidies, or antitrust policies.

Question 10

Characteristics of perfect competition:

Answer 10

1-Homogeneous or Identical Products
2-Large number of sellers
3-No entry or exit costs
4-perfect information
5-price takers
6-Zero Long-Run Economic Profit
7-Non-collusive behaviour
8-Perfect Mobility of Resources

Question 11

(Perfect competition) Profit maximising equilibrium in the short run:

Answer 11

In the short run, a firm in perfect competition seeks to maximize its profit or minimize its loss.
-MC < P, the firm should increase its output
- MC > P, the firm should decrease its output
-MC = P, the firm is maximizing its profit at the current output level.

Question 12

(Perfect competition) Profit maximising in the long run:

Answer 12

In the long run, firms in perfect competition adjust to reach a state of zero economic profit.
If firms are making economic profit in the short run, new firms will enter the market due to the absence of entry barriers. This increases supply, lowers prices, and reduces the profits of existing firms.
If firms are incurring economic losses in the short run, some firms will exit the market, reducing supply, raising prices, and allowing remaining firms to potentially cover their costs.

Question 13

Characteristics of monopolistically competitive markets:

Answer 13

1-Product Differentiation
2-Many sellers
3-Easy Entry and Exit
4-Non-price competition
5-Limited Price Control
6-Short run and Long run profit
7-Imperfect Information

Question 14

(Monopolistic competition) Profit Maximizing Equilibrium in the Short Run:

Answer 14

Firms maximizes its profit by producing the quantity of output where MC=MR.

Question 15

(Monopolistic competition) Profit Maximizing Equilibrium in the Long Run:

Answer 15

monopolistically competitive firms face competition and have the flexibility to adjust their product characteristics, prices, and production levels.
If a firm is making economic profits, new firms will be attracted to the market due to its attractiveness. This will increase competition.
As more firms enter, the demand for each individual firm’s product decreases, leading to a decrease in the demand curve for each firm.
In the long run, the firm’s economic profit will be reduced to zero as the demand curve shifts to the left.
Firms may continue to operate with zero economic profit, as long as they cover their average total costs (ATC).
If firms are experiencing losses, some may exit the market, and the remaining firms may experience a smaller decrease in demand, allowing them to cover their costs.

Question 16

Characteristics of Oligopoly:

Answer 16

1High Barriers to Entry and Exit (significant barriers that prevent new firms from entering the industry. e.g. high capital requirements, economies of scale, patents, and government regulations)

2-High concentration ratio (small number of large firms dominating the market. concentration ratio measures the market share held by the largest firms in the industry)

3-Interdependence of Firms (Oligopolistic firms are highly aware of the actions and decisions of their competitors. They must consider how their own choices, such as pricing and marketing strategies, will affect the behaviour and reactions of rival firms)

4-Product Differentiation (Oligopolistic firms often engage in product differentiation to distinguish their offerings from competitors. This can include branding, quality variations, and advertising to create brand loyalty)

Question 17

What is the definition of an Oligopoly ?

Answer 17

A market dominated by a few firms.

Question 18

What is the calculation of n-Firm Concentration Ratios and Their Significance?

Answer 18

The n-firm concentration ratio measures the combined market share of the largest n firms in an industry. It is calculated by summing the market shares of these firms.

Higher concentration ratios indicate a more concentrated industry with fewer dominant firms.

Lower concentration ratios suggest a more competitive industry with a greater number of smaller firms.

It can provide insights into the degree of market power held by the largest firms and potential antitrust concerns.

Question 19

What are the reasons for collusive behaviour?

Answer 19

Maintaining High Prices: Firms in an oligopoly may collude to set high prices and limit competition, increasing their profits collectively.

Stability: Collusion can provide market stability, reducing uncertainty for firms and consumers.

Avoiding Price Wars: Collusion helps firms avoid destructive price wars.

Question 20

What are the reasons for non-collusive behaviour?

Answer 20

Competition: Firms may choose to compete aggressively to gain market share and increase profits individually.

Legal Constraints: Antitrust laws and regulations prohibit collusion, encouraging firms to compete independently.

Differences in Objectives: Firms may have differing goals and incentives that make collusion difficult.

Question 21

What is overt collusion?

Answer 21

Overt Collusion: Occurs when firms openly agree to cooperate and set prices or output levels. This can lead to the formation of cartels, which are explicit agreements among firms to coordinate their actions.

Question 22

What is tacit collusion?

Answer 22

Tacit Collusion: Involves firms behaving in a manner that resembles collusion without any explicit agreement. Firms may follow observed pricing patterns set by competitors or engage in price leadership, where one dominant firm sets the price and others follow suit.

Question 23

What is single game theory (Prisoners Dilemma)?

Answer 23

The prisoner’s dilemma is a classic game theory scenario where two rational players, in this case, two firms, make decisions that result in suboptimal outcomes. In an oligopolistic context, if both firms choose to compete aggressively, they may trigger a price war and both suffer lower profits. However, if both firms collude and set high prices, they both earn higher profits. The dilemma arises because each firm has an incentive to betray the collusion agreement to gain a larger share of the profits, but if both firms do this, they both end up worse off.

Question 24

What is price wars?

Answer 24

Price Wars: Fierce competition where firms continuously lower prices to gain market share, often resulting in reduced profits for all.
(For market share)

Question 25

What is limit pricing?

Answer 25

Limit Pricing: A strategy where a dominant firm sets prices low enough to discourage new entrants from the market. (No new firms entering?)

Question 26

What is predatory pricing?

Answer 26

Predatory Pricing: Occurs when a firm sets very low prices with the intent of driving competitors out of the market, after which it can raise prices. - (Ideally the bigger firm would do this)

Question 27

What are the types of non-price competition?

Answer 27

Product Differentiation: Firms emphasize the unique qualities and features of their products through branding, quality, design, or advertising. Advertising and Marketing: Firms engage in extensive advertising and marketing campaigns to create brand loyalty and awareness. Innovation: Competing through the development of new products, technologies, or processes. Customer Service: Offering exceptional customer service and support as a competitive advantage. Distribution Channels: Establishing efficient distribution networks to reach customers faster and more conveniently.

Question 28

What are the characteristics of a monopoly?

Answer 28

Single Seller: In a monopoly, there is only one firm or seller that dominates the entire market, with no close substitutes for its product. Unique Product: The monopolist typically offers a unique product that has no perfect substitutes. This lack of substitutes gives the monopolist significant control over pricing. High Barriers to Entry: Monopolies often maintain their dominant position due to high barriers to entry, which can include factors like patents, economies of scale, control over essential resources, and government regulations. Price Maker: A monopoly has the power to set the price of its product, and it faces a downward-sloping demand curve. It can choose the price and quantity of output to maximize its profits. Market Power: Monopolies have substantial market power, meaning they can influence market conditions, restrict output, and charge higher prices than would be possible in a competitive market. Long-Run Profitability: Monopolies can earn long-term economic profits because of their ability to set prices above their production costs.

Question 29

Profit maximising equilibrium in a monopoly market:

Answer 29

Profit-maximizing equilibrium occurs where MC equals MR. 1-Calculate the marginal revenue curve (MR) by finding the change in total revenue resulting from a one-unit change in output. 2-Identify the quantity of output where MR = MC. This is the profit-maximizing quantity (Q*). 3-Determine the price (P*) at which the firm will sell this quantity by locating it on the demand curve. 4-Monopolist will maximize profit by producing Q* units of output and charging P* as the price.

Question 30

What is 3rd degree price discrimination ?

Answer 30

Involves charging different prices to different groups of consumers. For example different groups of customers have differing Price elasticities of demand. To maximise profits firms must take into account differing demand elasticities. e.g. Age Younger people have less disposable income than older people so charging younger people less will lead to profit maximisation. Effects on producers: - Producers can capture more consumer surplus, potentially increasing profits. Effects on consumers: -Consumers in the less elastic group benefit from lower prices. -However Consumers in the more elastic group pay higher prices, which can lead to reduced consumer surplus.

Question 31

Cost and benefits of monopoly to firms , Consumers , employees and suppliers:

Answer 31

Firms: Monopolies can earn significant profits in the long run, but they may face regulatory scrutiny and risk of government intervention. Consumers: Consumers may face higher prices, limited choices, and reduced consumer surplus. Employees: Monopolies may offer job security but can also reduce competition in labour markets, potentially impacting wages. Suppliers: Suppliers may have limited bargaining power and face pressure to offer lower prices.

Question 32

Natural Monopoly:

Answer 32

natural monopoly occurs when a single firm can efficiently serve the entire market due to significant economies of scale. Key features include: -High fixed costs relative to variable costs. -Declining average total cost as production scales up. -It is often found in industries like utilities (water, electricity) and infrastructure (railways, telecommunications). Natural monopolies can benefit consumers by providing services at lower costs than multiple competing firms would achieve, but they require regulation to prevent potential abuse of market power.

Question 33

What are characteristics of a contestable market ?

Answer 33

1-Low Barriers to entry an exit (easy for new companies to enter the market and compete with existing firms. Barriers to entry could include factors like high start-up costs, government regulations) 2-Perfect Information (perfect information about market conditions, including prices, costs, and demand) 3-No Sunk Costs (This means they can exit the market without suffering substantial financial losses) 4-No Collusion

Question 34

Implications of contestable markets for the behaviour of firms:

Answer 34

1-Price Competition ( intense price competition since they know that new entrants can easily undercut their prices if they attempt to charge excessive prices) 2-Efficiency and Innovation (Firms have an incentive to operate efficiently and innovate to maintain a competitive edge) 3-Short-Term Focus (short-term focus on maximizing profits since they are aware that the market conditions can change rapidly with the entry of new competitors.) 4-No Monopoly Power

Question 35

Types of barriers to entry and exit:

Answer 35

1-Economies of Scale (Firms that can produce at lower average costs due to economies of scale may deter new entrants, as newcomers may struggle to compete with established firms' cost advantages) 2-Capital Requirements ( High start-up and capital investment costs can be a significant barrier to entry) 3-Government Regulation ( Regulatory barriers, such as licensing requirements or safety standards, can limit entry into certain markets) 4-Access to Distribution Channels (Difficulty in accessing distribution channels or securing shelf space can act as a barrier) 5-Brand Loyalty (Established brands with strong customer loyalty can deter new entrants from gaining market share) 6-Network Effects (In industries where the value of a product or service increases with the number of users (network effects), it can be challenging for new entrants to compete with established networks) 7-Patents and Intellectual Property ( Firms with strong patent protection or proprietary technology can create barriers to entry by preventing others from using their innovations)

Question 36

Sunk costs and the degree of contestability:

Answer 36

Sunk costs are costs that have already been incurred and cannot be recovered. The presence of sunk costs can affect the degree of contestability in a market. In a contestable market: -Low Sunk Costs: When firms have minimal sunk costs, it becomes easier for them to exit the market if conditions become unprofitable. This enhances the contestability of the market, as firms are not financially tied to the industry. -High Sunk Costs: If firms have significant sunk costs, such as substantial investments in specialized equipment or infrastructure, they are less likely to exit the market quickly. High sunk costs can reduce the degree of contestability because firms may continue to operate even when they are not earning a profit, hoping to recoup their initial investments.