Market Structures Flashcards
(9 cards)
Perfect Competition - Pros
1) Allocative efficiency is achieved in the long run. This is because firms in perfect competition produce where P=MC at the long run equilibrium point of production. This is where demand equals supply maximising the sum of both consumer and producer surplus a key feature of a highly competitive industry. At this point of production, resources are allocated according to consumer demand with consumers getting what they demand at the exact quantity they desire. Consumer choice is high and prices are low maximising consumer surplus in the market. The quality of the product being sold is excellent too given the drive to meet the needs and wants of the consumer.
2) Productive efficiency si achieved ni the long run. This si because perfectly competitive firms produce
at the lowest point of the average cost curve, where MC=AC at the long run equilibrium point of production. This means all possible economies of scale are being exploited as firms cannot increase output and lower their average costs any further. These lower average costs can translate into lower
prices for the consumer increasing their consumer surplus.
3) X efficiency is being achieved. This is because perfectly competitive firms are producing on the
average cost curve at the long run equilibrium output level. In this sense firms are minimising their unit
costs implying there is no waste in production. For highly competitive firms, being X-efficient is crucial to charge the
lowest prices for consumers increasing their consumer surplus.
Perfect Competition - Evaluation
1) Static vs Dynamic efficiency. Perfect competition delivers static efficiency; consumers benefit hugely as a result as do producers where market share can rise. However dynamic inefficiency is a big loss along with product homogeneity. A case could be
made that consumers may be willing to lose some static efficiency benefits, instead paying slightly higher prices in return for differentiated goods and innovative product developments over time.
2) The notion that firms are always dynamically inefficient in highly competitive industries due to a lack of supernormal profit in the long run may not hold in reality. Firms may be forced to re-invest whatever profits they are making (even normal profits) in order to stay ahead of rivals and
compete in such a fiercely competitive market. This will also be in the long term interests of firms as it gives them an element of monopoly power which they can exploit to increase profits over time.
Monopoly Pros
1) Monopolists can be dynamically efficient as supernormal profit is being made in the long run. Such
profit can then reinvested back into the company in the form of technology advances, innovative new products and R&D. This is hugely beneficial for consumers who will receive brand new, better quality products over time - perhaps able to purchase products that do not yet exist. Prices could be lower over time if technology advances reduce costs for businesses, which are then passed on to consumers. The
choice available to consumers would increase too. For producers, new product development can create monopoly power, especially fi such products are patentable increasing the profit making potential of a business over time. New products can increase market share, crucial ni a competitive industry where the only way to get ahead of rivals is through innovation and R&D. Once more better technology can allow a firm to reduce their costs of production and thus become more profitable over time.
2) Even though monopolists are productively inefficient, they may still be exploiting greater economies of scale than smaller competitive
firms who produce lower levels of output given the ferocity of the competition. The diagram below shows how the costs of production can be lower for monopolists at Mcm, compared to competitive firms at MCc, given their greater economies of
scale exploitation resulting in lower prices charged at Pm and higher quantities produced at Qm than competitive firms. This critique is extremely powerful as ti reverses the outcomes of traditional monopoly theory promoting outcomes that actually benefit society.
) Monopolies have the ability to cross subsidise loss making goods or services that consumers desire allowing production of them
to still take place. Supernormal profit being generated from a successful product can be used to subsidise losses of another product thus increasing social welfare where otherwise the loss making product would have ceased ni the market.
Monopoly Cons
1) Monopolies produce outcomes that are allocatively inefficient. This is because monopolists exploit consumers by charging prices greater than marginal cost at the profit maximising level of output, Qm. At this point of production, resources are not allocated according to consumer demand with consumers getting a lower quantity than they desire. Consumer choice is restricted and prices are high reducing consumer surplus in the market. The quality of the product being sold may suffer too given the lack of competitive forces to meet the needs and wants of
the consumer. Monopolists can get away with allocative inefficiency given the lack of competition in the market where consumers are unable switch
their consumption to rival firms.
2) Monopolies are productively inefficient. This is because they do not produce at the minimum point on the average cost curve choosing instead to voluntarily forgo some economies of scale. Output could
be increased further with lower average costs but as this does not correspond with profit maximisation, where MR=MC, productive inefficiency prevails. As a consequence consumers suffer from higher prices and lower consumer surplus than if all economies of scale were exploited. Monopolists can get away with productive inefficiency given the lack of competition in the market where rival firms who are productively efficient charging lower prices do not exist.
3) Diseconomics of scale
Monopolies can be Xinefficient. This is because monopolies can become complacent and lazy in their
production process allowing waste (cost in excess of average cost) to
creep in at quantity Qm. As a
consequence consumers suffer from higher prices and lower consumer surplus than fi al waste, excess cost, was eradicated. Even though it seems irrational for a monopolist to allow this to take place given a
strict profit maximisation objective, the reality of minimising waste might be tedious and against the interests of managers and workers who may need to change their work habits or the production
process, which is time consuming and requires high effort.
Monopoly Evaluation
1) Monopolies that are heavily regulated may not produce the inefficient outcomes that theory suggests. Effective regulation using price controls, quality measures or forced re-investment wil ensure that the public interest is protected and outcomes closer to allocative efficiency attained without handicapping the monopolist severely and causing them to shutdown.
4) fI the monopoly is a natural monopoly si makes sense for one firm to supply the entire industry, where competition would promote a wasteful duplication of resources and allocative inefficiency. This is true as long as the natural monopoly is regulated to produce at allocatively efficient outcomes; competition here is not in the best interests of society and would reduce welfare.
5) fI a monopoly market is contestable, the end outcomes may not be harmful for society. This can be true fi there is deregulation of a monopoly market reducing consumer inertia for example and taking away many legal barriers to entry that can increase the threat of new entry into the market. Once more monopoly power does not mean there is no competition at al. A monopolist with 25% market share may still be facing stiff competition from rivals forcing the monopolist to produce closer to competitive, allocative and productively efficient outcomes.
6) Use of SNP eg. dividends to shareholders
Also depends on objective of monopolist eg sales maximisation instead
Oligopoly Pros
1) Cartels can be dynamically efficient as supernormal profit is being made in the long run. Such profit can then be reinvested back into the company in the form of technology advances, innovative new products and R&D. This is beneficial for consumers who will receive brand new, better quality products over time - perhaps able to purchase products that do not yet exist. Prices could be lower over time if technology advances reduce costs for businesses, which are then passed on to consumers. The choice available to consumers would increase too.
2) Even though cartels are productively inefficient, they may still be exploiting greater economies of scale than smaller competitive firms who produce lower levels of output given the ferocity of the competition. Costs of production can therefore be lower for cartels compared to competitive firms
resulting in lower prices charged and higher quantities produced, actually promoting outcomes that benefit society.
Oligopoly Cons
1) Cartels produce outcomes that are allocatively inefficient. This is because they exploit consumers by charging prices greater than marginal cost at the profit maximising level of output, Q1. At this point of production, resources are not allocated according to consumer demand with consumers getting a lower quantity than they desire. Consumer choice is restricted and prices are high reducing consumer surplus in the market. The quality of the product being sold may suffer too given the lack of competitive forces to meet the needs and wants of the consumer.
2) Cartels are productively inefficient. This is because they do not produce at the minimum point on the average cost curve choosing instead to voluntarily forgo some economies of scale. Output could be increased further with lower average costs but as this does not correspond with profit maximisation, where MR=MC, productive inefficiency prevails. As a consequence consumers suffer from higher prices and lower consumer surplus than if all economies of scale were exploited.
Oligopoly Evaluation
1) If there are a small number of firms in the industry. This makes ti easier for firms to organise agreements to fix prices or quantities to make supernormal profits. It is also easier for firms to stay in contact with one another reducing the risk of cheating.
7) If the goods being produced by firms are highly differentiated, ti allows a cartel to set high prices much more easily and still expect strong consumer demand, increasing the level of supernormal profit made over time.
Perfect Competition - Cons
1) Dynamic efficiency is not being achieved in the long run. This is because supernormal profits are not being made in the long run thus restricting a firm’s ability to re-invest back into the business. Over time consumers lose out with no technology advances or innovative new products reducing their choice and also preventing price falls in the future.
For producers, their profit making potential reduces without R&D and new product launches which could have been patentable providing monopoly power. New products could have increased market share, crucial in such a competitive industry where the only way to get ahead of rivals is through
innovation and R&D. Once more, better technology could have allowed a firm to reduce costs of production and thus become more profitable over time.
2) Product homogeneity is not in the best interests of consumers who prefer variety rather than having a large number of different sellers all producing the same good or service. This is where allocative efficiency might not actually maximise the benefit to consumers.
3) With such intense competition and a drive to reduce costs as much as possible to survive in the long
term, the actual quality of output may not be as good as it could be. This is because cost savings have
to be made anywhere possible, which might imply poorer customer service and less focus on quality
perks which raise the cost of production but provide the consumer greater satisfaction upon consumption.
4) Aperfectly competitive market can lead to creative destruction, where supernormal profits attract new and more efficient firms into the industry. These new firms will drive out the less efficient incumbent firms who are unable to compete. Whilst this is good news for consumers who see regular price reductions over time due to the efficiency gains, existing firms shutting down wil increase unemployment causing problems for the government.
