Markets In Action

Question 1

Main functions of the price mechanism

Answer 1

Allocation, Rationing, Signalling, Incentives

Question 2

Allocation

Answer 2

Allocating scarce resources away from markets exhibiting excess supply and into markets where there is excess demand

Question 3

Rationing

Answer 3

Prices serve to ration scarce resources when market demand outstrips supply

Question 4

Signalling

Answer 4

Prices adjust and provide information to buyers and sellers. Prices which cause excess demand can act as a signal to firms to raise prices for example

Question 5

Interest rates

Answer 5

The cost of borrowing money

Question 6

Elasticity

Answer 6

The responsiveness of something to changes in another component

Question 7

Nominal Income

Answer 7

Your income without taking into account the rate of inflation

Question 8

Real Income

Answer 8

Your income while taking into account the rate of inflation

Question 9

Perfect competition

Answer 9

1. Homogeneous products
2. Price takers
3. Perfect knowledge
4. Many firms
5. No barriers
6. AR=MR=D

Question 10

Imperfect competition (Monopoly)

Answer 10

1. Differentiated products
2. Price makers
3. Barriers to enter and exit
4. One firm
5. Imperfect knowledge
6. AR=D, MR different

Question 11

Market Conduct

Answer 11

How markets compete and whether firms work in isolation or have competition

Question 12

Market performance

Answer 12

Whether the market satisfices or profit maximises along with market efficiency

Question 13

Reasons for increase market competition

Answer 13

Price and non-price competition which can drive down prices, improve quality of goods. Firms will cut costs leading to greater efficiencies.
Creation of differentiated goods which can give consumers greater variety.

Question 14

Monopolistic competition

Answer 14

A form of imperfect competition. It’s like the perfect competition but more realistic. Many buyers and sellers, slightly differentiated goods, firms are price makers, low barriers to entry and exit, good info, non-price competition, profit maximisers

Question 15

Social efficiency

Answer 15

The optimal distribution of resources in society taking into consideration all the internal and external costs and benefits

Question 16

Oligopoly competition

Answer 16

1. Few firms dominate the market (4-6 hold 60% ms)
2. Differentiated goods
3. High barriers to entry/exit
4. Interdependence
5. Non-price competition
6. Fight for market share over profit maximising

Question 17

Contestable markets

Answer 17

Always changing and driven by the fear of competitors and threat of new entry. Almost all markets are contestable to some degree. An entrant has access to all production techniques with no barriers to entry/exit and no sunk costs.

Question 18

Hit and run entry

Answer 18

When businesses enter an industry to take advantage of temporarily high (supernormal) market profits then leave after taking those profits

Question 19

Sunk costs

Answer 19

Costs that cannot be recovered if a business decides to leave an industry. The existence of sunk costs makes a market less contestable

Question 20

Creative destruction

Answer 20

Evolution of innovations and technologies. When newer innovations destroy older economic structures while simultaneously creating new ones. For example the invention of the automobile caused the fall of the horse and carriage market

Question 21

Price fixing in a cartel

Answer 21

A cartel is a group of firms colluding to maintain high prices. In a competitive market demand is equal to supply but in a cartel they will charge the profit maximising price and will not set prices lower, they restrict output and increase price. Cheating in a cartel can destroy the cartel so they sanction the cheater and rebuild. Main aims are profit maximising and price fixing which is achieved by quarters based on each firms contributions

Question 22

Negatives of a cartel

Answer 22

Cartels allow inefficient firms to stay in business rather than cutting costs or going out of business, while other more efficient members of the cartel enjoy abnormal profits. Cartels portray the disadvantages of monopoly by protecting inefficient firms and enabling firms to enjoy an easy life protected from competition along with unnecessarily high prices for consumers

Question 23

Divorce of ownership from control

Answer 23

A situation where the owners (shareholders) and those who control the firm (managers) are different groups with different objectives

Question 24

Long run monopolistic competition

Answer 24

No allocative efficiency as MC is lower than price, consumers being exploited. No productive efficiency as not producing at lowest point of AC. No dynamic efficiency as no long run sp so not enough profit to reinvest

Question 25

Three business objectives

Answer 25

Profit maximisation, producing where MR=MC. Growth maximisation and survival. Market share Sales revenue maximisation, producing where MR=0

Question 26

satisficing

Answer 26

Achieving a satisfactory outcome rather than the best possible outcome

Question 27

Stakeholder conflict

Answer 27

Different stakeholder groups will have different views on what the company should be doing. Managers may want higher wages, workers may want improved job security and working conditions, shareholders may want to profit-maximise keeping salaries low and not innovating working conditions.

Question 28

Short run and long run perfect competition

Answer 28

As short run involves supernormal profits, new firms are attracted into the market and enter with no barriers. Initially, too many new firms enter into the market and supply expands with price reducing which can lead to subnormal profits which will create incentive to leave the market until a point of normal profits.

Question 29

Pros of a Monopoly

Answer 29

When substantial economies of scale are possible, unit costs of production reduce so firms may reduce prices (unlikely). Firms can use supernormal profits to reinvest into research and development and increase innovation and/or quality of products/services

Question 30

Short run and Long run monopolistic competition

Answer 30

Short run is very similar to monopoly, abnormal profits and low entry barriers + good info causes new firms to enter the market. AR (demand) shifts left for firms as consumers will have more variety of substitute goods. The AC curve becomes tangental to the AR curve at price level causing normal profits

Question 31

Interdependence in Oligopoly

Answer 31

Due to the elastic demand curve, if a firm raises prices, others will not follow causing a large loss in market share and reduced profits. Then the curve kinks to be inelastic, if one firm reduces prices, all firms follow causing reduced profits for everyone which is undesirable, creating price rigidity

Question 32

Pros and Cons of oligopoly

Answer 32

Firms benefit from economies of scale and may pass cost cuts as low prices to consumers, non-price competition causes innovation and development of better products. Small firms may find it difficult to enter the market, risk of mergers and collusion/cartels

Question 33

Price discrimination

Answer 33

Charging different prices to different customers for the same product or service, with prices based on different willingness to pay

Question 34

Consumer surplus

Answer 34

Economic welfare enjoyed by consumers, surplus is the difference between the price paid and the maximum price they were willing to pay

Question 35

Producer surplus

Answer 35

Economic welfare enjoyed by producers, the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept

Question 36

Deadweight loss

Answer 36

The loss of economic welfare when the max attainable level of welfare fails to be achieved

Question 37

Incentives

Answer 37

The level of price acts as an incentive for firms to either expand or cut supply