Perfect Competition, Imperfectly Competitive Markets and Monopoly 1

Question 1

What are the features of oligopoly?

Question 2

What are the market features of imperfect competition?

Answer 2

A few very large sellers
low freedom of entry
Differentiated products but doesn’t really matter
more imperfect information
Less independent-pay more attention to other producers.

Question 3

What determines the typical behaviour of firms in a particular industry?

Answer 3

Market structures

Market structures classify industries as either imperfectly competitive or perfectly competitive.

Question 4

What are the two main categories of market structure?

Answer 4

Imperfectly competitive and perfectly competitive

Examples of imperfectly competitive structures include monopoly and oligopoly.

Question 5

List the key characteristics that define market structure.

Answer 5

• Number of buyers and sellers
• Freedom of entry and exit
• Product differentiation
• Degree of perfect knowledge
• Degree of interdependence among firms

Question 6

What is a barrier to entry in market structure?

Answer 6

Factors that deter new firms from entering a market

Barriers can include capital costs, sunk costs, scale economies, and more.

Question 7

What are capital costs?

Answer 7

High expenses required to set up a business

An example is the cost of establishing a new mobile phone network.

Question 8

Define sunk costs.

Answer 8

Costs that cannot be recovered if a firm exits the market

Examples include marketing and website setup costs.

Question 9

What are economies of scale?

Answer 9

Cost advantages that arise as production scales up

Industries with large economies of scale may lead to natural monopolies.

Question 10

What are natural cost advantages?

Answer 10

Competitive advantages arising from factors like superior location

Example: A petrol station in the best town location attracting more customers.

Question 11

What are legal barriers to entry?

Answer 11

Laws that restrict new firms from entering a market

Examples include patents and copyrights.

Question 12

What are marketing barriers?

Answer 12

Challenges posed by existing firms with substantial marketing budgets

Heavy advertising can create brand loyalty that new entrants cannot match.

Question 13

What are anti-competitive practices?

Answer 13

Actions taken by firms to hinder new market entrants

Examples include refusing to supply retailers that sell rival products.

Question 14

What is perfect competition?

Answer 14

A market structure where many firms sell identical products and have free entry and exit

Characteristics include perfect knowledge and no significant barriers to entry.

Question 15

What is an oligopoly?

Answer 15

A market structure characterized by a few firms that dominate the market

Firms in an oligopoly are interdependent, meaning the actions of one affect others.

Question 16

What defines a monopoly?

Answer 16

A market structure where a single firm controls the entire market supply

Monopolies can arise from high barriers to entry and significant market power.

Question 18

What is the rule for profit maximisation?

Answer 18

Set marginal revenue (MR) equal to marginal cost (MC)

This means firms produce until the last unit produced has revenue equal to its cost.

Question 19

What assumptions are made in models of perfect competition and monopoly regarding firm objectives?

Answer 19

Profit maximisation is assumed

This is the primary objective of firms in these models.

Question 20

What are some informational difficulties firms face in achieving profit maximisation?

Answer 20

Firms may face:
* Using accounting costs instead of opportunity costs
* Difficulty estimating the demand curve
* Anticipating competitor reactions
* Uncertainty over the time period for maximisation

Question 21

What is the satisficing principle in the context of firm objectives?

Answer 21

Decision makers aim for a target level of profit rather than the absolute maximum

Firms may have multiple aims, with profit maximisation being just one.

Question 22

How does the satisficing principle influence firm behavior?

Answer 22

Firms may set minimum targets rather than maximum and can be less innovative

This occurs as managers seek to satisfy various stakeholders.

Question 23

What is the neo-Keynesian theory regarding profit maximisation?

Answer 23

Firms maximise profits in the long run rather than the short run

This theory suggests firms use a cost-plus pricing strategy.

Question 24

What is the difference between sales maximisation and revenue maximisation?

Answer 24

Sales is measured as volume, while revenue is measured as value

Managers may be judged based on sales or revenue performance.

Question 25

What are some reasons firms might aim for growth maximisation?

Answer 25

Managers gain utility from being in large firms and achieving economies of scale ## Footnote Large firms may offer greater salaries and power.

Question 26

What is the principle-agent problem?

Answer 26

A situation where the shareholder (principal) employs a manager (agent) to act on their behalf ## Footnote It can lead to inefficiencies due to asymmetric information.

Question 27

What are potential solutions to the principle-agent problem?

Answer 27

Solutions include: * Increased monitoring of managers * Linking managers’ salaries to firm profitability

Question 28

What influences the severity of the principle-agent problem?

Answer 28

The problem may be less severe in competitive markets ## Footnote Managers align their goals with shareholders to ensure survival.

Question 29

Fill in the blank: Firms may have multiple aims, and these often lead to ______ behavior.

Answer 29

satisficing

Question 30

True or False: All firms aim to maximise profit as their primary objective.

Answer 30

False ## Footnote Firms may pursue other objectives based on stakeholder interests.

Question 31

What can result from a firm focusing on survival?

Answer 31

Cautious and risk-averse behavior ## Footnote This is particularly common for small businesses during downturns.

Question 32

What is a common pricing strategy used by neo-Keynesian firms?

Answer 32

Cost-plus pricing strategy ## Footnote Firms calculate long run average costs and add a markup for profit.

Question 33

What are the two types of efficiency in economics?

Answer 33

Static and Dynamic efficiency

Question 34

What does static efficiency measure?

Answer 34

Efficiency at a point in time

Question 35

What are the two main measures of static efficiency?

Answer 35

* Productive efficiency * Allocative efficiency

Question 36

What is productive efficiency?

Answer 36

Achieved when production takes place at the level of output associated with the lowest possible average cost

Question 37

At what output level does productive efficiency occur?

Answer 37

At the lowest point on the AC curve.

Question 38

What is X-inefficiency?

Answer 38

When a firm fails to minimise its costs of production

Question 39

What is the difference between productive efficiency and X-efficiency?

Answer 39

Any point on the AC curve is X-efficient, while any point above the AC curve is X-inefficient

Question 40

What defines allocative efficiency?

Answer 40

Resources are used to produce goods and services that consumers want to buy

Question 41

What is the economic definition of allocative efficiency?

Answer 41

A situation where no consumer can be made better off without making another consumer worse off

Question 42

What is the criteria for allocative efficiency in economic theory?

Answer 42

P = MC

Question 43

What does dynamic efficiency measure?

Answer 43

Whether resources are allocated efficiently over a period of time

Question 44

How is dynamic efficiency linked to allocative and productive efficiency?

Answer 44

Investment leads to new/better products or processes that consumers wish to buy or new/better process that allowed the production process to become more efficient.

Question 45

Give an example of dynamic efficiency.

Answer 45

The development of digital streaming to replace physical CDs/DVDs

Question 46

Why is dynamic efficiency used as an argument for monopoly power?

Answer 46

Monopolies may charge higher prices but invest supernormal profits into research and development

Question 47

What industry is given as an example of high prices justifying research into new medicines?

Answer 47

The pharmaceutical drug industry

Question 48

What does perfect competition describe?

Answer 48

A market structure whose assumptions are extremely strong and highly unlikely to exist in most real-time and real-world markets

Question 49

Why is perfect competition still studied?

Answer 49

the theoretical model of perfect competition achieves a high level of economic efficiency. It is used as a benchmark against which to judge other forms of market structure

Question 50

Why have economists become more interested in perfect competition recently?

Answer 50

the rapid growth of ecommerce as a means of buying and selling goods and services

Question 51

What are the basic assumptions for perfect competition to exist?

Answer 51

1. Many small firms - each of whom produces an insignificant percentage of total market output and thus exercises no control over the ruling market price. 2. Many individual buyers - none of whom has any control over the market price – i.e. there is no monopsony power. 3. Perfect freedom of entry and exit from the industry - this assumption ensures all firms make normal profits in the long run. 4. Homogeneous (identical) products - products are perfect substitutes for each other. This leads to firms being price takers and facing a perfectly elastic demand curve for their product. 5. Perfect knowledge – buyers and sellers have perfect market information and can access this at zero cost which means no party has any power or control over the market due to imperfect information.

Question 52

Why is it true that the real world is imperfectly competitive?

Answer 52

Monopoly power, monopsony power, barriers to entry/exit, differentiated products, imperfect information (e.g. information gaps), influence of persuasive marketing and advertising. Asymmetric information, negative and positive externalities- divergence between private and social costs and benefits. There may be imperfect competition in related markets such as the market for essential raw materials, labour or capital goods.

Question 53

What must be the case to achieve the level of efficiency that the theory of perfect competition predicts?

Answer 53

That perfect competition exists in every market in the economy

Question 54

Describe allocative efficiency in perfect competition in the SR & SR

Answer 54

In both the short and long run, price is equal to marginal cost (P=MC) and allocative efficiency is achieved. At the ruling market price, consumer and producer surplus are maximised. No one can be made better off without making some other agent at least as worse off. In other words, the conditions are in place for a Pareto optimum allocation of resources.

Question 55

Why is productive efficiency not achieved in the SR but always in the LR?

Answer 55

Because profit maximising output only occurs at the lowest point of the average cost curve if normal profit is being made. In the short run in perfect competition, there can be firms making supernormal and subnormal profit as well. However in the long run, all firms in a perfectly competitive market will be productively efficient as all firms make normal profit.

Question 56

Why is innovation designed to make products differentiated from each other in order to gain a competitive advantage restricted in perfect competition?

Answer 56

Homogenous products and perfect information. A cost-reducing innovation from one producer will also, be immediately and without cost transferred to all of the other suppliers.

Question 57

What is argued to be the optimum market structure and why?

Answer 57

A competitive market rather than a perfectly competitive market. A competitive (contestable) market is argued to provide the discipline on firms necessary to keep their costs under control (productive/x efficiency) and refrain from exploiting the consumer by setting high prices and enjoying high profit margins (allocative efficiency) whilst at the same time providing the incentive to innovate to gain competitive advantage (dynamic efficiency). this can stimulate improvements in both static and dynamic efficiency in the long run.

Question 58

What are the assumptions of the model of pure monopoly?

Answer 58

There is only 1 firm in the industry. Complete barriers to entry prevent any new firms from entering the market.

Question 59

What is monopoly power?

Answer 59

When a firm is said to have monopoly power when it controls 25% or more of a market.

Question 60

What two sources generally lead to monopoly power?

Answer 60

Barriers to entry Growth

Question 61

What can growth be and what can it allow?

Answer 61

Growth can be either internal (organic) or external (by merger/acquisition). Integration will also potentially increase monopoly power by reducing the number of firms in the industry. Growth allows a firm to gain monopoly power over a market by increasing its market share.

Question 62

How does a monopoly make supernormal profits in the SR & LR?

Answer 62

Pure monopoly faces a downward sloping demand curve because the firm is the industry.(a price maker) Assuming that the monopolist is a profit maximising firm – equilibrium output is where MR = MC, giving output Qm sold at price Pm. AR > AC therefore supernormal (abnormal) profits are being made by the monopolist. In competitive markets, this level of profits acts as a signal for new firms to enter the industry in the long run. But a monopolist is usually able to prevent the entry of new firms by using barriers to entry, thereby allowing them to continue to make supernormal profits in the long run.

Question 63

What static efficiencies will a monopoly achieve?

Answer 63

None, a monopolist will be neither allocatively nor productively efficient at long run equilibrium. At profit maximising output, P>MC (not allocatively efficient) and profit maximising output is not at the lowest point on the AC curve (not productively efficient).

Question 64

Why do firms seek to grow? (motives)

Answer 64

1. The profit motive 2. The cost motive: economies of scale help to raise profit margins 3. The market power motive: increase their market dominance giving them increasing pricing power in the markets 4. The risk motive: desire to diversify production so that falling sales in one market might be compensated by stronger demand in another market. 5. Managerial motives: business expansion may be accelerated by the decisions of managers whose aims and objectives might be different from those who are major shareholders. (growth max)

Question 65

What is organic growth? (internal growth)

Answer 65

Happens when a business expands its own operations.

Question 66

How might organic growth occur?

Answer 66

- Expansion of existing production capacity through investment in new capital and technology (e.g. increasing number of classrooms) - Developing & launch of new products (e.g. offering BTECs or other qualifications) - Growing a customer base through marketing

Question 67

What is external growth?

Answer 67

The fastest route for growth which comes in the form of mergers and aquisitions (intergration)

Question 68

When does horizontal integration occur?

Answer 68

When two businesses in the same industry at the same stage of production become one.

Question 69

What are some examples of horizontal integration?

Answer 69

Disney buys Fox 2019 Facebook buys Instagram 2012

Question 70

What are the advantages of horizontal integration?

Answer 70

1. It increases the size of the business and allows for more internal economies of scale- lower LRAC- improved competitiveness and profits. 2. One large firms may need fewer workers, managers and premises than two- rationalisation to cost save 3. Creates a wider range of products (dversifcation) 4. Reduces competition by removing rivals- increases market share and pricing power (CMA may investigate)

Question 71

What is vertical integration?

Answer 71

When a business aquires another business in the same indsutry but at different stages of the supply chain (production).

Question 72

What are some examples of vertical integration?

Answer 72

Brewers owning and operating pubs Ikea owning forests

Question 73

What are the advantages of vertical integration?

Answer 73

1. Greater control of the supply chain- helping tor reduced costs and improve quality of inputs 2. Improved access to important raw material used in manufacturing 3. Better control over retail distribution channels e.g. pubs can make sure their products are sold in busy pubs and clubs.

Question 74

What does lateral integration involve?

Answer 74

Companies joining together that produce similar but related products e.g. Google and YouTube, Coke and Costa Coffee.

Question 75

What is conglomerate integration (diversification)?

Answer 75

Where the businesses joining together are in unrelated industries e.g. Amazon merger with Whole Foods, Unilever and Diageo.

Question 76

When do joint venture occur?

Answer 76

When two or more businesses work together to pursue a common project or goal. e.g. Google and NASA for Google Earth.

Question 77

What are some evaluative points on integration?

Answer 77

May integrations fail to achieve their aims. Huge financial costs of funding takeover many mergers fail because of clash of corporate cultures and failure to find lower LRAC. Competition policy concerns come into play, especially when there is risk of monopoly. Sizeable job losses with important socio-economic consequences in the area

Question 78

How do smaller businesses survive?

Answer 78

1. Act as a supplier/ sub-contractor to larger enterprises ( e.g. construction industry) 2. Can taker advantage of low PED and high YED for demand for specialist 'niche' goods and services 3. Smaller businesses are often innovative, flexible and can avoid diseconomies of scale.

Question 79

When do demergers happen?

Answer 79

When a business spins off one or more of the businesses that it owns into a separate company. The ai is to improve shareholder value by giving management to focus on reducing debt and costs. Demergers can also result from government intervention- CMA could want a monopoly to be broken up Examples include: Walmart selling Asda 2021, PayPal splitting from eBay 2014

Question 80

Why is competition generally seen as good?

Answer 80

Because of: 1. Lower prices as a result of the large number of competing firms already in the industry and low barriers to entry meaning the potential and actual entry of new firms to provide extra competition and ensure prices are kept low. 2. Economic efficiency Firms attempt to minimize their costs and move towards productive efficiency. Price will be closer to the MC of production leading to greater allocative efficiency. Faster rate of technological progress – e.g. dynamic efficiency - to maintain competitiveness.

Question 81

Why is monopoly generally seen as bad?

Answer 81

1. Monopolists earn extra profits at the expense of economic efficiency by setting prices above those that would exist in competitive markets (P>MC). 2. Monopolists will not be producing at the lowest possible average cost of production (productive inefficiency) at their profit maximising level of output. 3. Monopolists may suffer from X-inefficiency as the lack of competition means they fail to minimise costs of production.

Question 82

What are the potential benefits of monopoly?

Answer 82

1. Economies of scale and investment Monopoly suppliers might be better placed to exploit economies of scale – which means that consumers may benefit from lower prices. 2. Research/Development and Innovation Higher profits from monopoly may lead to a faster rate of technological development that reduces costs and produces better products for consumers. Creating monopoly power, in the form of patents and copyright (legal barriers to entry) which give a time limited monopoly on new products/processes/ideas, may also be required in some circumstances to persuade firms to invest in R&D and to innovate. 3. International Competitiveness In some markets, the economy needs large companies operating on a scale big enough to compete effectively in global markets – e.g. the global car market

Question 83

When do natural monoploies exist?

Answer 83

When there is great scope for economies of scale. It is associated with industries where there is a high ratio of fixed to variable costs. For example, the fixed costs of establishing a national distribution network for a product might be enormous, but the cost of supplying extra units of output may be very small. With a pure natural monopoly, there is only room for one firm to be able to exploit the available economies of scale fully.