Theme 3 - market structures Flashcards

Question

difference between static(allocative/productive/X) and dynamic efficiency

Answer 1

- static efficiency all occur at one specific production point - dynamic efficiency occurs over time

Answer 2

allocative efficiency - resources perfectly follow consumer demand - low prices, higher choice, maximisation of CS, high quality of production

Answer 3

allocative efficiency - resources perfectly follow consumer demand - low prices, higher choice, maximisation of CS, high quality of production productive efficiency - increased production at lower AC - higher profits - lower prices and greater market share Dynamic efficiency - new innovative products,lower prices, high CS X efficiency - low prices, high Cs

Answer 4

allocative efficiency - retained or increased market share, staying ahead of rivals, increased profit productive efficiency - more production at lower AC - higher profit - increased market share, lower prices dynamic efficiency - long run profit maximisation - lower costs over time - retained or increased market share - stay ahead of rivals X efficiency - lower costs, higher profit, lower prices and increased market share

Answer 5

allocative efficiency - retained or increased market share, staying ahead of rivals, increased profit

Answer 6

Agricultural Markets: Markets for crops like wheat, corn, and soybeans are often used as examples of near-perfect competition. There are numerous farmers (sellers) providing standardized products, with prices determined largely by market demand rather than individual sellers. Foreign Exchange Market: - The currency exchange market is often cited as close to perfect competition, with many buyers and sellers trading standardized currencies, freely determined by supply and demand. Stock Market for Commodities: - The trading of commodities like gold, silver, and crude oil in stock exchanges also approaches perfect competition due to high standardization and many participants, though slight differences can arise based on contracts.

Answer 7

Restaurants and Cafés: The food service industry exemplifies monopolistic competition. Restaurants offer differentiated products through cuisine, ambiance, location, and service, with easy entry and exit and many competitors. Retail Clothing Stores: The fashion retail market, including both branded stores and generic clothing shops, operates in a monopolistic competitive environment, as brands differentiate themselves through style, quality, and brand image. Beauty and Personal Care Products: Cosmetics, skincare, and personal care items are highly differentiated by branding, quality, and pricing, making the personal care industry a prime example of monopolistic competition. Fitness Centers and Gyms: Fitness centers differentiate through facilities, classes, and location, but there are many players with relatively easy entry and exit, fitting the monopolistic competition model.

Answer 8

- LOW BARRIERS TO ENTRY/EXIT - large pool of potential entrants - good information abt the market - hit and run profits

Answer 9

when new firms enter the market, snatch supernormal profits, then leave the market before firms and income can react and lower their profit margins

Answer 10

1. Lowers Barriers to Entry → More Firms Can Enter the Market → Increased Competition Technology reduces start-up costs by allowing firms to operate digitally instead of requiring physical infrastructure → This makes it easier for new firms to enter previously monopolized markets, increasing contestability → For example, e-commerce platforms reduce the need for expensive retail space, allowing small businesses to compete with larger firms → More competition forces existing firms to improve efficiency and lower prices, benefiting consumers. Example: The rise of online banking and fintech companies has challenged traditional banks by offering financial services without the need for physical branches, increasing contestability in the banking sector. 2. Reduces the Need for Large Sunk Costs → Firms Can Enter and Exit Markets More Easily → Market Becomes More Contestable New technology, such as cloud computing and software-as-a-service (SaaS), allows firms to operate without significant upfront investment in physical assets → Lower sunk costs reduce the risk of market entry, making it easier for new competitors to challenge established firms → As a result, incumbent firms face greater competitive pressure and must remain innovative and efficient to retain market share. Example: The media streaming industry became more contestable as platforms like Spotify and Netflix eliminated the need for costly distribution infrastructure (e.g., physical CDs or DVDs), allowing new entrants to emerge with lower initial investment. 3. Enhances Consumer Knowledge → Reduces Asymmetric Information → Encourages New Firms to Compete Technology improves access to market information, reducing information asymmetry between firms and consumers → Consumers can now compare prices, quality, and reviews easily, forcing firms to compete on price and service quality → New entrants can gain market share more quickly by offering better products or lower prices, making markets more contestable. Example: Price comparison websites (e.g., Skyscanner, Expedia) allow consumers to compare flights and hotels instantly, forcing firms to offer competitive pricing and reducing the power of previously dominant companies in the travel industry. 4. Creates Alternative Distribution Channels → Incumbents Lose Control of Supply Chains → Increases Contestability Technology enables new distribution models such as direct-to-consumer (D2C) sales, online platforms, and decentralized supply chains, reducing reliance on traditional distribution networks controlled by dominant firms → This allows smaller businesses to bypass intermediaries and reach customers directly, increasing competition in previously concentrated industries. Example: The rise of online marketplaces like Amazon, Etsy, and Shopify has allowed small businesses to sell products directly to customers, increasing contestability in the retail sector where large brick-and-mortar chains previously dominated. 5. Enables Disruptive Innovation → Challenges Existing Market Structures → Forces Incumbents to Adapt or Exit Technological advancements often lead to disruptive innovation, where new business models challenge traditional firms → This forces existing companies to adapt, lower prices, or risk losing market share → If dominant firms fail to keep up with technological changes, they lose their monopoly power, making the market more contestable. Example: The gig economy (e.g., Uber, Airbnb, Fiverr) has increased contestability in transportation, accommodation, and freelance work, challenging traditional taxi services, hotels, and employment agencies.

Answer 11

In a contestable market, a monopoly may choose to produce at AC = AR (breakeven) to reduce the threat of new entrants. High threat of entry exists in contestable markets due to low barriers to entry and exit ⟶ If a monopoly earns supernormal profits, new firms are incentivised to enter and undercut prices ⟶ To deter entry, the incumbent firm sets price = average cost, which removes the profit incentive for rivals ⟶ So the monopoly earns normal profit (AC = AR), mimicking competitive outcomes to stay unchallenged.

Answer 12

Allocative Efficiency - In a contestable market, firms are incentivized to produce at a price where demand equals supply, leading to allocative efficiency. - This is because if a firm charges above the market equilibrium price, new entrants can enter and undercut the incumbent's price, thus encouraging the incumbent to set prices that reflect consumer preferences. - As a result, resources are allocated in a way that maximizes total welfare, ensuring that goods and services are produced at the level that consumers want, and at prices they are willing to pay. X-efficiency - In a contestable market, firms are compelled to operate efficiently, minimizing costs, as they know that any inefficiency will attract potential entrants. - Since firms face the threat of competition, there is a strong incentive to reduce waste and improve operations, thus leading to lower costs and higher efficiency in the market. - This enhances productive output without unnecessary resource use, benefiting consumers and ensuring firms remain competitive. Productive Efficiency - Firms in a contestable market are motivated to produce at the lowest cost possible, utilizing their resources effectively. - Because they have the potential to face competition at any time, which forces them to minimize costs to maintain a competitive edge. - As a result, firms are more likely to adopt best practices and new technologies that enhance their efficiency, leading to a reduction in average costs. Job Creation - In a contestable market, firms that successfully innovate/ reduce costs often expand their operations, can lead to increased demand for labor. - The entry of new firms also provides job opportunities, as competition increases and firms grow to meet demand. - This growth in market activity and employment can increase economic growth and job creation within the economy.

Answer 13

Lack of Dynamic Efficiency - In a contestable market, firms may have limited incentives to innovate over the long term, as their profits are constantly threatened by the potential entry of new firms. - Since firms can only expect normal profits, the pressure to invest in long-term research and development or technological advancements is weakened. - This can result in a lack of dynamic efficiency, where innovation and progress are slowed down, ultimately reducing the overall rate of economic growth. Cost Cutting in Dangerous Areas - To stay competitive, firms in a contestable market may cut costs in ways that negatively affect product quality or worker safety. -For example, reducing spending on safety measures or using cheaper materials to lower production costs may endanger consumers or employees. - This drive for cost reduction in a highly competitive environment can lead to undesirable side effects, such as the exploitation of workers or a decline in product safety. Creative Destruction - Contestable markets may encourage "creative destruction," where inefficient firms are driven out of business as new, more innovative competitors enter the market. - While this can lead to improvements in overall market efficiency, it may also cause significant disruption, including job losses and the collapse of long-established businesses. - Such disruption can harm communities and create short-term economic instability, especially for workers in industries that are unable to adapt to new competition. Anti-Competitive Strategies - Even in a contestable market, incumbent firms may engage in anti-competitive strategies to deter potential entrants or maintain market dominance. - These strategies may include predatory pricing, where firms temporarily lower prices below cost to drive new entrants out of the market, or collusion to prevent market entry. - These reduce the effectiveness of contestability, potentially leading to monopolistic behavior and reducing the benefits of competition for consumers.

Answer 14

1. It depends on barriers to entry and exit If barriers to entry and exit are high, contestable markets may not exist ⟶ Firms in these markets may be able to exploit monopolistic behaviour without fear of new competitors ⟶ As a result, contestability has limited impact in highly regulated or capital-intensive industries. 2. It depends on the availability of information Contestable markets rely on firms having perfect information about costs, prices, and potential entrants ⟶ In reality, firms may face asymmetric information, making it difficult for them to price efficiently ⟶ Imperfect information can distort market behaviour and reduce contestability, especially in complex industries. 3. It depends on the degree of innovation In highly innovative industries, firms may face new competitors from disruptive technologies rather than just new entrants ⟶ This can increase the contestability of markets, but also unpredictability in pricing and competition ⟶ Firms may need to innovate continuously, which can lead to higher costs for consumers in the short run. 4. It depends on market concentration Contestable markets assume that firms do not have significant market power ⟶ However, in highly concentrated markets with few firms, firms may still exercise market power despite contestability ⟶ In such cases, the threat of entry may not be strong enough to drive prices down or increase efficiency. 5. It depends on the nature of demand If consumer demand is volatile or seasonal, firms may not be able to rely on consistent profits to deter entry ⟶ This can reduce market stability and create fluctuating market conditions, affecting the ability of firms to price efficiently ⟶ In this situation, contestability may have a limited role in influencing firm behaviour.

Answer 15

they are making supernormal profits

Answer 16

💰 To Increase Joint Profits Firms face incentives to avoid price wars in oligopolistic markets ⟶ By colluding, they agree to raise prices together or restrict output ⟶ This allows them to earn supernormal profits like a monopoly ⟶ These profits can then be shared, boosting financial stability for all involved. 🧱 To Reduce Market Uncertainty Oligopolistic firms are highly interdependent, with uncertain rival reactions ⟶ Collusion allows for price stability and predictable behaviour ⟶ Firms can then plan investment and output with greater confidence ⟶ This stability can improve long-term performance and reduce costly mistakes. 🔐 To Create Barriers to Entry High prices from collusion generate supernormal profits ⟶ These profits can be used to invest in branding, innovation, or lobbying ⟶ This increases barriers to entry, deterring new competition ⟶ Market power is thus protected, making collusion even more appealing. 📊 To Maintain Market Share Firms in oligopolies may fear losing market share from aggressive pricing ⟶ By colluding, they agree on output quotas or regional divisions ⟶ This reduces the need for aggressive competition ⟶ Each firm maintains stable revenue streams and market share over time.

Answer 17

the ability of a business to set prices above the level that would exist in a highly competitive market

Answer 18

🏦 High sunk costs discourage new entrants → High sunk costs mean firms can't recover their investment if they exit the market → This increases the risk for potential new firms → So fewer firms are willing to enter the market → Contestability of the market decreases 🔄 Existing firms can exploit their position → With high sunk costs, incumbent firms feel secure → They may engage in limit pricing or other barriers → These practices deter new firms from entering → Market power is sustained, reducing contestability 🧱 Barrier to hit-and-run entry → In a contestable market, firms can enter and exit freely → But sunk costs make it expensive to "test the waters" → This prevents hit-and-run entry by new competitors → The threat of entry (which maintains competition) is weakened 🛑 Reduces dynamic efficiency → Less contestability leads to reduced pressure to innovate → Firms are less worried about potential new entrants → This may lead to complacency and x-inefficiency → Long-run competitiveness and innovation may fall

Answer 19

🏃 1. Firms may price at normal profit (AC = AR) In a perfectly contestable market, barriers to entry and exit are low ⟶ Potential entrants can quickly compete away any supernormal profits ⟶ Incumbent firms lower prices to AC to deter new entry ⟶ This results in breakeven pricing to maintain market share. 💸 2. Firms reduce X-inefficiency Lack of competition can cause wasteful production and costs ⟶ But in a contestable market, the threat of entry forces firms to be efficient ⟶ Firms will minimise costs and avoid slack or unnecessary spending ⟶ This leads to greater X-efficiency in the long run. 📉 3. Less likely to engage in anti-competitive behaviour In less contestable markets, firms may collude or abuse dominance ⟶ But in contestable markets, any price rises may attract entry ⟶ Firms have a strong incentive to behave competitively ⟶ Resulting in lower prices and better outcomes for consumers. 🔁 4. Short-run hit-and-run entry becomes a risk If firms make supernormal profit, new firms may enter temporarily ⟶ These new firms can undercut prices, take market share, then exit ⟶ This possibility leads incumbent firms to limit prices or profit ⟶ Encouraging more competitive, consumer-friendly outcomes.

Answer 20

Product Variety and Consumer Choice In a monopolistic competitive market, firms offer differentiated products. This creates variety for consumers, improving consumer satisfaction and well-being. While firms might not produce at the minimum point of the average cost curve, the benefits of diversity in products may outweigh the inefficiencies associated with higher prices. Evaluation: The variety of products is a key benefit, but this also means that firms might not achieve full economies of scale, leading to higher average costs in comparison to perfectly competitive markets. Dynamism and Innovation Firms in monopolistic competition are incentivized to innovate to differentiate their products. This constant innovation leads to improvements in products and services over time. These innovations may increase overall welfare, even if firms are not producing at the lowest possible cost. Evaluation: Although innovation is a positive, the costs of innovation (e.g., advertising, research, development) may increase prices for consumers, leading to a trade-off between innovation and affordability. Lower Barriers to Entry Compared to monopolies or oligopolies, monopolistic competition typically has fewer barriers to entry. This encourages more firms to enter the market, leading to a more competitive environment. This can result in better service, lower prices, and more efficient outcomes over time as firms must constantly compete to maintain market share. Evaluation: While the lack of barriers promotes entry, the smaller scale of firms often results in less productive efficiency than in monopolies with significant economies of scale. Efficiency of Resource Allocation Monopolistic competition allocates resources more efficiently than a monopoly. Firms respond to consumer preferences, and competition forces firms to optimize their production processes and pricing strategies. Even though firms have some pricing power, their products are not unique enough to allow for total price gouging, and market forces still prevent excessive profits. Evaluation: While resources may be allocated more efficiently than in a monopoly, the lack of perfect competition means that the market is not operating at the most efficient point possible. The presence of price markups can still result in some inefficiency. Short-Run Profit Maximization vs Long-Term Efficiency In the short run, monopolistic competition allows firms to make supernormal profits. These profits provide incentives for more firms to enter the market, increasing competition and eventually driving prices down to the point where firms only make normal profit in the long run.

Answer 21

1. Low barriers to entry and exit 🔹 There are few legal or financial obstacles to starting a firm in the market ➡️ This means new entrants can join easily when profits are high ➡️ Which forces incumbent firms to price competitively and behave efficiently ➡️ Leading to outcomes that mirror those of more competitive markets (lower prices, higher allocative efficiency) 2. Access to technology and knowledge 🔹 Firms can easily access the same production technology or knowledge as existing firms ➡️ Reduces cost asymmetries between new and established firms ➡️ So new firms can be equally productive and compete effectively ➡️ Puts pressure on incumbent firms to remain innovative and efficient to survive 3. Weak brand loyalty or low sunk costs 🔹 Consumers are not highly attached to brands, and firms do not incur unrecoverable costs when entering/exiting ➡️ Makes it easier for new firms to gain market share without major upfront investment ➡️ Threat of entry disciplines current firms to operate efficiently and avoid supernormal profits ➡️ Improves dynamic and productive efficiency in the long run 4. Hit-and-run entry is possible 🔹 New firms can enter, exploit short-term profits, and exit quickly if prices fall ➡️ Means incumbent firms cannot rely on exploiting monopoly power without consequences ➡️ Encourages firms to keep prices close to average cost ➡️ Leads to lower prices and greater consumer surplus in the market

Answer 22

1. High sunk costs act as a barrier to exit If firms must make large upfront investments (e.g. in specialised equipment), → these sunk costs cannot be recovered if the firm fails and exits, → increasing the risk of market entry for potential rivals, → reducing the likelihood of new firms entering, → therefore lowering the degree of contestability. 2. Strong brand loyalty acts as a barrier to entry In some markets, consumers are loyal to existing firms due to established branding, → new firms struggle to attract customers even with lower prices, → making it hard to gain market share quickly, → which deters entry and limits competitive pressure, → meaning the market becomes less contestable. 3. Predatory or limit pricing deters entry Incumbent firms may cut prices aggressively (even below cost), → to make entry unprofitable for new firms, → causing potential entrants to be discouraged due to fear of unsustainable price wars, → limiting actual or potential competition, → reducing contestability. 4. Regulatory or legal barriers raise costs of entry Heavily regulated sectors (e.g. pharmaceuticals, banking) require licenses or approvals, → the time and cost to comply with rules increases, → which deters smaller or newer firms from entering, → creating a protection for incumbents, → and reducing market contestability. 5. Economies of scale create a cost advantage for incumbents Large firms benefit from lower average costs due to scale, → allowing them to undercut smaller entrants on price, → which means new firms cannot compete profitably, → so they are less likely to enter, → leading to low contestability in the market.

Answer 23

💷 Allocative Efficiency In perfect competition, price = marginal cost (P = MC) in the long run ➡️ This means resources are allocated to goods and services valued most by consumers ➡️ No one can be made better off without making someone else worse off ➡️ ⏩ Therefore, perfect competition leads to allocative efficiency, benefiting overall welfare 🏭 Productive Efficiency Firms in perfect competition must minimise costs to survive, as they’re price takers ➡️ In the long run, they produce at the lowest point on the average cost curve ➡️ This means there is no waste of resources in the production process ➡️ ⏩ Results in productive efficiency, with low prices and efficient output levels 🧍‍♂️🧍‍♀️ Consumer Benefits Many firms + no barriers to entry = high competition ➡️ Firms cannot set prices above the market rate, leading to lower prices ➡️ Products are also homogeneous, so firms can’t compete on branding alone ➡️ ⏩ Consumers benefit from low prices and maximum consumer surplus 🚀 Dynamic Pressure (in short run) Although long-run dynamic efficiency is low, in the short run, firms may innovate to gain temporary profit ➡️ Innovations can include new production methods or temporary product differentiation ➡️ Even small cost advantages matter when supernormal profits are short-lived ➡️ ⏩ Some dynamic efficiency pressure exists, though it’s weaker than in monopolistic markets ✅ No Barriers to Entry or Exit Easy entry/exit ensures that only efficient firms survive in the long run ➡️ Loss-making firms leave, new firms join when supernormal profits are available ➡️ This self-correcting mechanism keeps the market competitive and lean ➡️ ⏩ Leads to a highly responsive market structure, adjusting efficiently to consumer needs

Answer 24

💡 Lack of Dynamic Efficiency Firms only make normal profit in the long run due to free entry and exit ➡️ With no supernormal profit, there’s little incentive to invest in R&D or innovation ➡️ This limits improvements in technology, product development, and long-term productivity ➡️ ⏩ Results in low dynamic efficiency, reducing progress and innovation 🧠 No Product Variety Perfect competition assumes homogeneous products ➡️ This means consumers don’t get choice or differentiation (e.g. branding, features) ➡️ Unlike monopolistic competition, there's no non-price competition ➡️ ⏩ Leads to a lack of consumer satisfaction for those wanting unique or tailored goods 📉 Low Profits for Firms The pressure of being a price taker means firms must always lower costs ➡️ Even minor inefficiencies can force a firm out of the market ➡️ Firms may also cut corners on working conditions or environmental standards to survive ➡️ ⏩ Creates a harsh environment with low stability for firms and workers 🏗️ No Economies of Scale Firms remain small due to the large number of competitors and low barriers to entry ➡️ This prevents them from growing enough to exploit economies of scale (e.g. bulk buying, tech) ➡️ As a result, average costs stay higher than they could in more concentrated markets ➡️ ⏩ Leads to productive inefficiency at a wider industry level 🧾 Excessive Competition May Be Wasteful Firms constantly entering and exiting can result in uncertainty and duplication ➡️ Resources may be wasted on replication of infrastructure and short-term operations ➡️ Long-term planning becomes difficult when profits are tight and competition is intense ➡️ ⏩ This can reduce overall economic stability in the market

Answer 25

🎨 Product Variety for Consumers Firms in monopolistic competition sell differentiated products ➡️ Consumers can choose based on brand, quality, service, or design ➡️ This increases consumer satisfaction, especially for niche preferences ➡️ ⏩ Leads to greater consumer choice and utility than in perfect competition 💸 Normal Profits in the Long Run, Supernormal in the Short Run In the short run, product differentiation allows firms to earn supernormal profits ➡️ This gives an incentive to enter the market and innovate ➡️ In the long run, new entry reduces profits to normal, benefiting consumers ➡️ ⏩ Encourages healthy competition without the inefficiencies of monopoly 🚀 Incentive to Innovate and Improve Firms compete on non-price factors like advertising, packaging, and product upgrades ➡️ Even small differences can win over customers ➡️ This leads to dynamic efficiency, as firms constantly try to improve to stand out ➡️ ⏩ Results in continuous product development and innovation 🧍‍♂️🧍‍♀️ Ease of Entry and Exit Low barriers to entry and exit make the market highly contestable ➡️ New firms can enter when profits are attractive, promoting efficiency ➡️ Underperforming firms exit easily, avoiding long-term inefficiencies ➡️ ⏩ Leads to efficient resource allocation over time 📍 Responsive to Local/Niche Markets Firms can target specific consumer groups with tailored products ➡️ This encourages a more diverse and responsive market structure ➡️ Helps small businesses thrive where large firms may not operate ➡️ ⏩ Supports community-based entrepreneurship and market inclusivity

Answer 26

dynamic inefficiency in long run 🏭 Productive Inefficiency Firms don’t produce at the lowest point on their average cost curve monopolistic firms tend to restrict output to maximise profit, where MC = MR rather than where AC is minimised ⟶ This means they operate at a lower quantity and higher cost per unit than necessary ⟶ So they don’t exploit full economies of scale, leading to productive inefficiency. 💰 Allocative Inefficiency Prices are above marginal cost due to some price-setting power ➡️ Consumers pay more than the true opportunity cost of the product ➡️ Some consumers who value the good are priced out ➡️ ⏩ This causes a loss of allocative efficiency, reducing overall welfare 🎯 Too Much Focus on Non-Price Competition Firms may spend heavily on branding, advertising, and packaging ➡️ These costs don't improve the actual quality or function of the product ➡️ Prices might be inflated due to high marketing spend ➡️ ⏩ Leads to wasteful spending and potentially misleads consumers 🛑 Limited Economies of Scale Firms are relatively small due to the high number of competitors ➡️ They’re unlikely to grow large enough to enjoy significant economies of scale ➡️ This keeps average costs higher than in monopolies or oligopolies ➡️ ⏩ Results in higher prices and less efficiency for consumers 📉 Short-Term Focus Due to low barriers to entry, firms may focus on survival not growth ➡️ They often avoid long-term investment in capital or R&D ➡️ This restricts potential productivity gains and innovation ➡️ ⏩ Leads to less dynamic efficiency compared to more concentrated markets

Answer 27

🔁 Short-Run Efficiency: Dynamic but Not Productive or Allocative Firms can earn supernormal profits due to product differentiation ➡️ This encourages investment in branding and innovation ➡️ Leads to dynamic efficiency, improving consumer choice and quality ➡️ ⏩ However, prices remain above marginal cost, so there is allocative inefficiency, and firms don’t produce at minimum average cost, so productive inefficiency also exists 🏁 Long-Run Efficiency: Normal Profits, But Still Inefficient New firms enter the market, attracted by short-run supernormal profits ➡️ This increases competition and shifts each firm’s demand curve leftwards ➡️ Firms end up making only normal profits in the long run ➡️ ⏩ Still, they do not produce at minimum average cost (productive inefficiency) and P > MC (allocative inefficiency) remains 🚀 Dynamic Efficiency (Possible, Not Guaranteed) Firms aim to maintain demand by improving products or service ➡️ This may lead to product innovation or marketing strategies ➡️ Can result in some dynamic efficiency, benefiting consumers ➡️ ⏩ But the incentive may weaken in the long run as profits fall to normal ⚖️ Evaluation: Trade-Off Between Choice and Efficiency Consumers enjoy product variety and branding ➡️ But this comes at the cost of efficiency losses in both cost and price ➡️ The structure prioritises consumer choice over pure efficiency ➡️ ⏩ ⛔ Monopolistic competition is not productively or allocatively efficient in either the short or long run

Answer 28

📉 Short-Run: Allocatively Efficient but Not Productively Efficient In the short run, firms maximise profit where MC = MR ➡️ Since P = MC in perfect competition, this ensures allocative efficiency ➡️ However, firms may produce above minimum average cost ➡️ ⏩ This means productive inefficiency can exist in the short run 🏆 Long-Run: Both Allocatively and Productively Efficient Supernormal profits attract new firms ➡️ supply increases ➡️ This lowers price until firms earn only normal profit at the lowest point on the AC curve ➡️ P = MC (allocative efficiency) and output at minimum AC (productive efficiency) ➡️ ⏩ ⛳ Perfect competition achieves both allocative and productive efficiency in the long run 💡 Dynamic Efficiency: Low or Non-Existent In both short and long run, firms make zero supernormal profit in the long run ➡️ This removes the incentive or funds for research and development ➡️ Firms have little room to invest in innovation or technology ➡️ ⏩ 🔒 So dynamic efficiency is unlikely in perfect competition 🧮 X-Inefficiency: Low in Long Run High competition means firms must keep costs as low as possible ➡️ If they don’t, they’ll be undercut by rivals ➡️ This constant pressure drives out any wasteful behaviour ➡️ ⏩ ✅ Leads to low X-inefficiency in the long run

Answer 29

Firms produce differentiated products → → Each firm creates brand loyalty or non-price differences (e.g. design, location, quality) → → Consumers see their product as slightly unique → → This gives firms some control over the price as products are not perfect substitutes Imperfect information in the market → → Consumers may not be fully aware of rival prices or quality → → This reduces price sensitivity and cross-price elasticity → → Firms can raise prices slightly without losing all customers → → Result: Some monopoly power over their customer base High number of sellers, but not infinite → → Firms face some competition, but not perfectly elastic demand → → Each firm's demand curve is downward-sloping, not horizontal → → So they can still choose their price to some extent Low barriers to entry in the long run → → But in the short run, firms can exploit short-run supernormal profits due to branding or loyalty → → This allows temporary price-setting power before new firms erode it → → Long-run equilibrium tends to normal profits, but price-setting persists due to product differentiation

Answer 30

Firms face downward-sloping demand curves due to product differentiation → → They produce at a quantity where average costs (AC) are not minimized → → Firms don’t produce at the lowest point on the AC curve → → This means productive inefficiency compared to perfect competition In the long run, firms only make normal profits → → Entry and exit ensure price equals average cost (P = AC) but not minimum AC → → Firms produce at less than optimal scale → → Excess capacity exists, so resources aren’t used as efficiently as possible Product differentiation causes variety, but increases costs → → Costs rise due to marketing, advertising, and design expenses → → These added costs prevent firms from achieving minimum AC → → Leads to higher average costs than in more standardized markets Lack of strong price competition → → Firms have some price-setting power and don’t face perfectly elastic demand → → This reduces incentives to minimize costs aggressively → → Encourages allocative rather than productive efficiency focus

Answer 31

Firms face downward-sloping demand curves due to product differentiation → → They produce at a quantity where average costs (AC) are not minimized → → Firms don’t produce at the lowest point on the AC curve → → This means productive inefficiency compared to perfect competition In the long run, firms only make normal profits → → Entry and exit ensure price equals average cost (P = AC) but not minimum AC → → Firms produce at less than optimal scale → → Excess capacity exists, so resources aren’t used as efficiently as possible Product differentiation causes variety, but increases costs → → Costs rise due to marketing, advertising, and design expenses → → These added costs prevent firms from achieving minimum AC → → Leads to higher average costs than in more standardized markets Lack of strong price competition → → Firms have some price-setting power and don’t face perfectly elastic demand → → This reduces incentives to minimize costs aggressively → → Encourages allocative rather than productive efficiency focus

Answer 32

Perfect competition achieves allocative efficiency → → Price equals marginal cost (P = MC) → → Resources are allocated to where they’re most valued by consumers → → No welfare loss, so allocative efficiency holds Firms produce at minimum average cost → → In the long run, free entry and exit push firms to produce at lowest point of AC curve → → This minimises waste and maximises productive efficiency → → Productive efficiency is achieved Perfect information ensures optimal decisions → → Consumers and firms know prices and product quality perfectly → → Choices reflect true costs and benefits → → Resources aren’t wasted, supporting both allocative and productive efficiency No barriers to entry/exit maintain competition → → Ensures profits are normal and markets remain contestable → → Forces firms to keep costs low and prices competitive → → Firms have strong incentives to be efficient Lack of externalities assumed or corrected → → Markets reflect full social costs and benefits → → No divergence between private and social costs → → Allocative efficiency is maintained

Theme 3 - market structures Flashcards

(56 cards)