Theory Of The Firm

Question 1

What are high concentration and low concentration markets like and examples?

Answer 1

High concentration - few firms (UK banking sector)

Low concentration - many firms (clothing)

Question 2

KAPPBEN for perfect competition?

Answer 2

Perfect knowledge
Short run only
No price setting powers
Homogenous product
No entry exit barriers
Eg. Agriculture
Many small firms

Question 3

Describe perfect competition diagram for short and long run?

Answer 3

AR curve is horizontal because demand is perfectly elastic.

Short run shows SNP
Long run profits are eased away therefore no SNP (produces at min point on AC)

Question 4

When will firms in perfect competition shut down?

Answer 4

When they can’t cover AVC (MC=AVC)

Question 5

Efficiency of firms in perfect competition?

Answer 5

In the LONG RUN they are productively and allocatively efficient.

Question 6

KAPPBEN for monopolistic competition?

Answer 6

Imperfect but can tell when SNP is being made by other firms
Short run only
Minimal price setting power
Similar product
Low barriers to entry/exit
Eg. Restaurants
Many small firms

Question 7

Which market structures have no long run losses and why?

Answer 7

Perfect and monopolistic because they have no/low barriers to exit.

Question 8

Efficiency of monopolistic competition?

Answer 8

Neither allocative or productive efficiency

Question 9

Diagram of firm in monopolistic competition for short and long run?

Answer 9

Short run - normal diagram showing SNP

Long run - normal diagram showing no SNP (AC touches AR above MC=MR but doesn’t cross it)

Question 10

Define concentration ratio?

Answer 10

The market share controlled by the ‘n’ largest firms.

Question 11

KAPPBEN for a monopoly?

Answer 11

Imperfect
Yes
Unique
Price maker
High
Eg. British telecom
One firm dominates (plus 25% of market)

Question 12

Efficiency of monopoly?

Answer 12

Neither allocatively or productively

Question 13

Dishes for monopoly?

Answer 13

Normal diagram with larg SNP

Question 14

Advantages of monopoly as a result of SNP? (3)

Answer 14

• finance for investment
• reserves can be kept and saved so in periods of less demand they don’t have to lay off workers
• funds for R+D

Question 15

Advantages of monopoly as a result of monopoly power? (4)

Answer 15

• cross subsidisation can keep less used products from being eliminated from the market, such as rural bus services
• price discrimination raises TR to allow survival of goods/services
• they benefit from EofS therefore AC are lower
• SNP acts as incentive for rival firms to develop a better product, therefore bypassing barriers to entry

Question 16

What is cross subsidisation?

Answer 16

When firms take profits from one part of their company and use it to subsidise losses in another part of their company.

Question 17

Disadvantages of monopoly as a result of SNP? (3)

Answer 17

• less incentive to be efficient
• less incentive to develop new products
• have resources to make barriers to entry high

Question 18

Disadvantages of monopoly as a results of monopoly power? (5)

Answer 18

• high price for consumers
• can waste resources through cross subsidisation
• may price discriminate
• not productively efficient
• misallocation of resources if price is set above marginal cost

Question 19

Define price discrimination?

Answer 19

Charging a different price for the same good or service in different markets.

Question 20

3 conditions for price discrimination?

Answer 20

• high entry barriers and a degree of monopoly power
• at least 2 separate markets with different PEDs.
• markets must be kept separate at a cost lower than the gain in profits. This prevents resale between markets.

Question 21

Draw diagrams to show 3rd degree price discrimination?

Answer 21

Notes

Question 22

What is a natural monopoly and why do they exist?

Answer 22

When an industry can only support one firm (eg. Water/oil/gas)

They exist because some industries have very high start up costs and large EofS, and so it is inefficient and very expensive to have more than one firm in the market.

Question 23

What is a contestable market?

Answer 23

A market with low/no barriers to entry/exit and the threat of competition can change the behaviour of firms significantly.

Question 24

What is a monopsony?

Answer 24

When there is one sole buyer in a market who therefore can determine the price.

Question 25

Why can’t firms in a contestable market make short or long run abnormal profits?

Answer 25

Because if the price is too high then other ‘hit and run’ profit seeking firms will join the market, forcing the price down. Even in the short run SNP can’t be made because firms in the market already fear of other firms joining and then not leaving the market after the profit wears away, so they prefer to sell without SNP.

Question 26

Efficiency of firms in contestable market?

Answer 26

Allocatively and productively efficient

Question 27

How can supermarkets create a monopsony?

Answer 27

They can collude to create a monopsony market with farmers to guarantee themselves low prices.

Question 28

Advantages of monopsony market?

Answer 28

Lower consumer prices, can balance out monopoly price setting prices, can create better quality than perfectly competitive market.