chapter 8 market structures

Question 1

perfect competition

Answer 1

lots of sellers(low concentration ratio) that sell identical items

eg the market for wheat in America - thousands of farmers supply an identical good

Question 2

imperfect (monopolistic competition)

Answer 2

lots of sellers acting independently ( low concentration ratio ) selling close substitutes that are differentiated.

eg cafes, restaurants, barbers

Question 3

oligopoly

Answer 3

a dew large sellers ( high concentration ratio) dominate the market and are interdependent in actions

eg commercial banks, mobile phone networks, chocolate ( Nestle , Cadburys, Mars)

Question 4

monopoly

Answer 4

one one firm supplies the whole market

eg irish rail
google (search engine)

Question 5

what is low and high market concentration ?

Answer 5

low market concentration - this means thee are a lot of sellers, this means consumers have lots of choice and prices tend to be lower eg imperfect

high market concentration - this means there are a few large sellers, it often leads to higher prices prices and less choice eg oligopoly & monopoly

Question 6

what are the reasons why a low market concentration may present difficulties for consumers

Answer 6

1. confusing pricing - firms may have packages which make comparisons difficult and confusing for consumers

2.competition may be difficult - despite many firms being in the industry the competition my be limited and not offer much to choose from between the firms

3. lower standard of living - in an effort to increase sales some firms may “reduce” the quality of their products and/or reduce the content of their products.

Question 7

what are the reasons why a high market concentration may present difficulties for consumers

Answer 7

1. limited competition and choice - fewer competitors in a concentrated market can lead to limited product variety and choice for consumers, reducing their ability to find the best suited options for their preferences and needs.
2. higher prices and reduced affordability - dominant firms can exert greater control over pricing, leading to potentially higher prices for goods and services. this can make products less affordable and strain consumers budgets

3.lower quality and innovation - with reduced competitive pressure, firms may be less motivated to invest in quality improvements or innovation. this could result in lower product quality and fewer innovative offerings, ultimately impacting consumer satisfaction.

Question 8

what is the Herfindahl-Hirschman Index (HHI) ?

Answer 8

this index measures the market concentration by adding up the sum of all the individual firm’s market shares that are squared first.

eg if firm A has 42%, B has 31%, C has 15% and firm D has 12%

(42)squared + (31) squared + (15) squared + (12) squared = 3094

1- 1500 = low market concentration
1500-2500 = moderate market concentration
2500- 10000 = high market concentration

Question 9

what is perfect competition and what are the assumptions underlying this market ?

Answer 9

perfect competition - firms are selling identical products to other firms so therefore have no advantage or way of selling at a higher price to a competitor. All firms must accept the going rate and sell at that price( they are price takers ). because of this the demand curve facing a perfectly competitive firm is horizontal or perfectly elastic (D=AR=MR)
eg most of the market of Christmas trees

assumptions underlying perfect competition
1. there are many buyers in the industry - no individual buyer can influence, by his/her own actions, the market price of the goods. each individual firm is a price taker. each individual buyer acts independently.

2. there are many sellers in the industry - no individual seller can influence, by his/her own actions, the market price of the goods. each individual firm is a price taker. each individual seller acts independently, they don’t group together to influence the price in the market through collusion.
3. the goods are homogenous - the goods, which are supplied by the producers are identical. consumers cant differentiate between different seller’s goods, therefore there is no need for any firms to spend on competitive advertising.

4.there is freedom of entry and exit in/out of the industry - firms already in the industry cannot prevent new firms from joining. no barriers to entry/exist within the industry, so firms can enter if SNP are being earned in the industry.

5. perfect knowledge of profits in the industry exist - in the market everyone concerned has perfect knowledge as to profits made by other firms in the industry. consumers are fully aware of what other firms are changing for their goods.
6. each firm is a profit maximiser - firms will choose at produce at the output where MC=MR where MC cuts MR from below, rising after that point in order to maximise profits.

Question 10

short run position for a firm in Perfect Competition - summary of the position

Answer 10

1. equilibrium output - profit maximisation occurs at point A on the graph, where MC=MR ( MR cuts MR below and is rising after the point)
2. price & output - firm produces the output shown at Q1 and sells at the price p1.

3.cost of production - the average cost of production for each unit are shown at point c1.

4.level of profit earned - supernormal profits (SNP’s) are being earned as AR>AC at Q1.

5.efficiency - firms costs are shown at C1, this is not the lowest point of the AC curve (shown at point B) therefore in the short run firms are not as efficient as they could be and are wasteful of scarce resources.

Question 11

how firms in perfect competition go from the short run to the long run

Answer 11

1. market supply curve shifts out to the right - new entrants are attracted by SNP and there are no barriers to entry and full knowledge of profits, so they’ll enter, so the market supply curve will shift rightward from S1 to S2.
2. the market price falls due to excess supply - more/new suppliers entering means that there will be an excess supply at P1 as QS>QD, leading to a lower equilibrium market price of P2.

3.individual firm’s D/C (AC curves) falls - the AR/MR of each firm( firms are price takers so take the market price) is lower after the change in supply, so the new selling price firms take is lower (P2<P1).

4.firm will now produce a smaller quantity - firms will end up selling less output individually as there are more firms operating in the industry.Q2 is lower than Q1 from the short run.

5. amount of SNP’s earned will fall until they are eliminated - new entrants will continue to join all SNP’s that existed are eliminated. if too many entrants enter, then the least efficient will leave until are firms are making normal profit in the long run.

Question 12

summary of a long run position for a firm in perfect competition

Answer 12

1. equilibrium output - profit maximisation occurs at point A on the graph, where MC=MR ( MC cuts MR from below and is rising after that point)
2. price & output - firm produces the output show at Q1 and sells at the price P1.
3. cost of production - the average cost of producing for each unit are shown at point C 1
4. level of profit earned - normal profit is earned in the long run (AR=AC) new firms will enter the market (no barriers exist and there is full knowledge of profits) until SNP is eliminated, where AR will equal AC.
5. efficiency - the firm will produce at point A, which is the lowest of the AC curve, therefore making it the most efficient use of society’s resources.

Question 13

compare the SR and LR under perfect competition

Answer 13

1.price and output - when new firms enter the industry the market price falls and the firm must accept the market price

the price in the long run is lower than it is in the short run as the firm must accept the market price

the firm’s output in the long run is lower than in the short run. as new firms enter the industry each firm will supply a smaller fraction of the total output.

2. profits - in the short run the firm earns SNP as AR>AC. in the long run, new firms “compete” away the SNP so only normal profit is earned where AR=AC>
3. efficiency - in the SR as there is SNP there is no incentive for firms to be efficient and they do not produce at the lowest point of the AC curve.

in the LR, only firms that are efficient and produce at the lowest point on the AC curve will survive.

Question 14

why does a firm in perfect competition tend not to engage in advertising ?

Answer 14

1. homogenous goods - goods are identical to other sellers, therefore the firm has little to advertise as their product is the same as every other supplier’s
2. increase in costs - if a firm advertises it would increase its own costs and therefore decrease its profits/make a loss, without gaining any additional revenue.
3. benefits all firms in the industry - advertising by a single firm would not benefit this firm, but the entire industry, so its not in an individual firms interest to advertise

Question 15

what are the advantages of perfect competition ?

Answer 15

1. the firm sells its products at the lowest possible prices( they sell at the lowest point on the AC curve, so they couldn’t sell at any lower price.

2.the firm produces at the lowest point of average costs so there is no waste of scarce resources. society benefits from no excess capacity existing- they are efficient.

3. as the goods are homogenous there is no need for wasteful advertising. therefore costs are lower than they would be, benefiting consumers/ overall output in the market.
4. because freedom of entry and exists no firm will continue to earn SNP’s in the long run as new firms will enter. there is no exploitation of consumers through higher prices as only normal profits are earned

Question 16

what are the disadvantages of perfect competition ?

Answer 16

1. output is so low for each individual firm that they don’t benefit from economies of scale which would lower average costs and potentially the selling price also.
2. consumers may prefer product differentiation so they have choices between alternatives rather than having no choice as all goods sold are identical.

3.there is little scope for research and development and innovation which might improve the quality or lower costs as firms don’t have excess profits to invest in research.

Question 17

what is monopolistic/ imperfect competition ?

Answer 17

an imperfectly competitive firm faces a downward sloping demand curve( AR curve ). goods aren’t identical because it sells a differentiated product, and as such it can decide what price to charge. each firm has a product that consumers view as somewhat distinct from the products of competing firms.

if the firm increases the product price there will be a reduction in demand as some consumers will switch to rival firms ( close substitutes ) that have become relatively cheaper following the increase in their price.

eg coffee shops, restaurants, newsagents, takeaways , barbers

Question 18

what is product differentiation ?

Answer 18

the action taken by firms to make the goods which are produced different to close substitutes

Question 19

product differentiation - branding

Answer 19

by establishing a different and distinctive brand names for the products

eg nike, adidas, under armour

Question 20

product differentiation - competitive advertising

Answer 20

creating differences in the products in the minds of consumers eg through packaging which clearly distinguishes one product from another

eg Moro vs Star bar
Coke vs Pepsi
apple products

Question 21

product differentiation - product innovation

Answer 21

firms develop their product further ( add value) so that it is better or more advanced than that of competitors

eg super milk with vitamins
lower fat yogurts

Question 22

assumptions underlying imperfect competition - product differentiation exists

Answer 22

the goods supplied by the firm are not homogenous but are close substitutes. firms use branding and competitive advertising to distinguish their products from one another

eg restaurants use branding, location , services, and ingredients to differentiate

Question 23

assumptions underlying imperfect competition - there are many sellers in the industry

Answer 23

an individual seller can influence the quantity sold by changing the price it charges for its own output. each seller acts independently setting their own price and are subject to the law of demand

eg each restaurant sets their own prices based on their own cost structures

Question 23

assumptions underlying imperfect competition - there are many buyers

Answer 23

an individual buyer, by his/her own actions, cannot influence the market price of the goods

eg lots of people use restaurants - there are no large buyers that could negotiate better delas to influence the price paid

Question 23

assumptions underlying imperfect competition - there is freedom to entry and exist

Answer 23

no barriers to entry and exist within the industry/ it is possible for firms to enter/ leave the industry as they see SNP/ are making a loss eg other entrepreneurs are allowed to open new restaurants to join the market

Question 24

assumptions underlying imperfect competition - reasonable knowledge of profits exist

Answer 24

within the industry each firm has reasonable knowledge or profits made by other firms. consumers have a reasonable knowledge of the prices being charged for different products. eg an entrepreneur could figure out if SNP are being earned by restaurants

Question 24

assumptions underlying imperfect competition - each firm attempts to maximise profits

Answer 24

in order to achieve this firms will produce the output where MC= MR where MC has cut MR from below and rises after that point

Question 25

what is competitive advertising

Answer 25

this is advertising which stresses the advantages of one firms products/ services over its rivals

Question 26

what are the possible disadvantages of advertising for the consumer ?

Answer 26

1.increased prices - the firm may have to increase prices to cover the increased costs due to advertising 2. false or misleading claims - consumers may be present with inaccurate or incomplete information leading to confusion/ mis- information. 3. impulse buying/ creates unsustainable wants - the advertising may lead customers to impulse buy and so "waste" part of their income. advertising may create a desire in consumers for a life style which is not attainable. 4. harmful commodities - advertising may encourage the consumption of harmful commodities eg cigarettes, alcohol which may damage the health of the consumer. 5. unnecessary pollution - consumers may have to pay for the removal of litter caused by advertising such as leaflets discarded etc.

Question 27

what are the advantages imperfect competition may offer to the consumer ?

Answer 27

1. greater choice - goods are homogenous, but are close substitutes, therefore consumers have a greater choice of goods/services between differentiated goods so they face a variety of choices 2. normal profit - in the long run consumers are not being exploited as firms are earning normal profits/ 3. lower prices - competition between firms in the industry will help lower prices and make them more competitive for consumers. some items such as newspapers, magazines, sporting and music events may be cheaper due to revenues earned by the supplier from competitive advertising. 4.innovative goods/services - innovation is encouraged as firms will constantly strive to gain a competitive edge over their rivals, hence, consumers get the benefit of modern up-to-date goods/services 5. access to information - consumers may have more information available to them because of the extensive competitive advertising used within the industry

Question 28

what are the assumptions underlying the theory of monopoly ?

Answer 28

1. there is only one firm in the industry - one firm exists within the industry so there is no distinction between the firm and industry. one firm supplies the total output for the entire industry. FIRM = INDUSTRY 2. a monopolist can control price or output, not both - a firm can control price or output but not both. if it sets the price the output produced will be determined by consumers. if it sets the output the price will be determined by the market. 3. a monopolist's aim is profit maximisation - it is possible for the firm to earn SNP's in both the short and long run. a firm aims to make maximum profits and it achieves this when the output they sell is where MC = MR ( MC cuts MR from below and rises after that point ) 4. barriers to entry exist preventing new firms from joining - when SNP are earned in the short run, new firms would like to enter to share these profits but cant due to barriers to entry. these barriers prevent the entry of new firms into the industry so the monopolist can enjoy SNP in the long run also. eg strong brand loyalty, sole ownership of a raw material, patent/ copyright

Question 29

what are the barriers to entry that can prevent entry (monopoly)

Answer 29

1.legal restrictions - the government may grant a firm the sole right to supply a good or service so that there is a statutory restriction on competition in the market eg Irish rail or Dublin bus have a monopoly on some transport routes 2.