Market Structures

Question 1

define market structure

Answer 1

the characteristics of a market that can be used to explain the behaviour of firms within it

+

Question 2

characteristics of perfect competition

6 main

Answer 2

1. infinite number of buyers and sellers and concentration ratio of 0
2. homogeneous products
3. 2 makes firms price takers
4. no barriers to entry or exit
5. perfect info of market conditions for P and C
6. objective: profit maximise

Question 3

characteristics of monopoly

6 main factors

Answer 3

1. one dominant firm
2. differentiated products
3. 2 gives firms price making power
4. high barriers to entry and exit
5. imperfect info for P and C
6. firms are profit maximisers

Question 4

characteristics of oligopoly

6 + 2 unique factor (inter… and price/non-price)

Answer 4

1. few large firms dominate market, concentration ratio approx. 70%
2. product differentiation
3. 2. makes firms price makers
4. high barrier to entry and exit
5. strategic interdependence
6. non-price competition and price rigidity
7. objective varies depending on best way to increase market share under current market conditions

Question 5

characteristics of monopolistic competition

Answer 5

1. large no. of buyers and sellers
2. low barriers to entry and exit
3. slight product differentiation
4. 3. makes firms price makers
5. non-price competition to increase market share as cannot increase prices significantly
6. objective: profit max

examples: fast food industry!

Question 6

why can SNP exist in the SR but not in the LR for monopolistic competition?

Answer 6

in the SR, firm can exploit the price making power they have due to producing a unique good or service to charge a price higher than AC, making SNP

in the LR, there are low BTE, meaning that any firm that is incentivised to enter the market due to the existence of high SNP can do so, this reducing the incumbent’s demand (shift left) until AC is tangent to AR. This is because the same no. of customers are shared among more firms now. This results in normal profits

Question 7

steps to draw LR monopolistic diagram

Answer 7

1. AR and MR
2. MC
3. profit max price and output
4. draw AC such that it is tangent to the AR curve at the profit max price BUT the MC curve still intersects AC at its lowest point

Question 8

implication of monopolistic competition being ‘slightly differentiated’?

Answer 8

firms have price making power leading to a downward sloping demand curve, but not as much as a monopoly

due to much greater competition, cannot increase prices by too much or will lose market share so demand curve is price elastic

Question 9

define contestable market

Answer 9

market where entry is free and exit is costless, meaning the threat of new entrants is faced by all current firms

Question 10

define concentration ratio

Answer 10

measure of the combined market share of the biggest 3, 4 or 5 firms in an industry. For example, (now use a simple worked example)

Question 11

what are some barriers to entry?

Answer 11

1. legal barriers - patents, copyrights
2. access to key inputs
3. brand name, loyalty and advertising
4. high capital set up costs
5. high EOS exploited by existing firms
6. sunk costs

Question 12

what are some barriers to exit?

Answer 12

sunk costs - losing capital investment if some costs like R&D cannot be recovered and capital assets cannot be transfered

Question 13

define predatory pricing

Answer 13

firm sells goods below AVC to force competitors out of the market

Question 14

define limit pricing

Answer 14

firms temporarily abandon profit max objective to stop new firms from entering a market by pricing low enough to discourage entrants with higher costs, while still pricing high enough to still be profitable for the incumbent firm

Question 15

explain the SR and LR equilbrium of PC firms

Answer 15

• two paned analysis to show that ruling market price is accepted by price taking firms
• to profit max where MR=MC can choose the Q they produce
• at this quantity, P > AC so SNP is made
• two paned analysis to show outward shift of market S
• in the LR, existence of SNP signals and incentivises new entrants
• no BTE so can enter
• market supply shifts right, leading to new lower market price.
• This is equal to supply curve for individual firm, which shifts down until tangential to AC
• now only normal profit is made
• SNP not sustainable so firms always return to this LR eq

Question 16

explain the SR shut down rule

Answer 16

• draw diagram showing ATC above price and AVC below price at a quantity Q
• firms can continue producing at a loss in the SR, i.e. if P<AC, as long as P<AVC
• at

Question 17

PC performance pros

Answer 17

1. AE in the LR - explain readjustment of price to equal ATC, making P=MC
2. PE in the LR - EOS fully exploited

2. firms with high unit costs cannot afford to remain in the market in the LR as price falls, so the only firms remaining are operating at or close to their MES

Question 18

PC performance cons

Answer 18

1. no DE in LR - no SNP; homogeneous products
2. product homogeneity doesn’t benefit consumers who want choice
3. cut quality of output to cut costs

Question 19

when is a situation pareto efficient?

Answer 19

when you cannot make someone better off without making someone else worse off

if you CAN do this, situation is pareto inefficient

Question 20

challenge assumptions of PC

Answer 20

1. all firms have some degree of price setting power as products are differentiated ITO variations, branding - even in highly competitive markets
2. increasing product complexity increases info asymmetries
3. ignores existence of patents/copyrights - BTE
4. exit will never be costless!

Question 21

evaluate outcomes of PC

Answer 21

1. consumers may be prepared to trade off some static efficiency for dynamic efficiency
2. in reality, firms in highly competitive markets will reinvest even normal profits n hopes of gaining competitive advantages

Question 22

describe LR and SR monopoly behaviour

Question 23

3 conditions for price discrimination

Answer 23

1. firm has some degree of monopoly power
2. firm is able to segment market based on varying values of PED
3. firm can prevent arbitrage

Question 24

define price discrimination

Answer 24

charging different groups of consumers different prices for the same good or service for reasons unrelated to costs

Question 25

explain first degree PD

Answer 25

each consumer is charged the maximum price they are willing to pay for a good or service all consumer surplus is extracted and turned into producer surplus, i.e. SNP

Question 26

explain second degree PD

Answer 26

is also known as excess capacity pricing, where empty seats/space in a hotel or stadium for e.g. are sold at a lower price to contribute to FC in a hotel, rooms can be filled for the same MC until they reach capacity a profit maximising hotel will produce where MR=MC, but at this point there are excess rooms the hotel could contribute to its FC if it can sell these rooms for more than MC, by claiming 'last minute deals' hence hotel can contribute to FC and these consumers will benefit from extra CS by paying less

Question 27

explain third degree PD

Answer 27

firm is able to segment the market based on varying PED. Dividing into two submarkets - elastic and inelastic demand due to differences in age, location, time e.g. for train travel - peak time travellers and leisure travellers at a single price charged to the whole market, a lower profit of ____ is made assume the MC and AC of supply to both markets is the same as in the whole market profit maximising firm will produce at point where MR=MC. The profit max price will be higher in the peak and lower in the off-peak market a higher total profit of ____ is made by price discriminating

Question 28

define natural monopoly and its characteristics ## Footnote 4 main

Answer 28

type of monopoly where one large firm can supply the entire market at a lower LRAC than if multiple smaller firms supplied the market **AS LONG AS THEY'RE REGULATED** 1. this is due to having an **overwhelming cost advantage** - the industry having very high FC (capital infra) and low MC, meaning that AC are minimised at high level of output 2. this means there are **significant EOS** to exploit as the firm's LRAC curve is downward sloping over a much larger range of output 3. competition is undesirable 4. tend to operate in public interest and be publically owned ## Footnote tend to operate in public interest and be state owned

Question 29

characteristics of perfectly contestable markets ## Footnote 4

Answer 29

1. no barriers to entry or exit, particularly sunk costs 2. large pool of potential entrants create threat of entry 3. perfect info on costs and tech for firms 4. incumbents subject to hit and run competition

Question 30

why is competition undesirable in a NM?

Answer 30

1. more firms means each exploits lower EOS (PE) 2. wasteful duplication of capital resources if firms leave market (AE) 3. no incentive for new entrants to compete with incumbent natural monopolist as EOS differential can be used to predatory price and force out

Question 31

how has technology increased contestability?

Answer 31

1. lower barriers to entry and exit and sunk costs - can operate online; easier advertising to overcome brand loyalty 2. innovation - easier to disrupt markets e.g. Uber and Airbnb, but also lower costs to compete with 3. better info - knowing costs, tech make level playing field

Question 32

describe firm behaviour in NM

Answer 32

- profit maximising NM will produce where MR=MC - makes X SNP - this is a socially undesirable outcome since the service is essential to society, e.g. water distribution/rail**** - P>MC , and Q is below Q , leads to price exclusion and shortages - regulators intervene and frce monopolist to produce at social optimum - increases quantity and lowers price and increases social welfare - however, monpolist suffers a loss of X at this price since it is below AC - regulators must offer unit subsidy equvalent to the unit loss to incentivise firm to produce - socially optimal output is restored ## Footnote **** many natural monopolies operate services in the public interest

Question 33

explain why monopolies are allocatively inefficient and create a DWL

Answer 33

1. monopoly has market power so can set price above MC at the profit max output where MR=MC 2. this is consumer surplus that has been extracted to turn into SNP, X 3. this higher price leads to DWL of consumer welfare since the price is higher and quantity lower than the social optimum P*Q* 4. this is the loss of net efficiency from the loss of socially desirable trades

Question 34

monopoly performance pros

Answer 34

1. SNP made in LR - promote DE 2. despite productive inefficiency, may be large enough to exploit higher EOS than smaller competitive firms - lower prices 3. can cross-subsidise loss-making socially desirable goods with SNP

Question 35

monopoly performance cons

Answer 35

1. Allo. inefficient 2. productively inefficient - to profit max must produce at below MES 3. regressive effects on poorer households - relative poverty and income inequality

Question 36

monopoly performance evaluation

Answer 36

1. inefficiency depends on quality of regulation - surrogate for competition 2. natural monopoly is good provided regulation 3. depends on CONTESTABILITY of market - threat of competition may force a monopolist to charge less and improve quality 4. depends on objectives of firm - not all are profit maximisers, differing price, output and investment decisions

Question 37

explain what the kinked demand curve shows

Answer 37

explains price rigidity in oligopoly - 1) there is no incentive to change prices and 2) there is no need to change prices

Question 38

explain how game theory can be applied to oligopoly

Answer 38

models strategic interdependence - explain dominant strategy - this is determined by each firm anticipating their rivals' reaction before choosing - no way to unilaterally improve outcome so this is also NE - explain NE - this is a LR equilibrium since both firms would perefer to keep prices low instead of being undercut - not most profitable outcome but explains why price rigidity exists

Question 39

what causes price wars?

Answer 39

1. collapse of cartel price fixing agreement 2. incentive to win market share 3. entry of new firms threatening incumbent market position 4. managerial motives - reduce price to increase revenue and hence bonus 5. response to recesssion to generate cash and survive

Question 40

define collusion

Answer 40

rival firms cooperate with the aim of maximising joint profits, reducing the costs of competition and reducing market uncertainty. They behave anti-competitively by price fixing, restricting supply or market sharing

Question 41

describe price collusion in oligopoly

Answer 41

- competitive market equlibrium occurs when MC=AR - however cartel has enough market power to control supply and behave as a profit maximising monopolist, producing at MR=MC and pricing above MC - each individual cartel member becomes a price taker, selling at the cartel price - to control market supply, cartel will set each member a production quota - individual members make a profit of X, but there is potential to make more by producing slightly more at a lower price than the cartel - this is the incentive to cheat on the collusive agreement due to self-interest, explaining why cartels eventually lose power and break down as members depress the cartel price

Question 42

conditions for effective collusion

Answer 42

1. industry regulators are weak 2. penalties for collusion are low compared to potential revenues from colluding 3. group of firms have a high percentage of total sales and control over market supply 4. firms can communicate well and have similar stratrgic objectives 5. products are standardised and output is easily measurable (quotas) 6. brands are strong and have consumer loyalty - less of an incentive to cheat if consumers won't switch

Question 43

why do cartels break down

Answer 43

1. enforcement problems (quota, prices) - cheating and price wars 2. falling demand - recession (Cash) or tastes change 3. non-cartel firms join market successfully 4. legal barriers or whistle-blowing members 5. some members have higher costs than others - lower profits at agreed prices 6. strategic objectives change/trust breaks down

Question 44

costs of collusion

Answer 44

1. AE and PE 2. artificial BTE erected that reduces contestability in the LR

Question 45

pros of collusion

Answer 45

1. some collusive acts are socially beneficial - product quality, innovation 2. SNP can promote DE (linked to 1)

Question 46

evaluate impact of collusion on consumer welfare

Question 47

oligopoly performance pros/cons

Answer 47

if competitive oligopoly - PC pros/cons if collusive oligopoly - monopoly pros/cons

Question 48

oligopoly performance eval

Answer 48

1. quality of regulation - surrogate for competition 2. depends on contestability 3. depends on objectives of firm - influence price, output and investment decisions

Question 49

referencing economic welfare, what are the pros of price discrimination

Answer 49

1. some consumers benefit from lower prices and higher CS - price becomes closer to MC 2. potential for cross-subsidisation of loss-making socially desirable G/S 3. higher SNP may promote DE

Question 50

referencing economic welfare, what are the cons of price discrimination?

Answer 50

1. consumer exploitation and loss of AE - worsened relative poverty and income inequality 2. used as limit pricing strategy to erect BTE and limit competition in LR - higher prices, lower output and quality

Question 51

price discrimination eval

Question 52

describe the LR market readjustment for monopolistic competition

Question 53

why do natural monopolies need to be regulated?

Answer 53

unregulated, natural monopolies will operate at the profit max price and output where P exceeds MC and quantity is lower than AE outcome natural monopolies tend to be firms providing essential goods and services like water and electricity. At a lower quantity, people will have to go without and significant welfare loss will occur