A2 Microeconomics

Perfect Competition (PC):

• Many small firms
• Homogeneous goods (identical goods)
• Perfect knowledge
• No barriers to entry
• Price taker
• Perfectly elastic demand (horizontal)

Short-run=abnormal profit, which is eroded away because of entry of new firms whch increases supply, lowers price and erodes abnormal profit. So PC earns normal profit in long-run.

Operates at allocative efficiency (AR = MC).

Monopolistic Competition.

Same as PC but produces slightly differentiated goods. So, demand relatively elastic (downward sloping).

Short-run = abnormal profit.

Long-run = AC is tangential to AR curve.

Oligopoly:

May be amny firms but only few firms dominate the market.

• High concentration ratio (size of firm in relation to industry)
• Interdependent
• High barriers to entry.exit
• Non-price competition (price competition causes price war)
• Price rigidity (shown through kinked demand curve)
• Collusion (agreements between firms which restricts competition).

Monopoly:

Legal = firm with at least 25% market share.

Pure = firm with 100% market share.

• Only firm in industry
• High barriers to entry (sunk, capital costs, legal, economies of scale).
• Imperfect knowledge
• Unique goods
• Price discriminates (charges diff prices to diff consumers for same good).

+ R&D, econ of scale, cross-subsidise, creative destruction (incentive for new firms to enter market with better innovated goods), global competition.

- Productively & Allocatively INefficient, X-inefficiency, consumer welfare decreases.

Natural Monopoly:

Market structure that is only able to support one firm in the industry; only profitable to have one firm in industry. Eg: water, gas, utility.

Where sunk costs are so high that AC is always falling.

So MC and AC curve are falling with MC below AC.

Produces at MC=MR. But as only one firm in industry, govt will want natural monopoly firm to operate at allocative efficiency (AE, where AR=MC) as supply of goods needs to match consumer demand.

• Price regulated to prevent exploitation of consumer (RPI-X and RPI+K).

Price Discrimination:

Firm must:

• have MARKET POWER
• be able to SEPERATE THE MARKET
• buyers must have DIFF PEDs.
• PREVENT RESALE of the good.

+ Firm earns higher supernormal profit.

+ Some consumers with elastic demand will receive lower price.

- Consumers with inelastic demand receive higher prices.

- Difficult to meet all 4 conditions mentioned above.

Monopoly and Efficiency:

• Monopolies operate at profit max MC=MR.
• Less output and higher prices in monopoly than perfect competition.
• May be productively inefficient due to X-inefficiencies when costs are too high. This may occur due to lack of competition so less incentive to cut costs as they already benefit from econ of scale.
• Allocatively inefficient as prices are too high and low output, so too high a demand and too low supply.
• But, monopoly is dynamically efficient (efficieny that occurs over a period of time), due to high supernormal profits which can be used to invest in R&D (research & development) to create innovative products. Thus, this may increase consumer welfare as innovation can provide more choice to consumers.

Price Regulation:

• Prevents abuse of monopoly power (as monopolies have the power to set prices above MC, allocatively inefficient) and creates an allocatively efficient firm.
• - But, limiting prices limits profits so less can be spent on R&D. This can decrease dynamic efficiency.
• - There is a problem of assymetric info where the regulator/govt has insufficient data or info to base the price cap on. Eg: prices could be set which are too high/too low.