3.4 Market Structure

3.4.1 What is allocative efficiency?
Allocative efficiency is when P=MC
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3.4.1 What is productive efficiency?
When a firm operates at the lowest point on the lowest average cost curve. MC=AC.
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3.4.1 What is dynamic efficiency?
Efficiency over time, can be achieved by investing in human capital
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3.4.1 What is x-inefficiency?
Lack of dynamism when firms have little competition so are not incentivised to lower their average costs. Aren't productively efficient.
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3.4.1 Efficiencies in Perfect Competition
Productively efficient in the long run. Allocatively efficient in the short/long run. Pareto efficiency.
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3.4.1 Efficiencies in Monopolistic Competition
No allocative or productive efficiencies.
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3.4.1 Efficiencies in Oligopoly
No allocative or productive efficiencies.
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3.4.1 Efficiencies in a Monopoly
No allocative or productive efficiencies. X-inefficient.
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3.4.2 What are characteristics of perfect competition?
No barriers to entry/exit. An infinite number of buyers and sellers. Price taker. Perfect information. Homogeneous products. Super normal profits only available in the short run. Aim to maximise profits.
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3.4.3 What are characteristics of monopolistic competition?
Low barriers to entry/exit. A large number of small firms. Some ability to set price. Similar products with little differentiation. Aim to maximise profits. Eg. fast-food takeaways, hairdressers.
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3.4.4 What are characteristics of an oligopoly?
Significant barriers to entry/exit. Small number of large firms. Product differentiation. Price rigidity. Price makers. May or may not be profit maximisers. Potential for price wars and collusion. High concentration ratio. Interdependance of firms.
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3.4.4 What is interdependence in the context of an oligopoly.
How firms in a competitive oligopoly are affected by rival firms' pricing and output decisions.
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3.4.4 Calculating n-firm concentration ratio
Add up percentage of the market of n-firms relative to the percentage of the whole market.
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3.4.4 What is collusion?
When firms work together to determine price and/or output.
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3.4.4 Why do firms collude?
To reduces uncertainty that may exist among firms in an industry regarding prices and output.
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3.4.4 What is non-collusive behaviour?
The behaviour of a firm under non-collusive oligopoly will depend on how it thinks other firms will react to its policies. Game theory can be used to examine the best strategy a firm can adopt for each assumption about its rivals.
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3.4.4 What is the game theory?
The reactions of one player to changes in strategy by another player.
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3.4.4 What is the aim of the game theory?
To examine the best strategy a firm can adopt for each assumption about its rival’s behaviour and it provides insight into interdependent decision making that occurs in competitive markets.
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3.4.4 What is the prisoners dilemma?
In the situation, two people are questioned over their involvement in a crime and are kept apart so they can’t communicate. The dominant strategy in this situation is to confess: greatest reward and least bad.
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(Carry on from prisoners dilemma) 3.4.4 Why may they not confess?
However, if the prisoners could collude or had confidence in one another, the best option would be to deny the crime; this is the Nash equilibrium.
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3.4.4 What is tacit collusion?
Firms appear to be organising prices and/or output without a formal agreement. It is hard to prove. Price leader sets a higher price and firms copy. Non-competitive behaviour.
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3.4.4 What is overt collusion?
When firms have a formal, open agreement to organise prices and/or output. Highly illegal. A formal collusive agreement is called a cartel, which is a group of firms who enter into agreement to mutually set prices.
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3.4.4 What is price leadership?
Price leadership is where one firm has advantages due to its size or costs and becomes the dominant firm. Other firms will tend to follow this firm because they would be fearful of taking on the firm on in any form of price war.
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3.4.4. What is barometric firm price leadership?
When a firm develops a reuptation for being able to predict the next move in the industry and other firms decide to follow the leader.
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3.4.4 What are price wars?
When price cutting leads to retaliation by other firms (kinked demand curve). Firms are frequently making losses. In the short term, firms will continue to produce if their AVC is below AR but in the long run, they will leave the market - prices rise
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3.4.4 What is predatory pricing?
Cutting prices below average costs to force firms out of the market as they don't make profits. This is illegal usually done by firms who have large enough to be able to sustain losses
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3.4.4 What is entry limit pricing?
Firms set prices so they make normal profits to discourage new firms entering the market. It is mainly used in contestable markets. However, firms cannot make profits as high as they would have liked.
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3.4.4 What is non-price competition?
Advertising, loyalty cards, branding, quality, customer service, product development. The problem with these methods is that they are often expensive and there is no guarantee that it would be successful.
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3.4.5 What is a monopoly?
A firm can be legally considered as having monopoly power by CMA if it has more than 25% of the market.
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3.4.5 What are characteristics of a monopoly?
Barriers to entry/exit are really high. Supernormal profits in the short run and long run. Heterogenous goods. Imperfect information. Dominated by a single large firm. Aim to maximise profits. (MC=MR)
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3.4.5 What is a barrier to entry?
A feature of a market that makes it difficult for new firms to enter the market.
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3.4.5 What are types of barriers?
Economies of scale, legal barriers (red-tape), product differentiation, sunk costs.
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3.4.5 What are sunk costs?
Costs that cannot be recovered if a firm is unsuccessful in a market and has to leave.
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3.4.5 What are advantages of a monopoly?
Financial economies of scale, technical economies of scale, marketing economies, managerial economies of scale, innovation.
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3.4.5 What are disadvantages of a monopoly?
Diseconomies of scale. Productive and allocatively inefficiency. X-inefficient.
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3.4.5 What is third degree price discrimination?
Firms with monopoly power charge different groups of consumers different prices for the same product allowing it to increase producer surplus at the expense of consumer surplus.
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3.4.5 What are conditions necessary for third degree price discrimination?
Firms must have monopoly power. Different sub-market consumers with different elasticities of demand. No seepage between markets (keep groups seperate)
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3.4.5 What are advantages of third degree price discrimination?
Supernormal profits may be reinvested leading to better quality products. Those on lower incomes can access services.
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3.4.5 What are disadvantages of third degree price discrimination?
Earning or increasing supernormal profit can be seen as inequitable. Increases producer surplus at the expense of consumer surplus. May be exploiting those greatest in need.
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3.4.5 What is a natural monopoly?
Economies of scale are so large that even a single producer is not able to fully exploit all of them. Government may be reluctant to break a natural monopoly as this could reduce efficiency.
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3.4.5 What are characteristics of a natural monopoly?
High fixed costs. Low to negligible marginal costs. Large economies of scale.
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3.4.5 What are advantages of natural monopolies?
Supernormal profits available to reinvest leading to dynamic efficiencies. Increased financial security for its workers.
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3.4.5 What are disadvantages of natural monopolies?
Consumers may pay higher prices and see a poorer quality service , due to a lack of competition. There is less choice for consumers. A monopoly is productively inefficient, they don’t produce at MC=AC. Not allocatively efficient as P>MC.
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3.4.6 What is a monopsony?
Sole buyer of a resource and has the same basic characteristics as a monopoly. Eg. NHS and nurses.
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3.4.6 What are advantages of a monopsony?
Increased buying power. Can drive down costs which can result in lower prices. Higher profits - reinvest.
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3.4.6 What are disadvantages of a monopsony?
Suppliers may be forced out of business. Reduced consumer choice. Higher profits of monopsony can increase inequality.
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3.4.7 What is a contestible market?
A market with freedom of entry and exit. Making markets more contestible can lead to incumbent firms behaving in more economically desirable ways with regards to pricing and static efficiency.
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3.4.7 What are characteristics of contestable market?
Low barriers to entry and or exit. Low sunk costs. Low levels of supernormal profits. Firms produce close to where P=MC (allocatively efficient). Perfect knowledge.
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3.4.7 What are hit and run firms?
Firms that are attracted to the supernormal profits so enter the market. This means incumbent firms only make normal profits. This can be avoided by entry limit pricing.
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