Perfect competition, Monopolisitic competition, Monopoly, Oligopoly & Competition Policy

What is a patent?

Exclusive right to use or sell an invention for a number of years; could be product or process.

What is a concentration ratio? -What is it used for?

The percentage of market share taken up by the largest firms. -It is used to determine the market structure and competitiveness of the market.

The model of perfect competition is a...?

Theoretical abstract

But it does lead to... Efficiency?

Static: if allocative and productive efficiency are achieved at any particular point in time. But static efficiency. A not last forever, since technology and consumer tastes change: need to invest in new technology.

The behaviour predicted in monopolistic models are more...?

Realistic.

Benefits of Monopoly (7)

-Abnormal Profit; provides security and funds for investment to maintain a competitive edge and also for R&D; leading to dynamic efficiency. -Needed to match large over-seas competitors in a global market. -Cross-subsidisation of markets may lead to an increased range of goods or services available to the consumer. -Price discrimination may raise total revenue which allows the survival of a product or service. It can also benefit some consumers in the form of lower prices for certain groups. -Monopolies can take advantage of economies of scale, which lowers the cost per unit; increase in consumer surplus. -Natural monopolies avoid the problems of duplication and wasteful advertising (e.g. Royal Mail). -Intellectual property rights (IPRs) allow a form of legal limited monopoly that can be in the consumer's interest because they benefit from better quality, innovative products. Without the protection of IPRs, firms would have little incentive to risk their resources investing in innovative product and processes: other firms would simply be able to copy those ideas and immediately compete away any supernormal profits.

Why may monopolies be considered undesirable? (5)

-Consumer exploitation; high pricing power. -Lack of consumer choice. -Government regulation may be required. -Negative externalities. -Low prices to suppliers.

How does the Prisoner's Dilemma model show First-Mover Advantage?

-If the firms cooperate and agree to restrict output to low levels, then the outcome for both firms is better than if they both output at a high level: this could work well for both firms, if they can both be trusted. -However, it is in the interest of each firm to stop cooperating and raise output: as long as they do this before the other firm decides to. -This is because if one firm decides to 'cheat' and increase output, then its actually in the interests of the other firm to keep producing at a lower level and take the reduced profit (instead of raising output and forcing both companies to make a loss). THIS IS AN ILLUSTRATION OF FIRST-MOVER ADVANTAGE. -The theory shows why cartels can be unstable: every firm knows they can get an advantage if they break the agreement before anyone else does.

How do natural monopolies lead to lower prices?

-Industries where there are high fixed costs and/or large economies of scale lead to natural monopolies. -If there was more than one firm in the industry, then they would all have the same high fixed costs. This would lead to higher costs per customer than could be obtained by a single firm. They will also have continuous economies of scale. -In this case, a monopoly might be more efficient than having lots of firms competing. E.g. The supply of water is a natural monopoly: it makes no sense for competing firms to all lay separate pipes.

How can privatisation improve efficiency?

-Publicly owned firms/industries tend to be inefficient because they lack competition and this can lead to market failure. Governments may decide to increase competition through privatisation. -Privatisation is the transfer of the ownership of a firm/industry from the public sector to the private sector. -Some economists believe this will lead to a more efficient firm/industry because it will be open to free market competition. Private firms have shareholders, so they'll usually need to maximise their profits to keep them happy.

Examples of monopolistic competition?

-Shoe repairs & key makers -Taxi & Minibus companies -Sandwich bars & coffee stores -Hairdressing salons -Dry-cleaners & laundrettes -Bars & Nightclubs

Conditions required for price discrimination to work? (3)

-The seller must have some price-making power (e.g. Barriers to entry preventing competition). So monopolies and oligopolies can price discriminate. -The firm must be able to distinguish separate groups of customers who have different PED: there must be a different PED for each group of consumers: the firm is able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. Additionally, the cost of finding out this information must be lower than any potential gains. -The firm must be able to prevent seepage - it must be able to prevent customers who have bought a product at a low price re-selling it themselves at a higher price to customers who could have been charged more.

How can a monopoly make supernormal profits in the long run? (4)

1. A monopolist maximises profits where MC=MR at a price above AC. This leads to supernormal profits being made. 2. In competitive markets, abnormal profits are a signal for the entry of new firms leading to lower prices and profits. 3. But this assumes cost less entry into an industry - in reality there are often barriers to entry. In a monopoly market, the barriers to entry are total, so no new firms enter the market, and this supernormal profit is not competed away 4. A monopoly uses patents and marketing spending to build brand loyalty and make entry harder. This means the situation remains as it is - this is the long run equilibrium position for a monopolist.

In monopolistic competition, the short run position is like...? -Expand.

A Monopoly. The barriers to entry and/or the product differentiation mean that supernormal profits can be made, but only in the short run.

What is a dominant firm?

A firm that has at least 40% of their given market.

What is a natural monopoly? -E.g.

A natural monopoly may arise when there are extremely high fixed costs of distribution, such as when large-scale infrastructure is required to ensure supply. These costs are also sunk costs and deter entry and exit. -For example, Royal Mail.

Government role in natural monopolies.

A profit maximising natural monopoly will restrict output where MC=MR. A government might be reluctant to break up a natural monopoly as this could reduce efficiency. However, it might want to provide subsidies to the natural monopoly so that it increases output to the point where demand (AR) = supply (MC). This will reduce prices.

What is a pure monopoly?

A single supplier that dominates the entire market - the market has 100% concentration.

How do oligopolies behave? (2)

An oligopoly is a market: 1. in which the firms are interdependent - i.e. the actions of each firm will have some kind of effect on the others. 2. in which firms use competitive or collusive strategies to make this interdependence work to their advantage.

Do monopolistic firms achieve economies of scale? -Why?

Firms in monopolistic competition have also chosen to restrict output in order to maximise profits. -This means they do not benefit from all of the economies of scale they could.

How can abnormal profits be made in the short run?

In the short run, there is a lack of firms in an industry; this low supply of firms means the market ruling price will be greater than the firms' average cost, creating abnormal profit.

What is privatisation?

It is the transfer of assets from the public (government) sector to the private sector.

What is price discrimination?

This entails charging different prices to different groups of people for the same product or service.

What is competitive oligopolistic behaviour?

This is when the various firms don't cooperate, but compete with each other (especially on price).

Why are natural monopolies sometimes more efficient?

Trying to increase competition by encouraging new entrants creates a potential loss of efficiency; the new entrant would have to duplicate all the fixed factors. Therefore, it may be more efficient to allow one firm to supply the market to avoid a wasteful duplication of resources.

Drawbacks of Monopoly (8)

-Abnormal profit can mean little incentive to be efficient or develop new products: become complacent. -No need to increase efficiency, so X-inefficiency can remain high. -High prices and lower output for consumers; reduced consumer surplus compared to a competitive market. -Monopolies can waste resources by cross-subsidisation, using profits from one part of organisation to finance losses in another. -Monopolies may engage in price discrimination to raise producer surplus and reduce consumer surplus. This may involve charging higher prices to consumers with inelastic demand. -Monopolies are allocatively and productively inefficient. They are also likely to carry X-inefficiency. -By setting a price above marginal cost, prices are above the resource cost. -Monopolies deny consumers variety and choice which is available in competitive markets.

How do governments try to encourage competition in markets?

-Encourage new enterprises with advice and start-up subsides. -Increase consumer knowledge by ensuring comparison information is available. -Introduce more consumer choice and competition. -Privatise and deregulate large monopolistic nationalised industries. -Discourage mergers and takeovers which might excessively reduce the number of competing firms. -Encourage more international competition: e.g. Joining the EU, countries enter into a multinational 'single market'.

Example of markets that approximate to perfect competition (2)

1. Agricultural produce: e.g. small scale dairy farmers produce a homogeneous product (milk). There are many sellers and the farmers are price takers as they have no control over price. In recent years, low price of milk has resulted in many UK dairy farmers leaving the industry as they are unable to make normal profits. 2. Foreign exchange market: there are many dealers in currencies, which are homogeneous. Each $100 looks the same to a buyer.

Pillars of competition policy (4)

1. Anti-trust and cartels: this involves the elimination of agreements that restrict competition including price-fixing and other abuses by firms who hold a dominant market position. 2. Market liberalisation: involves introducing competition in previously monopolistic sectors such as energy supply, retail banking, postal services, mobile telecommunications etc. 3. State aid control: competition policy analyses state aid measures such as airline subsidies to ensure that such measures do not distort the level of competition in the single market. 4. Merger control: they monitor mergers and take-overs so they can prevent those that aren't beneficial to the efficiency of the market or consumers. They may choose to stop a merger that would give too high a market share and make it a monopoly. (e.g. fox takeover of sky in the public interest of media plurality)

Aims of price fixing: (3)

1. Businesses recognise their interdependence; act together to maximise joint profit. 2. Cut some of the costs of competition; e.g. marketing wars. 3. Reduces industry uncertainty.

How can collusion bring about similar outcomes to a monopoly? (3)

1. Collusive oligopolies generally lead to there being higher prices and restricted output (and underconsumption) as well as allocative and productive inefficiency. 2. Firms in collusive oligopolies often have the resources to invest in more efficient production methods and achieve dynamic efficiency, BUT there is not always incentive for them to do so. 3. Because firms in a collusive oligopoly do not lower prices even though they could, they make supernormal profits at the expense of consumers.

Reasons for breakdown of cartels. (5)

1. Enforcement problems: it may become difficult for the cartel to enforce its output quota and there may be dispute about how to share out profits. 2. Falling market demand: this creates excess capacity and puts pressure on individual firms to discount prices to maintain revenue. 3. Successful entry of non-cartel firms into the industry: rapid technological change can undermine a cartel's control; e.g. new entrant with an innovative and successful alternative. 4. Exposure of illegal price fixing: such as CMA. 5. Exposure of price fixing by whistle blowing firms: firms who previously engaged in a cartel that decides to withdraw and pass on information to competition authorities.

Reasons why oligopolies may not be as bad as they sound. (3)

1. Formal collusion is quite unlikely to occur because it's usually illegal, and any informal collusion is likely to be temporary, because one firm will soon decide to 'cheat', and lower its prices to gain an advantage (first-mover advantage). This kind of behaviour is likely to trigger a price war (and falling prices). 2. Even in a collusive oligopoly: -if firms aren't competing on price, then non-price competition might even be stronger, leading to some dynamic efficiency. This would be good for consumers if it led to product innovations and improvements. -firms are unlikely to raise prices to very high levels. This is because high prices may provide a strong incentive for new entrants to join the market, even if barriers to entry are high. 3. Competitive oligopolies can achieve high levels of efficiency: these markets often work well in practice.

However, in the short run, there are two possibilities: (2)

1. If the selling price (AR) is still above the firm's AVC, then the firm may continue to trade temporarily. 2. If the selling price (AR) falls below the level of the firm's AVC, then it will leave the market immediately.

Aims of privatisation (6)

1. Improving efficiency: reduce X-inefficiency (where costs are higher than they would be if competition existed). 2. Improving the quality and range of services: profit incentive should work towards achieving this. 3. Lower prices: result of increased competition. 4. Widening share ownership: more of the labour force can become shareholders. 5. Revenue raising: one off boost to government revenue;reducing public borrowing. 6. The creation of companies who can compete on an international scale.

Examples of collusive behaviour:

1. In South Africa, an investigation revealed that six oil companies (including Shell and BP) had colluded to keep diesel prices artificially high and were accused of engaging in extensive exchanges of commercially sensitive information. 2. Milk prices in supermarkets: Asda & Sainsbury's colluded with Dairy suppliers to increase the price of milk, cheese and other dairy products. 3. Price fixing in air travel: British Airways and Virgin; the two companies colluded on the extra price of fuel surcharges in response to rising oil prices.

Examples of non-price competition? (6) -E.g. (3)

1. Innovation 2. Quality of service 3. Free upgrades 4. Loyalty card schemes 5. Branding 6. Sales Promotions -Waitrose: best 'in-store' experience. -Iceland: delivery convenience. -Coffee industry: for many customers, the price of coffee is secondary to the quality and environment of the coffee shop. Therefore, traditional coffee shops like Costa and Starbucks sway towards the use of more non-price competition to attract customers.

Evaluating privatisation (3)

1. It depends on the industry: e.g. in telecoms, profit incentive can help to increase efficiency; in health care/public transport, profit motive is less important. 2. It depends on quality of regulation: do regulators make the privatised firms meet certain standards of service and keep prices low? 3. It depends on market structure (contestable and competitive); creating a private monopoly may harm consumer interests, but if the market is highly competitive, there is greater scope for efficiency savings.

Disadvantages of privatisation (7)

1. It may create a natural monopoly (BUT not always a bad thing e.g. Royal Mail: EoS) 2. Is it within public interest: e.g. if the NHS was to be privatised. 3. Government loses out on potential dividends. 4. Firms can also be focuses on the short term pressures to make profits for shareholders. 5. Industries become fragmented (e.g. railway networks: there have been disputes over who is responsible for safety). Less focus on safety and quality, more on profits. 6. Rise in prices: e.g. rail ticket prices. 7. Job loses; coal privatisation - 200,000 jobs lost. 8. A privatised public monopoly is likely to become a private monopoly: so extra measures such as deregulation need to be taken to avoid this. 9. PFI will often cost more in the long run than it's worth; so adds to government debt and may not represent value for money.

Characteristics of perfect competition (7)

1. Many suppliers: there is an infinite number of suppliers and consumers, making the market very competitive so no single firm has any 'market power'. (Highly elastic market; consumers are very responsive to a change in price as it is easy to substitute). 2. Each business is a price taker: Each business produces identical products, they therefore have to accept the market price or customers will substitute. 3. Identical output/products are homogeneous: so consumers can switch between products from different firms and all products are perfect substitutes for each other. -This also means no branding as this makes products seem different. 4. Producers have perfect knowledge of market conditions: No firm has any 'secret' low cost production method, and every firm knows the prices charged by every other firm. -There is no incentive for technological change as any idea or process introduced by one firm would immediately be available to all other firms; unrecoverable costs would also rise as firms cannot raise prices to compensate. 5. Consumers have perfect information (perfect knowledge of all goods and prices in a market): every consumer decision is well-informed. 6. No barriers to entry and exit: firms can easily enter and leave the market; sunk costs are likely to be low. 7. Firms are profit maximisers: so all decisions a firm makes are geared towards maximising profit; so firms will choose to operate at a level of output where MC=MR.

Roles of the regulators: (4)

1. Monitoring and regulating prices: ensure companies do not exploit their monopoly power by charging excessive prices. 2. Standards of customer service: companies that fail to meet specified service standards can be fined or have their franchise/licence taken away. 3. Opening up markets: encourage competition by removing or lower barriers to entry. 4. The surrogate competitor: regulation can act as a form of surrogate competition, attempting to ensure prices, profits and quality are similar to what could be achieved in competitive markets.

Examples of Regulation (2)

1. PPI (Payment Protection Insurance): there was little competition in the PPI market in the UK, a high level of rejected claims and a lot of cases of selling unnecessary cover. The market was investigated by the CMA, who produced a list of requirements for firms, such as providing information about the right to cancel and costs. The aims were to prevent future mis-selling, help consumers make informed decisions, and increase competition in the market. 2. Mobile Phone Roaming Charges: the European Commission has monitored these charges since 2007 and found that a lack of competition has led to excessively high charges. The EC has used price caps to significantly reduce data roaming charges for calls and texts. All telecommunications providers in member states must comply with these price caps. Firms can offer lower prices than the caps to compete with each other.

Key features of a monopoly (4)

1. Price setting power: downward sloping AR and MR curve. Potential for using price discrimination between consumers. 2. Barriers to entry: supernormal profits are available in the long run (e.g. brand loyalty, high sunk costs...) 3. Imperfect information: there is an imbalance of information - existing firms in the market may have extensive knowledge, giving them a significant advantage over new entrants. 4. Profit maximisation: is assumed, but not always the case (may pursue other objectives)

Advantages of privatisation (8)

1. Private companies have profit incentives and cut costs and become more efficient (productive efficiency). 2. Lack of political interference. 3. Short term-ism: governments have short term views (only thinking in terms of next election) = public choice theory (politicians are assumed to want to maximise their utility by maximising votes); thus not always thinking about long term interests of the economy. 4. Increased competition, thus improving efficiency. 5. Government revenue is raised from the sale. 6. Better quality of service: e.g. BT installation waiting times. 7. Improves resource allocation: privatised firms have to react to market signals of supply and demand. 8. PFIs enable the building of important facilities that the government cannot afford to build.

Governments can intervene in a variety of ways (3)

1. Privatisation can introduce competition into a market where there's a Public Monopoly: it can open it up to competition and force it to respond to market signals. 2. Regulation can be used to Control or Prevent Monopoly Power: e.g. introducing price caps (incentive to increase efficiency to increase profits) e.g. introduce quality standards (food production or construction) e.g. imposing windfall taxes (tax excessive profits at a higher rate) e.g. performance targets 3. Deregulation can also be used to Increase Competition: make a market more contestable, so its easier for new firms to enter the market. -This increases competition, causing the price to fall closer to marginal cost, and output to increase.

Forms of privatisation (6)

1. Sale of public (nationalised) firms: e.g. Royal Mail was privatised through the sale of shares. 2. Contracting out services: a government pays a private firm to carry out work on their behalf, e.g. cleaning government-owned buildings, such as hospitals or schools. 3. Selling of individual state assets: e.g. council houses and government buildings. 4. Deregulation: removing of regulation to encourage competition. 5. Competitive tendering: private firms bid/compete to gain a contract to provide a service for the government. Firms will compete on price and quality of the service offered. 6. Public Private Partnerships (PPPs): a private firm works with a government to build something or provide a service for the public. E.g. a Private Finance Initiative (PFI): a private firm is contracted by the government to run a project. e.g. in the UK, some hospitals or schools are built by a private firm, then the government leases the buildings from the firm.

Limitations of the model of monopolistic competition: (2)

1. Some firms will be better at brand differentiation and therefore, in the real world, will be able to make super-normal profit. New firms will not be seen as a close substitute. 2. There is considerable overlap with oligopoly. The main difference is that the monopolistic competition assumes no barriers to entry. In the real world, there are likely to be barriers to entry.

Competitive behaviour is more likely when...? (4)

1. The firm has lower costs than the others. 2. There's a relatively large number of big firms in the market (making it harder to know what everyone else is doing). 3. The firms produce products that are very similar. 4. Barriers to entry are relatively low.

Collusive behaviour is more likely when...? (4)

1. The firms all have similar costs. 2. There are relatively few firms in the market (so its easier to check what other firms are charging etc...). 3. 'Brand Loyalty' means customers are less likely to buy from a different firm, even when their prices are lower. 4. Barriers to entry are relatively high.

Examples of price discrimination (4)

1. Theatres and cinemas offer 'concession' prices for certain groups (e.g. Students and pensioners). 2. Window cleaners could charge more in a high income neighbourhood than a lower-income area. 3. Train tickets at rush hour out more than they same train ticket at other times of day. 4. Pharmaceutical drugs may be sold at different prices in different countries.

In monopolistic competition, the conditions of perfect competition are 'relaxed' slightly. How? (2)

1. There is some product differentiation: either due to advertising or because of real difference in products. -This means the seller has some degree of price-making power. -So each seller's demand curve slopes downwards. -But the smaller the product differences, the more price elastic each product will be. -PED is higher (more elastic) than a monopoly. 2. There are either barriers no barriers to entry or they will be very low. -This means that if very high supernormal profits are earned, new entrants can join the industry fairly easily.

Disadvantages of a perfectly competitive market (5)

1. Undifferentiated products: difficult to obtain a competitive edge/stand out in the market. 2. Economies of scale: cannot fully exploit benefits of EoS - highly contestable. 3. Lack of abnormal profits: easy barriers to entry and exit - abnormal profits are eroded away/hit and run competition occurs. 4. Perfect knowledge: no incentive to enhance technology. 5. Externalities: no incentive to minimise negative externalities/take responsibility (e.g. pollution).

When will a business continue to produce in the short run?

A business needs to make at least normal profit in the long run to justify remaining in an industry. BUT in the short run, a firm will continue to produce as long as price per unit >/= AVC

Allocative efficiency occurs when...? -How does this occur in a perfectly competitive market?

A good's price is equal to what consumers want to pay for it. -This happens in a perfectly competitive market because the price mechanism ensures that producers supply exactly what consumers demand. So P = MC or P = MU.

What would happen, in the short run, to profits of a firm in a perfectly competitive market if demand was to increase?

A rise in demand for a good would cause the demand curve to increase from D1 to D2. Quantity produced to increase to Q2, resulting in an upward shift for AR and MR for individual firms. This results in an increase in profits; since AR>AC; the firms are now making supernormal profits.

Advantages and Disadvantages of First Degree Price Discrimination

Advantages: -If successful, the firm can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus. Disadvantages: -This is hard to achieve unless a business has full information on every consumer's individual preferences and willingness to pay. -Difficulty in preventing seepage. -The transaction costs involved in finding out through market research what each buyer is prepared to pay is the main barrier.

Advantages and Disadvantages of Price Discrimination

Advantages: 1. Firms are able to increase revenue; profit maximize. 2. Increased investment; increased revenue used for research and development. 3. Lower prices for some; some consumers benefit from lower fares. -Often the people who end up paying more have higher incomes, so are more able to afford those higher prices. Some people see this as fair, especially if the greater profits are used to subsidise lower prices paid by others (e.g. Train passengers commuting to work pay higher prices and profits from these consumers could be used to help support daytime services. 4. Manages demand; encourage people to travel at unpopular times (avoid over-crowding/spread out demand). Disadvantages: 1. Higher prices for some; some consumers end up paying higher prices = allocatively inefficient (in all cases, AR>MC) 2. Decline in consumer surplus; transfer of money from consumers to firms. 3. Potentially unfair; e.g. adults paying full prices could be unemployed. 4. Administration costs in separating the market. 5. Predatory pricing.

What is an oligopoly? (3 factors)

An oligopoly is a market: 1. that's dominated by a few firms, thus a high concentration ratio. 2. high barriers to entry, meaning new entrants cannot easily compete away supernormal profits. 3. firms offer differentiated products (output provided may be similar but not identical).

Price setting or price making power is available to who?

Any business with a downward sloping demand (AR) curve.

What is a working monopoly?

Any firm with greater than 25% of the industry's total sales.

What is a monopsony?

Bargaining power. When a single buyer dominates a market. A monopsonist can act a as a price maker, and drive down prices: e.g. Supermarkets unfairly use market power to force suppliers to sell products at a price which means those suppliers make a loss. However, this could be in the interest of consumers if supermarkets pass this on in the form of lower prices.

Key difference with monopoly:

Barriers to entry in monopoly are high, but low in monopolistic. -Therefore, in the LR, firms in monopolistic competition only make normal profit.

Key difference with perfect competition:

Differentiated products: - In monopolistic competition, firms produce differentiated products, therefore, are not price takers (have inelastic demand).

Perfect competition doesn't lead to ... Efficiency?

Dynamic. In perfectly competitive markets, they only earn normal profit, so there's no reward for taking risks, so they will not engage in investment for research and development. This, dynamic efficiencies not achieved.

Example of Second Degree Price Discrimination

E.g. Hotel Industry. -Spare rooms are sold on a last minute standby basis: the fixed costs of production are high, and the marginal or variable costs are low. -Therefore, if there are unsold rooms, it is in the hotel's best interest to offload spare capacity at a discounted prices providing that the extra revenue at least covers the marginal cost of each unit (MR>MC). -There is nearly always supplementary profit to be made. Firms may be quite happy to accept a smaller profit margin if it means they manage to steal an advantage on their rival firms.

Example of Third Degree Price Discrimination

E.g. Rail and tube travellers can be subdivided into commuter and casual travellers, and cinema goers can be subdivided into adults and children. -Splitting the market into peak and off-peak use is very common and occurs regularly. -This is the most common type of price discrimination.

Perfectly competitive markets will achieve allocative efficiency, assuming there are no...? -Why?

Externalities. -Allocative efficiency occurs when P=MSC (marginal social cost: including external costs). -Perfect competition results in a long run equilibrium where P = MPC (marginal private cost: ignoring external costs). -But if there are negative externalities, say, then MPC<MSC (which means P<MSC), this means there will be allocative inefficiency, leading to overproduction and overconsumption.

Why are monopolies said to be dynamically efficient?

Firms are able to earn abnormal profits in the long run; Therefore, there may be a faster rate of technological development that will reduce costs and produce better quality items for consumers. Monopoly power can be good for innovation.

How can being the 'First-Mover' be a disadvantage?

For example, suppose several firms are all deciding whether to launch a new type of product into a market: -The 'first mover' could make a huge profit by winning a large market share very early. -However, if they've overestimated the demand for the product, they may make huge losses. -Also, competitors may be able to use a lot of the technology that the firm firm has developed, reducing their costs and allowing them to charge a lower price than the first mover.

What happens to profit in the long run? -Where is the new equilibrium established?

Freedom/low barriers to entry ensure that only normal profit will be made in the long run. Any short term abnormal profits will attract/provide incentive for new firms to enter the market and erode profits. As new firms enter the market, the supply curve will shift right, reducing market price until all excess profits have been competed away and a new long run equilibrium is reached. -The new equilibrium is established at the lowest point on the firm's AC curve, so firms become productively efficient. -P also = MC, so firms are allocatively efficient too.

What is game theory?

Game theory is a branch of maths. -It's all to do with analysing situations where two or more 'players' (e.g. people, firms, etc.) are each trying to work out what to do to further their own interests. -The fate of each of the players depends on their own decisions, and the decisions of everyone else. So all the players are interdependent. This is why it's often used to analyse situations in economics. -The problem for firms is that they have imperfect knowledge of other firms' actions and reactions.

Example of PPP

In 2010, M&S agreed a 5-year partnership with Somerset County Council Waste Partnership for M&S to provide funding for the council to collect waste from roadsides in the country. This funding has enabled the county council to improve its recycling services, and M&S has benefited from the collection of recyclable plastic that can be used for its products.

Merger that was given clearance:

In 2015, the takeover of 99p stores by Poundland was investigated. -However, the merger was given clearance as there would still be significant competition in that 'single price point market': from Poundworld, Poundstretcher as well as supermarkets.

Why do governments choose to intervene in concentrated markets?

In concentrated markets where monopoly power is causing market failure, the government may use competition policy to increase competition. -E.g. if a monopoly exists and prices are above the market equilibrium price, there's a misallocation of resources and a dead weight welfare loss. -The intention of the government is to protect the interests of consumers by promoting competition and encouraging the market to function more efficiently. -Governments can do this through the use of competition policy.

Collusive behaviour diagram explanation.

In the case where colluding firms have agreement to restrict output to maintain high prices, firms set a price (Po) and a level of output (Qo) that will maximise profits for the industry (where MC = MR in the industry). They then agree output quotas and the resulting supernormal profits for these firms is shown in green.

What is the Prisoner's Dilemma?

It illustrates why it is difficult to cooperate, even when it is in the best interest of both parties. -Both players are assumed to select their own dominant strategies for short-sighted personal gain/self-interest. -Eventually, they reach an equilibrium in which they are both worse off than they would have been if they could both agree to select an alternative strategy.

What is non-price competition?

It involves advertising and marketing strategies to increase consumer demand and develop brand loyalty.

Monopolistic competition/imperfect competition:

It is a form on imperfect competition: it lies part-way along the range of market structures: between perfect competition and monopolies.

What is X-efficiency?

It measures how successfully a firm keeps its costs down. X-inefficiency means that production costs could be reduced at that level of production. X-inefficiency can be caused by: -using factors of production in a wasteful way (e.g. Employing more people than necessary) -paying too much for factors of production (e.g. Paying workers more than is needed or buying raw materials at higher prices than necessary)

Why is a monopoly productively inefficient?

MC is not equal to AC at long run equilibrium position for a monopoly: Not operating at lowest point of AC curve. Lack of incentive to reduce costs due to lack of competition; element of complacency. Monopolies know: -High brand loyalty -High barriers to entry -Pricing power

If the market price (AR) falls below a firm's average unit-cost (AC), the firm is...? -If this occurs in the long run, what will happen?

Making less than normal profit: a loss. -In the long run, since there are no barriers to entry or exit, the firm will just leave the market.

In perfect competition, a market's supply curve = ? -Why?

Marginal Cost (MC). -Because producers' marginal costs increase as quantity increases due to the law of diminishing returns.

In perfect competition, a market's demand curve = ? -Why?

Marginal Utility (MU). -Because consumers' demand reflects what that good is worth to them and that decreases as quantity increases due to the law of diminishing marginal utility.

Firms that collude on price may still compete in other ways, such as...? (3)

Marketing policies. 1. For example, colluding firms may try to differentiate their products from the competitors', either by improving them or creating a strong brand loyalty, through advertising techniques, to attract and retain customers. 2. They could also use sales promotions such as loyalty rewards for customers who make repeat purchases. 3. They may even try to find new export markets.

Does monopolistic competition lead to dynamic efficiency? -Why?

No. The lack of barriers to entry mean that firms are unlikely to invest huge amounts of money on new innovations: so there is likely to be less dynamic efficiency. -In the long run, the absence of supernormal profit will mean there won't be much money available for investment.

Second Degree Price Discrimination

Often used in wholesale markets, where lower prices are charged to people who purchase large quantities (i.e. price varies with quantity demanded). This involves businesses selling off packages or blocks of a product deemed to be surplus capacity at lower prices than previously advertised. -Price tends to fall as the quantity bought increases.

Where does the shutdown price in a competitive market occur?

P = Min AVC Beyond this point, firms cannot cover variable costs, so producing more would not be worth it.

In monopolistic competition, the long run position is like...? -Expand.

Perfect Competition. The barriers to entry are fairly low, so new entrants will join the industry. -These new entrants cause the established firm's demand curve to shift left (overall demand is split between more firms). -New entrants continue to join until only normal profit can be made: where P = AR = AC. -At this point the slopes of the AC curve and the demand curve touch tangentially (i.e. they meet but don't cross). -Since the firm is not producing at the lowest point of the AC curve, this outcome is not productively efficient. -Since the equilibrium price is greater than MC, this is not allocatively efficient. -Despite this, a monopolistically competitive market will generally achieve much greater efficiency levels than a monopoly market.

How are perfectly competitive firms productively efficient? -This is attained in..?

Perfectly competitive firms aim to produce at lowest point on AC to gain market share/maximise sales. -Having to compete gives firms a strong incentive to reduce waste and inefficiency. -The long run: in an equilibrium where AC=MC.

How are perfectly competitive firms allocatively efficient?

Perfectly competitive firms are price takers; consumer surplus is maximised as price = MC. Allocatively efficient; no barriers to entry; supernormal profits made in SR; signal for new firms to enter; outward shift of supply; market price falls; in LR, price taking firms produce at output where AR = ATC

Example of competition policy in the energy market.

Price controls on prepayment meters and setting up a customer database to help rival suppliers target customers stuck on expensive default tariffs: as larger companies were overcharging.

Why is a monopoly allocatively inefficient? -This creates a...?

Price is not = MC. Monopolist is able to charge a higher price than MC; reducing consumer surplus. -Producers are 'over-rewarded' for the products they're providing. -Because of the restricted supply, the product will also be under consumed - consumers aren't getting as much of the product as they want. -There is a deadweight welfare loss too (loss of potential revenue that the producer isn't receiving on higher outputs of the product that the consumers would have been prepared to pay for, but which isn't produced).

Because monopolistic competition results in firms not producing at the lowest point of the AC curve, prices...? -Why?

Prices tend to be higher in monopolistic competition than in perfect competition. -This is because firms in monopolistic competition need to spend money differentiating their product (e.g. by advertising) and creating brand loyalty. Whereas there is no need for advertising in perfect competition as consumers have perfect knowledge.

What is Nash equilibrium?

This is an idea in a game theory: any situation where all of the participants in a game are pursuing their best possible strategy given all the strategies of all of the other participants. -No incentive to change their strategy: would end up worse off.

What is collusive behaviour? -Different types? (2)

This is when various firms cooperate with each other, especially over what prices are charged. 1. Formal collusion: involves an agreement between the firms - i.e. they form a cartel. This is usually illegal. 2. Informal collusion is tacit: i.e. it happens without any kind of agreement. This happens when each firm knows it's in their best interests not to compete... as long as the other firms do the same.

Third Degree Price Discrimination

This means charging a different prices for the same product to different segments of the market. These segments could be: -customers of different ages -customers who buy at different times: e.g. A telephone company charging different amounts for phone calls made during office hours and evening. -customers in different places/countries

Explain the 'Kinked Demand Curve' Model.

This model relies on the assumption that if one firm raises its prices, then other firms will not raise theirs: the firm that raises its price will see a fall in demand as consumers are likely to substitute. Therefore, when price is increased, demand is elastic. The model also assumes that if one firm lowers its prices, then other firms will follow: thus, a firm which lowers its prices will not gain any market share as other firms will reduce their prices to remain competitive. Therefore, when price is decreased, demand is inelastic. The outcome of this model suggests that there is no incentive to change prices in oligopolistic markets: raising or lowering prices will have negative impacts for the firm, resulting in price stability.

What is a duopoly? -E.g.?

When two firms are in dominance. -E.g. Pepsi and Coca Cola

To maximise profit, the seller would set price where?

Where MC=MR for each segment of the market: -charge a higher price to more inelastic PED -charge a lower price to more elastic PED

First Degree Price Discrimination

Where each individual customer is charged the maximum they would be willing to pay: Perfect price discrimination: charging whatever the market will bear. -Sometimes known as optimal pricing, the firm separates the market into each individual consumer and charges them what they are willing to pay.

Perfectly competitive markets are only productively efficient if...?

You assume that there are no economies of scale. -On a perfectly competitive market, there's an infinite number of firms. -This means that each firm is very small, and so can't take full advantage of economies of scale. -If there are economies of scale, then an industry made up of an infinite number of very small firms may be less productively efficient than if there was one very big form (e.g. Monopoly).