Unit 3.4 Market structures

What are the characteristics of a LOW contestable/uncontestable market

*HIGH barriers of entry and exit* e.g. • There are *patents on products or production methods* • *Advertising* by *incumbent firms* has already created *strong brand loyalty* • There's a threat of *limit pricing (i.e. predatory pricing*) tactics by the *incumbent firms* • *Trade restrictions* don't allow foreign entrants • *Sunk costs are high* (Barriers of exit)

What are some characteristics of HIGH contestable markets

*LOW barriers of entry and exit*: e.g. - *low fixed costs* e.g. low levels of capital - *low sunk costs* - *weak brand names/few patents* - *low potential profitability in the long run*

What is price discrimination?

*Price discrimination* is when a seller *charges different prices* to *different customers* for the *exact same product.* this is to *maximise profits* e.g. • *Flight tickets that have been earlier booked are (a lot) cheaper than those that are booked just before departure*. • Apple's student discount for their products. • Pharmaceutical drugs may be sold at different prices in different countries.

What is allocative efficiency

*Producing* at a point where the *price of a good is equal to the marginal cost of production (P = MC)* This *maximises welfare* because the *price charged* for the last unit *= the cost of making the last unit*, so the net *welfare falls if any more is produced* This happens in a *perfectly competitive market * because the *price mechanism ensures that producers supply exactly what consumers demand*

How does perfect competition lead to productive efficiency

*Productive efficiency* is about ensuring the *costs of production are as low* as they can be. This will mean that *prices to consumers can be low* as well. In perfect competition, productive efficiency comes about as a *direct result of all firms trying to maximise their profits*. At the *long run equilibrium* of perfect competition, a firm will produce a *quantity of goods* such that: *marginal revenue (MR) = marginal costs (MC)* • *Output above this level (MC > MR) reduces profit*, so firms *wouldn't produce* it. • *Output below this level (i.e. MR > MC)* would mean the *firm would earn more revenue from extra output* than it would spend in costs — so the firm would *expand output* as this would *increase profit.*

What is the N-firm concentration ratio?

*Some industries are dominated by just a few companies* (e.g. Boeing and Airbus planes). These are called *concentrated markets.*

What are the characteristics of monopolistic competition markets

- *large number of buyers and sellers* - *Few barriers of entry and it is easy for firms to recoup their capital expenditure on exit* - Consumers face a *wide choice of differentiated products (- so demand curve slopes down)* Each firm has a slight degree of monopoly power in controlling the *quality and physical differences between products* - Firms have *some influence on price* so are *price makers*

What are the benefits of oligopolies to producers, consumers, workers and the government????????

- *predatory pricing and barriers of entry & exit* makes it easy for big producers to strive

What are the costs of oligopolies to producers, consumers, workers and the government????????

- *predatory pricing and barriers of entry & exit* makes it hard for new producers to enter - Consumers face *high prices*

What are the benefits of contestable markets to firms and consumers ??????

- Easy way for firms to make a *quick profit*

How do monopolies maximise profit

- Monopolies make a supernormal profit in the *short and long run* as there are high *barriers of entry* that prevent competitors from entering, so *no supernormal profits can be competed away* - Therefore, monopolies *maximise profit at the output level where MC = MR* - If the firm produces a quantity QM, the *demand (or AR) curve* shows the *price the firm can set* — PM. - At this output the a*verage cost (AC) of producing each unit is ACM.* The *difference between ACM and PM is the supernormal profit per unit*. So the *total supernormal profit is shown by the green area.*

What are the characteristics of a (pure) monopoly

- Only *1 large firm* which owns *100% of market share* - *Products are unique* (no close substitutes e.g. oil) - There is *imperfect knowledge* - There are *very high barriers of entry* and exit - The firm is the *price maker* e.g. the US oil industry in the 1910s (all owned by 1 company) Even though *firms with monopoly power are price makers,* *consumers can still choose whether or not to buy their products*. So *demand will still depend on the price* — as always, the higher the price, the lower the demand will be.

What are the costs of contestable markets to firms and consumers ??????

- Risks firms *going out of business* or making only *normal profits in the long run* - Less monopoly power, *more competition*, so *lower prices for consumers*

What are the benefits of monopolies to consumers and firms ?

- Supernormal profit means *finance fro investment and R & D* - Firms have *international competitiveness* - Increased *range of goods available for consumers* - *economies of scale means greater efficiency*

What are the benefits of price discrimination to customers and sellers

- The *extra revenue* generated by the firm can be used to *improve the quality of the product* or *invest in productive methods* which results in *lower cost for consumer* - Sellers get *higher profits* - This can be more *equal* as people who pay more *(rich) subsidise people who can't afford it*

What are the costs of price discrimination to customers and sellers

- The consumer has *less consumer surplus* - In all cases, the *average revenue is greater than MC* — so price discrimination does *not lead to allocative efficiency*, because *allocative efficiency occurs when P = MC* - Consumers are *not treated equally*

What are the benefits of monopsony to consumers, firms and the government

- The government is the *only buyer of defense in a country* so can *drive down prices* - *Lower prices are passed on to consumers* - *High quality goods* - *Monopsony prices can drive down monopoly prices*

What are the characteristics of an oligopoly (7)

- The market is *dominated by few large firms e.g. Microsoft Windows and Mac OS* - There are *high barriers to entry* (so new entrants can't easily compete away supernormal profits) - Firms offer *differentiated products* (i.e. products are *similar but not identical*). - Firms are *interdependent* to each other (the actions of 1 firm can effect another firm e.g. lowering prices) - There is *imperfect market knowledge* - Oligopolies *can set price* but generally tend to *limit /fix price* to *eliminate competitors* (*collusive strategies*

What are the 7 characteristics of a perfectly competitive (theoretical) market (suppliers & consumers, knowledge, Products, barriers of entry/exit, firms aims, prices)

- There's an *many suppliers & consumers* - Producers and Consumers have *perfect information of market conditions* - Products are *homogeneous (identical) - so demand curve is horizontal* - There are *no barriers of entry or exit* (join and leave easily) - Firms are *profit maximisers (MC = MR)* - All prices set by the *price mechanism* (firms are *price takers*)

What are the costs of monopsony to consumers, firms and the government

- This *exploits suppliers* which may make a *loss* - If a firm is the *single buyer of labor* in a market, it can exploit its power & *lower the wages* of its employees.

Why is there no dynamic efficiency in perfectly competitive markets

1) Dynamic efficiency is about *improving efficiency* in the *long term*, so it refers to the willingness and eagerness of firms: a) to carry out R & D to improve existing products or develop new ones. b) to *invest in new technology* or training to improve the production process & *reduce production costs.* However, these *strategies* involve considerable *investment and therefore risk*, so they will only take place if there's adequate reward. However, Firms in a perfectly competitive market earn only *normal profit, so there's no reward for taking risks.* This means *dynamic efficiencies will not be achieved.*

How does perfectly competitive markets lead to static (allocative and productive efficiency) in the long run ??????

1) If *allocative and productive efficiency are achieved* at any particular point in time, this is called *static efficiency*. But static efficiency *can't last forever,* since *technology and consumer tastes change*. For example, the methods used to make cars in the 1920s might have been allocatively and productively efficient at the time, but they'd be hopelessly out of date now. 2) To remain *allocatively and productively efficient*, car makers would have needed to *invest in new production technology & design new models*.

What is the profit maximising equilibrium in the LONG RUN in monopolistically competitive markets

1) In *monopolistic competition*, the *barriers to entry are fairly low and knowledge is perfect*, so *new entrants will join* the industry. These new entrants will cause the *established firm's demand (AR) curve to shift to the left (compete away demand)* 2) New entrants will continue to join (and the established firm's demand curve will continue to shift left) until: • *Only normal profit can be earned* — this is where *P = AR = AC*. At this point the slopes of the AC curve and the demand (or AR) curve touch tangentially. This is shown by the red dot. • At this quantity, *MR = MC*

What happens to supernormal profits (short run) in perfectly competitive markets

1) In perfect competition, *no firm will make supernormal profits * in the *long run.* 2) This is because any *short-term supernormal profits (PP1QA)* *attract new firms* to the market (since there are *no barriers to entry*). This means supernormal profits are '*competed away*' in the long term — i.e. *supply increases, industry supply curve shifts right, so price falls from P to P1 and profits too as firms are forced to lower prices to P1Q1*. 3) Check and *understand the diagram* (I know it looks complex)

What are the 4 market structure sarranged from most competitive to least competitive (number of sellers)

1) Perfect competition (high competition) 2) Monopolistic competition 3) Oligopoly 4) Monopoly (no competition)

What are the conditions required for price discrimination (3)

1) The seller must have *price making power* (monopoly power) 2) The firm must be able to *distinguish separate groups* of customers who have *different price elasticities of demand (PED)* 3) The seller can prevent *seepage* which is customers *reselling their products at a higher price to other customers*

What is the 2nd assumption and explanation of the kinked demand curve (competition)

A *firm which lowers its prices* will *not gain any market share* (although the overall size of the market may increase slightly, given that *all the firms will have lowered their prices*). In other words: *When price is increased, demand is price elastic* This means *any firm that reduces prices will lose out* — they *won't gain market share* but the *average price* for their products will *have fallen*.

Why may a firm leave a perfectly competitive market

A firm will *Leave a market* if it's *Unable to make a profit* in the *Long Run*: 1) If the *market price (AR) falls below a firm's average unit-cost (AC)*, the firm is making *less than normal profit* (i.e. a loss). 2) There are *no barriers to exit in a perfectly competitive market*, so in the *LONG RUN* the firm will just *leave the market*.

What is a cartel

A formal agreement between firms to *limit competition* by *limiting output or price*

What is a monopsony

A monopsony is a situation when a *single buyer dominates a market.* *A monopsonist* can act as a *price maker,* and *drive down prices* For example, *supermarkets* are sometimes accused of acting as *monopsonists when buying from their suppliers* Some people claim *supermarkets unfairly use their market powe*r to *force suppliers to sell* their products at a *loss*

Why are natural monopolies efficient as 1 firm

A natural monopoly will have *continuous economies of scale* — i.e. *LRAC always falls as output increases* (meaning MC is always below AC - fixed costs). A government may be *reluctant to break up a natural monopoly* as it *reduces 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 also *reduce prices*

What is an example of a contestable market

A range of markets have recently become contestable e.g. The Airline industry: New budget airlines like *Ryanair and EasyJet* have joined by *leasing airplanes and flying to small airports* to reduce costs. They became very *established over the years*

How can patents act as a barrier to entry in oligopolies

An *innovative new product *or service can give a firm a head start over its rivals which can be difficult for a new entrant to overcome. If the *new technology is also patented* then *other firms can't simply copy* the new design — it's *legally protected.* e.g. Microsoft Windows

Why are hit and run tactics used in HIGH contestable markets

Because of *low barriers of entry and exit*: • This means *entering* a market *while supernormal profits* can be made... • ...and then *leaving the market once prices have been driven down to normal-profit* levels

Why is there no dynamic efficiency in monopolistically competitive markets

Because there is *no supernormal profits in the long run*, so firms are *unlikely to invest a lot of money in innovation* Also, there would *not be much money for investment as there is little supernormal profits*

Why may governments want to encourage competition (2)

By *encouraging competition*, governments hope to achieve these same kinds of *efficiencies in real life*. For example, governments want to make sure firms: (i) are forced to *produce efficiently*, *reducing costs* where possible, (ii) set *prices at a level that's fair* to consumers,

How are collusive oligopolies similar to monopolies

Collusive oligopolies generally lead to *higher prices and restricted output* (and underconsumption), as well as *allocative and productive inefficiency.* Firms in collusive oligopolies often have the *resources to invest in more efficient production methods* and achieve *dynamic efficiency*, but there's *not always an incentive for them to do so*. So collusive oligopolies can lead to *market failure* This means *CONSUMERS* have to *pay higher prices*

What is and what are characteristics of contestable markets (2)

Contestability refers to *how open a market is to new competitors* (i.e. *potential competition*): In a contestable market: • The *barriers to entry and exit are low*. So if excess profits are made by incumbent firms, new firms will enter. • *Supernormal profits* can potentially be *made by new firms* (at least in the *short term*) These factors mean that *incumbent firms* always face the *threat of increased competition*. So, incumbent firms have an *incentive to set prices at a level* that *won't generate vast supernormal profits*

What is dynamic efficiency

Dynamic efficiency is about *improving efficiency in the long term, *so it refers to the willingness and eagerness of firms: a) to carry out *research and development* to *improve existing products* or develop new ones. b) to *invest in new technology or training* to improve the production process and *reduce production costs.*

How can economies of scale and limit pricing act as a barrier for entry in oligopolies

Economies of scale could be a barrier because existing firms are able to *produce at a lower average cost than those starting up* Large firms can *hide supernormal profits* by *limiting their prices by economies of scale* to *deter new entrants* (*predatory pricing*) The big firms can *agree* to *limit prices* in an act of *collusion*

What is third degree price discrimination

Firms *charge different amounts* for *different segments* of the market e.g: − customers of different *ages* — for example, a leisure center might have *different prices for adults, children* and pensioners. − customers who buy at *different times* — for example, a telephone company might charge *different amounts for phone calls* made *during office hours and phone calls made in the evening*. − customers in *different places* — for example, a *pharmaceutical company* might *sell its goods (drugs)* at *different prices in different countries.*

How can a firm operating third degree price discrimination maximise profits (diagrams)

For example, a seller can identify two groups of customers (Group A and Group B) with *different price elasticities of demand* (PED), as in these diagrams To maximise profit, the seller would set the price for each group at a level where MC = MR. This means: − it will *charge a higher price* to the group with a more *inelastic PED*. − It will *charge a lower price* to the group with a more *elastic PED* (e.g. PB for Group B). • The *green areas represent the supernormal profit* earned from each group. This total *supernormal profit is greater than if the same price* were *charged to everyone.*

Why is being the first mover in game theory not always the advantage

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*.

How does price leadership work as a form of collusion

If 1 firm increases prices, all the other firms will *follow the leader and increase prices* as well. so *prices remain at similar levels* to each other

How can game theory/the prisoners dilemma model explain how how interdependent firms might act in an oligopolistic market?

If 2 firms, firms X and Y *collude to set high price levels at $500* They can both make $100 profit However, if Firm Y breaks the agreement and lowers the price, more people will buy Firm Y's product getting them more profit ($200) and Firm X will have low profit ($50) Firm X could also do the same and break the collusion giving them more profit These situations all end in both firms lowering price, so both firms will be making equal but less profit ($25) than if they kept the agreement The theory of first-mover advantage shows why cartels can be unstable — *every firm knows they can get an advantage* if they *break the agreement first*

What is the profit maximising equilibrium in the SHORT RUN in monopolistically competitive markets

In *monopolistic competition*, the *barriers to entry* and/or the product differentiation mean that *supernormal profits can be made*, but only in the *short run.* • The *profit-maximising* level of output occurs where *MC = MR*. • The diagram shows the output leading to the profit-maximising price (P). • This means the firm earns *supernormal profit of the blue shaded region*

How is a perfect competition market shown on a supply and demand curve

In *perfect competition,* a market's *demand curve = 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*. Also, a market's *supply curve = marginal cost (MC)*, because *producers' marginal costs increase as quantity increases* due to the *law of diminishing returns*

Why are firms in perfectly competitive market productively efficient

In a perfectly competitive market, the long run output level is at the *bottom of the average-cost (AC) curve *— i.e. at the *lowest possible cost level*. In other words, firms in a perfectly competitive market will be *productively efficient*. Having to *compete* gives *firms a strong incentive to reduce waste and inefficiency (X inefficiency)* - or they may be *forced to leave the market*. (ASSUMING THERE IS NO ECONOMIES OF SCALE - because firms are too small)

Why would a firm leave immediately or later if it is not making a profit in a perfectly competitive market in the SHORT RUN (2)

In the *short run*, there are 2 possibilities: • If the *total revenue (P1Q1)* is *>* average variable costs *(AVC)*, then the firm may *continue to trade temporarily to pay off fixed costs.* • If the *total revenue (P2Q2) falls below* the level of the firm's *average variable costs (AVC)*, then it will *leave the market immediately (making a loss - so can't pay off fixed costs AND variable costs).*

What does price discrimination do to consumer surplus

It *converts consumer surplus* (difference between the actual selling price of a product and the price a consumer would have been willing to pay) to *producer surplus.* This is so *profits can be maximised*

What would be the n-firm concentration ratio for monopolies, oligopolies, monopolistically competitive and perfectly competitive markets

Monopoly - 1 firm has 100% of the market share Oligopolies - *f*ive or *f*ewer *f*irms control *50%* of the market share Monopolistically competitive market - a *low concentration ratio, mainly small firms* Perfectly competitive - *very low concentration ratio, many small firms*

What is productive efficiency

Occurs at the *lowest cost per unit output* or the *lowest point of the average cost curve* (where the MC curve = AC curve)

How can incumbent firms stop new entrants in a highly contestable market

Set up barriers to prevent entry - e.g. by *driving down supernormal profits in the short run* to *avoid attracting new entrants*. This may be the *best way to maximise profit in the long run.* - *Advertising* to create *brand loyalty* - *Predatory pricing* to shoo away competition

Why are firms in a monopolistically competitive market not productively or allocatively efficient

Since the *firm is not producing at the lowest point on the AC curve*, this outcome is *not productively efficient.* And since the *equilibrium price is greater than and not equal to MC*, this is *not allocatively efficient*. (But despite this, it still achieves *greater efficiency levels than a monopoly* market.

What are the assumptions for a perfectly competitive market e.g. Agricultural markets (3)

The conditions for a perfectly competitive market ensure that the *rationing, signalling and incentive* functions of the *price mechanism* work *perfectly*. In particular: • all *firms are price takers* ('the *market' sets the price* according to *consumers' preferences, rationing* resources and *signalling* priorities), • *consumers and producers* have *perfect knowledge* of the market, and there are *no barriers to entry or exit*. • *Perfectly competitive* markets will *achieve allocative efficiency, assuming that there are no externalities (where the S curve intersects with D curve) - so welfare is maximised*

Why are monopolies inefficient (2)

The firm is *not operating at its lowest point of the AC curve* (where MC = AC) so monopolies *aren't productively efficient* The *price charged by the firm is greater than MC (P>MC)*. This means that a monopoly market is not allocatively efficient. Producers are being 'over-rewarded' for the products they're providing. This means there's a *deadweight welfare loss too*

How can the *n*-firm concentration ratio be used to calculate the level of domination of a market

The level of domination is measured by a concentration ratio. • Suppose *3 firms control 90% of the market*, while another *40 firms control the other 10%.* • The *3-firm concentration ratio would be 90%* (i.e. the *3largest firms control 90% of the market*). • It's easy to *calculate the n-firm concentration ratio* of a market. For example, suppose a *market is worth £45m* and you wanted to find the *3-firm concentration ratio*. If the *biggest 3 firms have revenues of £15m, £9m & £7m* respectively, the *3-firm concentration ratio is: (15 + 9 + 7)/45 × 100 = 68.9%*

Why is there price stability in competitive oligopolies explained by the kinked demand curve

The outcome is that *firms have no incentive to change prices*. If they either *raise or lower prices*, they will *lose out* as a result. The result is *price stability* for prolonged periods of time.

Why is a monopoly dynamically efficient

The security a monopolist has in the market (as well as the *supernormal profits*) means it can take a long-term view and *invest in developing and improving products* for the future — this can lead to *dynamic efficiency.*

Why do firms in monopolistically competitive markets not make losses in the long run

They do not make losses in the long run because, there are *low barriers of exit* which means firms making losses can just quickly leave the industry

What is collusion and its types (2)

This is when the various *firms cooperate* with each other, especially over what *prices are charged*. • *Formal/overt collusion* involves an *agreement* between the firms — i.e. they form a cartel. This is usually *illegal.* • *Informal/tacit collusion* — 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 all the other firms do the same. It's also illegal e.g. Airline ticket pricing.

What is X inefficiency and how is it caused

X-efficiency 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: 1) either *using factors of production in a wasteful* way (e.g. by employing more people than necessary), 2) or *paying too much for factors of production* (e.g. paying workers more than is needed or buying raw materials at higher prices than necessary).

What is the kinked demand curve of oligopoly useful in explaining?

You can *understand some outcomes from certain oligopolistic* markets by 'playing the game' from each firm's perspective. For example, the model of the kinked demand curve *illustrates why prices are often quite stable*, even in some competitive oligopolies

Why are prices higher in monopolistically competitive martkets than perfectly competitive markets?

unlike in perfect competition, in monopolistic competition the *firm is not producing at the lowest point on the AC curve*. These different positions on the AC curve mean that *prices in monopolistic competition tend to be higher* than in perfect competition This is also because *firms in monopolistic competition need to spend money* on *differentiating* their product (e.g. by *advertising*) and creating brand loyalty

How can a government increase competition

• *Encourage new enterprises* with *advice and start-up subsidies.* • *Increase consumer knowledge *by ensuring that comparison information is available. • *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. by joining the EU, countries enter into a multinational 'single market'.

When is competitive behavior likely to happen e.g. price wars

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

How can branding act as a barrier to entry in oligopolies

• *Strong branding* means that some products are very *well known to consumers*. The familiarity of the product often makes it a *consumer's first choice, *and puts *new entrants to a market at a disadvantage*. • A strong brand can be the result of a firm making *genuinely better products* than the competition, or by *effective advertising*. This makes it *difficult for new firms to attract competiition*

What are ways firms in collusive oligopolies can compete (*non-price competition*)

• *advertising and branding* • *quality* • endorsement • product placement • after-sales service

What are the types of differences in products in markets that are monopolistically competitive (3)

• *physical* - product features • marketing - *advertising, packaging* • *distribution* - *shop, online,* telephone This helps firms differentiate their products so they can *retain their price-making power to make supernormal profits*

What is First degree price discrimination

• First degree price discrimination is where each *individual customer is charged the maximum they would be willing to pay*. • This would *turn all the consumer surplus into extra revenue for the seller.* • However, the *cost of gathering* the required *information *to do this, and the difficulty in *preventing seepage*, makes this method *unlikely to be used* in practice

What is game theory in oligopoly?

• 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

How can sunk costs act as a barrier to entry in oligopolies

• If *investments can't be recovered when a firm decides to leave* a market, then that may make any attempt to break into a market *very risky and unappealing so deter new firms.* In this case, the *barriers of exit act as a barrier of entry*

What is the 1st assumption and explanation of the kinked demand curve (competition)

• If *one firm raises its prices*, then the *other firms will not raise theirs* this is because when 1 firm increases prices, *demand falls*, so consumers will *switch to other firms products* - *when price is increased, demand is elastic* - So the firms that raises prices *loses out* and its *TR falls*

How can legal challenges act as a barrier to entry in oligopolies

• If an activity *requires a licence*, then this *restricts* the number and speed of entry of *new firms* coming into a market. For example, pubs, *pharmacists*, food outlets, dentists and taxis all require licences before they can operate. • *New factories* may need *planning permission * before they can be built.

What is a natural monopoly

• Industries where there are *high fixed costs* and/or there are *large economies of scale* lead to *natural monopolies*. This gives them *HIGH MONOPOLY POWER* • In this case, a *monopoly might be more efficient than having lots of firms competing*. For example, the *supply of water/gas/electricity* is a natural monopoly — it makes no sense for competing firms to all lay separate pipes/pylons. • If there was *more than one firm* in the industry, then they would all have the *same high fixed cost*s. This would lead to *higher costs per customer* than could be obtained by a single firm

What are the costs of monopolies to consumers and firms ?

• Supernormal profit means *less incentive to be efficient and innovative* - *X inefficiencies* • *Consumer choice is restricted*, since there are no alternative products. • *Consumer have to pay higher prices* • Monopolists may undertake *price discrimination to raise producer surplus and decrease consumer surplus* • *Monopsonist power* may also be used to *exploit suppliers.*

When does collusive behavior happen

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

What are the types of efficiency (5)

• allocative efficiency • productive efficiency • dynamic efficiency • X-inefficiency

What is second degree price discrimination

• buyers who *buy in larger volumes get lower prices* (*wholesale*) • This *turns some of the consumer surplus into revenue* for the seller, and *encourages larger orders*.

What are the barriers of entry and exit in oligopolies (6)

• economies of scale • limit pricing • patents • branding • sunk costs • legal.

What are 3 ways firms can compete on price

• price wars e.g. Apple introducing a $400 phone • predatory pricing e.g. Airline ticket price • limit pricing i.e. to stop competition

How can you show a loss in supernormal profits in the long run

− The firm's *total revenue is TR = Q × P* (= *total area of P1MCQ10*). − The firm's *total costs are TC = Q × c* (= the *area of P2D2Q10)*, since c is the firm's average cost (AC) at this level of output). − Subtract *TC from TR to find the firm's profit*. − Here, *TR > TC*, so this firm is currently making a *supernormal profit* of TR - TC (= the area P1MCD2P1)