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Economics (Market Structures)
Terms in this set (29)
Four main elements of Market Structure
1. Barriers to entry and exit
2. the number of buyers and sellers (consumer vs producer markets)
3. the types of good and services sold in the market (identical/differentiated)
4. how price is determined in the market (controls on price, firm/government)
Many buyers and sellers (actions of one particular buyer or sellers have little influence)
goods are homogeneous, not differentiated
Perfectly free entry
firms are price takers
Ex. cabbages and carrots
All buyers and sellers have perfect information
No transaction costs or transport costs
Each firm works independently and tries to maximize profit
Each firm believes it can sell any quantity it wants at the given market price. Cant raise or lower prices because of competitors.
Many buyers, one seller
very difficult for new firms to enter
firms are price setters
ex. local water company
Selling firms demand function is the market demand function
If monopolist earns abnormal profit, there is no worry for new entrants
Can restrict the number of goods it produces in order to raise prices and make abnormal profit
Spatial monopoly: only provider of a good or service in a specific area.
Barriers to Entry (monopoly)
Structural barriers are entry barriers over which neither
incumbent firms nor the entrants have direct control
(e.g. economies of scale, absolute cost advantage,
Language and Cultural Barriers
-limit pricing: the monopolist may decide to set a price below this profit maximising level, but still enable it to make higher profits than in a competitive market.
-Predatory Pricing: The act of setting prices low in an attempt to eliminate the competition.
-Brand Proliferation: the firm has several brands in the same product/product category. It means that the list of independent brands swells up.
Legal Barriers to entry
Registration, certification and licensing of businesses
Monopoly rights. Monopoly rights may be granted by
Patents. Ownership of a patent confers monopoly rights and the potential to earn an abnormal profit, usually for a fixed period.
Government policies. tariffs, tax policies and employment laws may all impede entry, either directly or indirectly.
Geographical barriers to entry
Tariffs, quotas, subsidies to domestic producers.
Physical barriers such as customs
Technical barriers: may not be able to meet the specific technical standards or employment standards, etc.
Aspects of a country's fiscal regime
may disadvantage foreign firms. Exchange controls
may impose costs on foreign firms that need to
convert currencies in order to trade
Preferential Public Procurement Policies
Purchasing policies practiced by national governments may give preferential treatment to domestic firms,
placing foreign competitors at a disadvantage.
Advantages of a monolopy
Large monopolists benefit from economies of scale and scope, which may result in lower priced products
under a monopoly: greater output and standardisation can lead to lower costs
Industries such as gas, water, etc are natural monopolies, any competition would result in wasteful duplication of systems
Monopoly profits may be used to finance R&D programs to stimulate technological progress
monopolies lead to stable market conditions and avoid many forms of non-price competition, preserving scarce economic resources.
Disadvantages of a monopoly
Prices are usually higher and output lower leading to excess capacity and leaving scarce resources idle
Monopolies can raise prices and deter entry
Technological progress is slow, competitive pressure to produce new products and processes are absent
high prices and low outputs results in loss of economic welfare.
Monopolists as sole suppliers are in a position to price
discriminate between different markets. (Price
large number of buyers and a several sellers
goods are similar but differentiated
free entry or easy access
firms are price setters
Ex. builders, restaurants
Brands and trademarks
Community or national differences
Large number of buyers, only a few sellers
goods can be differentiated or homogeneous
restriction to entry
Firms are price setters
Ex. cars, cement
Behaviour pursued will influence the behaviour of
- recognition of interdependence,
- rigid price,
- non price competition,
- and collusion
Competition vs. Collusion
Competition:price wars, but more likely non price with rigid prices
Collusion: secret or illegal cooperation in order to deceive others. Tacit or explicit Can gain higher profits through collusion.
can pool industry information, reduce uncertainty,
inflate prices and increase profitability
can act as joint monopolist
Tacit Collusion:no explicit attempt to collude: industry tradition, trade associations, public announcement, price leadership models, barometric, dominant
Explicit collusion - Cartel - Explicit agreement between
firms with respect to levels of price and output, pools all information regarding the whole industry, in a better position to detect cheating
Agreements:prices to be charged, methods of calculating price, market allocation, production and sales quota, product quality, credit terms, methods of bidding for tenders, sanctions - i.e. punishment for sales above the quota
Factors that deter collusion
What is good for most firms may not be good for individual firms
Anti-trust laws in the US deter collusion
Coordination becomes difficult the more firms that are involved
Firm may not wish to collude if their are no punishments for breaking the agreement
the most efficient firms may be tempted to break the ranks by cutting prices and increasing market share.
Competitive Oligopoly: the Kinked Demand Curve
If firm increases its price, it will lose a lot of its market share. If the firm lowers its price, so will its competitors, no gain in market share by changing price
Kink is at price P0, the price at which the firm is selling 0Q0. Above P0 - the demand curve is relatively elastic. Below P0 - the demand is less elastic (inelastic)because the firm believes that a reduction in price
will be matched.
Profits are maximised where MC equals MR, where
the MC curve intersects the vertical discontinuity in
MC rises or falls within the discontinuity, as shown by points A and B, price and output will remain
Barometer of Price Rigidity
the angle of the kink in the demand curve
Factors that affect the angle of the kink
if there ar every few rivals, changes in price may be closely followed because of the firms awareness of interdependence
the size of the rivals: One large firm may act as price leader, may be no kink with collusion
If entrants are unsure about the market structure,
or incumbent firms are unsure about the intentions
of entrants, firms may adopt a wait-and-see
The same may also be true in a new industry, where
firms are attempting to size each other up.
If there is substantial shareholder control, risk averse
managers may decide to play safe, by
avoiding actions that could provoke damaging
reactions from rivals.
Horizontal when firm is price taker
Downward sloping when firm is price setter
Minimum efficient Scale
term used in industrial organisation to denote the smallest output that a plant (or firm) can produce such that its long run average costs are minimised
Each player selects a strategy or strategies that will maximise his or her own payoff. The property of interdependence is a defining characteristic of the game
Different types of games
Constant-sum game: the sum of the payoffs
to all players is always the same, whichever
strategies are chosen.
Non-constant sum game, the sum of the
payoffs depends on the strategies chosen.
Zero-sum game is a constant-sum game in
which the sum of the gains and losses of all
players is always zero. A game of poker is a zerosum
game: one player's winnings are exactly
matched the losses of rival players
one player has a strategy that will yield a higher payoff regardless of that the other player chooses
One player has a strategy that will yield a lower payoff no matter what the other player chooses
A game in which each player plays its dominant strategy and the payoff is less than if the players had each played their dominated strategies
Maximising the maximum outcomes: best of the best
Maximising the minimum outcomes: best of the worst
Criterion for assessing whether a market structure is
'better' under perfect competition or where some
element of monopoly power exists.
Allocative efficiency occurs when the value that
consumers place on good or service (reflected in the
price they are prepared to pay) equals the cost of
resources used up in production.
It is helpful in making decisions about whether a market
can be made to operate in a more efficient way.
More on Allocative efficiency
Perfect competition leads to efficient use of scarce resources- lots of small firms cant use economies of scale
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