3.4 Market Structures

• What is Allocative Efficiency and when does it occur?

  When resources are allocated in such a way that consumers and producers get maximum possible benefit.

  Occurs when MC=AR
• What is Productive Efficiency?

  When resources are allocated in such a way that avg. costs are minimised.

  Occurs when MC=AC
• What is Dynamic Efficiency?

  Long-term efficiency as a result of innovation when firms reinvest its profits - improves manufacturing methods.
• What is X-Inefficiency and why does it occur?

  When firm lacks incentive to control production costs - Total costs are higher than they should be.

  Often occurs due to lack in competition in a market where a firm has no consequence for making a loss.
• What are the Characteristics of Perfect Competition?

  • Many buyers and sellers
  • Price takers
  • No barriers to entry and exit
  • Symmetric info. between buyers and sellers
  • Products are homogenous
• What are the Characteristics of Monopolistic Markets?

  • Large no. of small firms
  • Low barriers to entry and exit
  • Products are slightly differentiated
  • Low degree of market power - have some price-setting ability
  • Profit maximisers
• Characteristics of Oligopoly?

  • High barriers to entry and exit
  • High concentration ratio (0.6)
  • Interdependence of firms
  • Products are highly differentiated
  • Small no. of large firms
• What is Overt Collusion?

  When firms explicitly agree to raise prices (price fixing).
• What is Tacit Collusion?

  When firms monitor each other's behaviour and follow the firm.
• What are the types of Price Competition used in an Oligopoly?

  • Price Wars: When competitors repeatedly lower prices to undercut each other to gain more market share.
  • Predatory Pricing: Lowering prices when a new firm joins to drive them out - illegal as it is anticompetitive
  • Limit Pricing: When firms set a limit on high the price will go in an industry - barriers to entry ∝ limit price.
• What are the types of Non-Price Competition used in an Oligopoly?

  • Branding
  • Customer Service
  • Packaging
  • Loyalty rewards - gift cards
• What are the Characteristics of a Monopoly?

  • Only 1 single seller
  • High barriers to entry
  • No subsitute products
  • Price makers - control output
  • >25% market share
• What are the Benefits and Drawbacks of Monopoly on Firms?

  + Supernormal Profit can be used for Research and Development and product innovation

  + EoS can lower avg. costs of production

  + Price discrimination can increase profits and revenue

  • Lack of competition can lead to X-Inefficiency - misallocation of resources
  • Cross subsidisation can create inefficiencies
• What are the Benefits and Drawbacks of Monopoly on Consumers?

  + Product innovation will lead to higher quality goods

  + Cross subsidisation can lower prices on products that firm provides

  + Prices may fall if firm pass on their cost savings by lowering prices (due to Economies of Scale)

  
  

  • Little competition = higher prices since there are no substitutes
  • Product quality may worsen over-time due to lack of competition and therefore product innovation
  • Consumer surplus may fall overall
• What are the Benefits and Drawbacks of Monopoly on Employees?

  + Supernormal Profits often result in higher wages

  • Having only 1 seller in industry limits opportunity to change employers
• What are the Benefits and Drawbacks of Monopoly on Suppliers?

  + Increased sales volume due to supplying monopoly firm

  • Monopolies have power to dictate what price they will pay suppliers for good/service - not profitable in LR
• What is Third Degree Price Discrimination?

  When firm charges different prices to different consumers for the same good/service.
• What are the Conditions required for TDPD?

  • Market Power: Firm must be price makers - works best when there are little / no substitutes
  • Varying consumer price elasticity of demand: Consumers must be willing to pay at any appropriate given price point
  • Ability to prevent resales: Stop consumers from buying in low-price sub market and resell for higher prices in sub markets.
• What are the Benefits and Drawbacks of TDPD on Consumers?

  + Other consumers will benefit as they are able to take adv. of lower prices

  • Most consumers lose out as they have to pay higher prices
• What are the Benefits and Drawbacks of TDPD on Producers?

  + Total revenue increases due to higher profits

  • Setting up and enforcing TDPD can increase avg. costs and can be time consuming
• What are the Characteristics of a Monopsony?

  • There is 1 dominant buyer
  • They are wage makers
  • They are profit maximisers
  • They purchase large portion of market supply from suppliers
• What are the Benefits and Drawbacks of Monopsony Power on Firms?

  + Reduced costs of production lead to higher profits

  • May suffer from reputation damage for treatment of suppliers - unethical
  • Price pressure on suppliers often results in conflict - difficulty in managing
  • In LR, may drive suppliers out which will disrupt entire supply chain
• What are the Benefits and Drawbacks of Monopoly on Employees?

  + Higher profits = higher wages

  • May find it difficult to reconcile with their ethics due to treatment of suppliers
• What are the Benefits and Drawbacks of Monopoly on Consumers?

  + Lower avg. costs = lower prices

  • Quality of product may fall as suppliers attempt to cut costs in response to price pressure
• What are the Benefits and Drawbacks of Monopoly on Suppliers?

  + Can enhance supplier's reputation - opens up new opportunities

  + Can also provide opportunity to increase sales volume

  • May seek to reallocate resources to more profitable industries - leads to fall in supply in current market
  • Suppliers may be driven out of business by monopsonists
• What are the Characteristics of a Contestable Market?

  • No barriers to entry & exit
  • No competitive disadvantages on entry
  • Perfect information
  • Hit & Run Competition
  • No advantages on non-price factors
• What is meant by the term 'Hit & Run' ?

  Short-run Supernormal profits acts as a profit-signalling mechanism to new firms to enter market, take as much supernormal profit as possible and leave the market.
• How can a firm prevent 'Hit & Run' ?

  • Use Limit Pricing
  • Causes for incumbent firms to make normal profit - no SNP signal
  • Disincentivises firms from entering market