market structures

• Types of Efficiency


  • Allocative Efficiency
  • Productive Efficiency
  • Dynamic Efficiency
  • X-inefficiency
• Allocative Efficiency


  Occurs at the level of output where average revenue = marginal cost (AR = MC). At this point, resources are allocated in such a way that consumers & producers get the maximum possible benefit. No one can be made better off without making someone else worse off. There is no excess demand or supply.
• Productive Efficiency


  Occurs at the level of output where marginal cost = average cost (MC=AC). At this point average costs are minimised. There is no wastage of scarce resources & a high level of factor productivity.
• Dynamic Efficiency


  Long-term efficiency is a result of innovation as a firm reinvests its profits. It results in improvements to manufacturing methods. This lowers both the short-run & long-run average total costs.
• 1. inefficiency


  Occurs when a firm lacks the incentive to control production costs. The ATC is higher than it should be. It often occurs due to a lack of competition in industry or in a firm that has no consequences for making a loss (e.g. some government owned companies).
• Efficiency & inefficiency in Different Market Structures
• Market structures are the characteristics of the market in which a firm or industry operates. These characteristics typically include the number of buyers, the number & size of firms, the type of product in the market (homogenous or differentiated), the types of barriers to entry and exit, and the degree of competition.
• Market structures can be separated into perfect competition & imperfect competition. Imperfect competition includes the following market structures: Monopolistic, Oligopoly, Monopoly.
• Perfectly competitive market


  Experiences allocative & productive efficiency
• Imperfect market


  Inefficiencies exist at the profit maximisation level of output
• In a perfectly competitive market, the firm produces at the profit maximisation level of output where MC=MR, is productively efficient as MC=AC at this level of output, and is allocatively efficient as AR (P)=MC. The firm is unlikely to experience dynamic efficiency as it is unlikely to have supernormal profits to reinvest.
• In an imperfectly competitive market, the firm produces at the profit maximisation level of output where MC=MR, is not productively efficient as AC > MC at this level of output, and is not allocatively efficient as AR (P) > MC at this level of output. The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation.
• Efficiency


  How well the market allocates resources, and the relationship between scarce inputs and outputs
• Types of efficiency


  • Allocative efficiency
  • Productive efficiency
  • Dynamic efficiency
  • X-inefficiency
• Allocative efficiency


  Resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised. It will occur when the value to society from consumption is equal to the marginal cost of production, where P=MC.
• Productive efficiency


  A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product. The minimum resources are used to produce the maximum output. This can only exist if firms produce at the bottom of the AC curve, in the short run this is where MC=AC.
• Dynamic efficiency


  Resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production techniques. The alternative is static efficiency: efficiency at a set point in time.
• 1. inefficiency


  If a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack. This is a specific type of productive inefficiency as it occurs when they fail to minimise their cost for that specific output.
• Perfect competition is a market where there is a high degree of competition, but the word 'perfect' does not mean it maximises welfare or produces ideal results
• Characteristics of perfect competition

  • Many buyers and sellers
  • Freedom of entry and exit from the industry
  • Perfect knowledge
  • Homogenous product
• Profit maximising equilibrium in perfect competition

  1. Firms produce at MC=MR

  2. In short run, possible to make normal, supernormal or loss

  3. In long run, only possible to make normal profit
• Perfect competition


  • Productively efficient as they produce where MC=AC
  • Allocatively efficient as they produce where P=MC
  • Not dynamically efficient as no incentive for innovation
• Competition should keep costs, and therefore prices, low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be.
• Monopolistic competition


  A form of imperfect competition, with a downward sloping demand curve. It lies in between the two extremes of perfect competition and monopoly.
• Characteristics of monopolistic competition


  • Large number of buyers and sellers
  • No barriers to entry or exit
  • Differentiated, non-homogenous goods or services
• Profit maximising equilibrium in monopolistic competition

  1. In short run, possible to make supernormal, normal or loss

  2. In long run, only possible to make normal profit
• Monopolistic competition


  • Not allocatively or productively efficient as MR does not equal AR so AC cannot equal MC and AC cannot equal MR
  • Likely to be dynamically efficient as differentiated products incentivise innovation
• In monopolistic competition compared to perfect competition, less is sold at a higher price and firms may not necessarily be producing at the lowest cost. However, the market will offer greater variety and may be able to enjoy some degree of economies of scale.
• Oligopoly


  A market where there are a few firms that dominate the market and have the majority of market share, although this does not mean there won't be other firms in the market
• Characteristics of oligopoly


  • Products are generally differentiated
  • Supply in the industry must be concentrated in the hands of a relatively small number of firms, meaning there is a high concentration ratio
  • Firms must be interdependent (so the actions of one firm will directly affect another)
  • There are barriers to entry
• Economies of scale


  Ability to enjoy some degree of economies of scale
• Characteristics of oligopoly


  • Products are generally differentiated
  • Supply in the industry must be concentrated in the hands of a relatively small number of firms, meaning there is a high concentration ratio
  • Firms must be interdependent (so the actions of one firm will directly affect another)
  • There are barriers to entry
• 1. firm concentration ratio


  Measures the percentage of the total market that a particular number of firms have
• Calculating N-firm concentration ratio

  Total sales of n firms x 100 / total size of market
• Collusion


  Firms make collective agreements that reduce competition
• Non-collusive oligopoly

  When firms don't collude
• Firms compete


  Lowering prices to gain new customers is likely to cause other firms to lower their prices
• Firms collude


  They could maximise industry profits
• Collusion


  Reduces the uncertainty firms face and reduces the fear of engaging in competitive price cutting or advertising, which will reduce industry profits
• Collusion is illegal