Market structures

• What does efficiency measure?

  How well resources are used, or the output relative to another factor
• What is allocative efficiency?

  Where price equals the marginal cost of production
• What should happen if consumer satisfaction from the last unit is more than its cost?

  Production should be increased
• What should happen if consumer satisfaction from the last unit is less than its cost?

  Production should be decreased
• What is productive efficiency?

  Where a firm operates at the output at which average cost is lowest
• What does it mean when marginal cost equals average cost?

  It indicates that a firm is productively efficient
• What is the implication for consumers if price equals average cost?

  It is the lowest price consumers can enjoy, therefore is the optimal consumer surplus
• What is the issue with productive efficiency for consumers?

  Firms have little incentive to operate at this point and have no incentive to lower the price this far, so consumers can't enjoy optimal consumer surplus
• When does allocative efficiency occur in chocolate making?

  When cost equals price for the last chocolate
• How do productive and allocative efficiency relate in perfect competition?

  They will be the same in the long run, though otherwise productive efficiency kicks in before allocative efficiency does
• What is dynamic efficiency?

  Where a firm uses its resources more efficiently over time
• How can dynamic efficiency be achieved?

  Through innovation and investment of new products and production processes
• What is X-inefficiency?

  Where costs rise due to lack of competition in a market
• In which markets is X-inefficiency likely to occur?

  In a monopoly or public sector firms, as there is little incentive for firms to minimise costs and workers might not be as productive if wages and employment are not dependent on revenues
• What can result from a lack of competitive pressure?

  Managerial slack, and an upward shift in the average cost curve
• What is the relationship between dynamic efficiency and technological advances?

  There is a positive relationship
• What are the efficiency concepts in different market structures?

  In perfect competition, firms can achieve allocative efficiency in both the short and long run, and can achieve productive efficiency in the short run only, but in all other market structures these efficiencies are unobtainable
• What is perfect competition?

  A market which is highly competitive
• What are the characteristics of perfect competition?

  There are many buyers and sellers, firms are price takers and so face a horizontal demand curve, the goods sold are homogeneous, there are no barriers to entry or exit, and there is perfect knowledge or information of the market
• What is the business objective pursued by firms in perfect competition?

  Profit maximisation, so where MC=MR
• How is the market price determined in a perfectly competitive market?

  By the interaction of supply and demand
• What profits can be made in perfect competition?

  Supernormal profits can be made in the short run, though it acts as a signal for other firms to enter the industry, causing the supernormal profits to be lost in the long run
• What happens to the market price as new firms enter the industry in perfect competition?

  The market price decreases, though market supply increases
• What is the outcome for firms in the long run under perfect competition?

  Firms make only normal profit
• What occurs when a perfectly competitive firm is making a loss?

  AC > AR at the profit/loss maximising output
• What does a firm in a perfectly competetive market need to consider when deciding whether to shut down?

  If the firm is making a loss, they still have to pay fixed costs in the short run even if they shut down immidiately, so the firm has to take a risk on whether they should remain in the market to cover its average variable costs or whether they should shut down immidiately
• What should a loss making firm decide to do in a perfectly competetive market?

  They need to look at the shutdown point where the price the firm recieves covers the average variable costs, and the firm should only shut down if they would not be able to cover these costs, since they would make less of a loss if they left the market
• What happens to the market supply curve when some firms leave the industry?

  It shifts to the left
• What happens to the market price as existing firms leave the industry in perfect competition?

  The market price increases, and market supply decreases
• How does the output of remaining firms change when some firms exit the market in perfect competition?

  The output of remaining firms would increase because each one will make a little more marginal revenue, also allowing marginal costs to increase in order to maintain profit maximisation
• What must always be true for profit maximization in perfect competition?

  MC must equal MR
• What are the characteristics of monopolistic competition?

  There are many buyers and sellers, firms are price makers and so face a downward sloping demand curve, the goods sold are differentiated, there are low barriers to entry and exit, and there is some brand loyalty but no major brands
• How is monopolistic competition different from perfect competition?

  The goods sold are differentiated instead of homogeneous, there are low barriers to entry instead of none, and firms are price makers instead of price takers
• What is the shape of the AR (demand) curve in monopolistic competition?

  It is downward sloping, with the MR curve being twice as steep
• What is the business objective pursued by firms in monopolistic competiton?

  Profit maximisation, so where MC = MR
• What profits can be made in monopolistic competition?

  Supernormal profits can be made in the short run, though it acts as a signal for other firms to enter the industry, causing the supernormal profits to be lost in the long run
• What does the average revenue (AR) curve indicate when it is above the average costs (AC) curve?

  That the firm is making supernormal profit, and therefore is doing so in the short run
• In the long run, what type of profit do firms in monopolistic competition make?

  Normal profit
• How does the short-run equilibrium differ from the long-run equilibrium in monopolistic competition?

  Supernormal profits can be made in the short run, which is not possible in the long run
• How does the presence of differentiated products affect competition in monopolistic markets?

  It allows firms to have some market power