Intensity of Market Competition

• Firms face more intense competition in the market when:

  • There are more firms in the same market
  • There is no dominant firm
  • Barriers to entry are weak, enabling potential firms to enter the market
• When a product is homogeneous, firms are under immense pressure to keep costs down to compete against rival firms on prices. The converse is true with differentiated products.
• Greater access to information makes it easier and cheaper for:

  • Consumers to compare price and quality between rival firms
  • Existing and potential firms to compete with one another
• The 4 market structures include:

  • Perfect Competition
  • Monopolistic Competition
  • Oligopoly
  • Monopoly
• The 3 types of barriers to entry include:

  • Structural barriers to entry
  • Strategic barriers to entry
  • Statutory barriers to entry
• Structural barriers refer to basic industry conditions such as cost and demand which prevent potential firms from entering the market.
• Strategic barriers to entry refer to intentionally created or enhanced by incumbent firms in the market to deter entry.
• Statutory barriers to entry refers to the laws and regulations made by the government to restrict potential firms from entering a market.
• When the costs are high relative to the size of the market demand, the market can profitably support only a small number of firms. This is a form of Structural BTE, and can lead to a natural monopoly in the extreme case.
• Reasons for Structural BTE:

  • Type of Technology required might be expensive
  • Purchasing in bulk requires high transport costs
  • Small population in small towns
  • Niche products with low demand
• Network Economies is defined as the benefits to consumers of having a network of other people using the same product or service. This is a form of Structural BTE.
• Types of Strategic BTEs include:

  • Aggressive pricing strategies
  • Product recognition
  • Product proliferation
  • Product complexity
  • Switching cost
  • Control of essential factor inputs and/or distribution channels
• Firms utilise product recognition in order to differentiate their product from rival firms' and build up brand loyalty, which makes it difficult for users to switch brands.
• Product proliferation is the process of producing many variants of the same product which actively competes against one another as well as against rival firms.
• A product with high complexity requires consumers to have more information about its availiability and quality of product service. Hence consumers will buy from firms that have extensive and established dealer networks that can help service their problems.
• Types of Statutory BTEs include:

  • Licenses or exclusive franchises
  • Intellectual property rights
  • Tariffs and other trade restrictions
• Market concentration measures the extent to which market shares are concentrated between a small number of firms.
• Market concentration ratio is computed as the percentage of total sales or production accounted for by the largest firms in an industry.
• Market power refers to the ability of a seller to exert significant influence over the quantity of the good or service traded or price at which they are sold.
• The influence of the intensity of market competition can be seen through:

  • Relative PED values of the firm's demand curve
  • Mark-up of price over marginal cost
• In a monopoly or an oligopoly, firm's demand curve are relatively price inelastic. While in a monopolistic competitive market, firm's demand curve are relatively price elastic.
• Incumbent firms are disciplined by potential firms repeatedly entering and leaving the market ( known as freedom of exit ) and stealing supernormal profits from the incumbent firms.
• A large markup of P over MC is an indication of a firm's strength of market power.
• A perfectly contestable market occurs when:

  • There is an extremely easy entry into the market and virtually costless exit
  • New firms entering the market can produce at the same costs as existing firms
• In the short-run, profits earned by firms are solely dependent on the costs and demand conditions in the market.
• In the long-run, profits earned by the firms are also dependent on the strength of the barriers to entry and exit.
• In the long-run, with a market with weak to no BTE, firms are able to enter or leave the market such that the marginal firm makes only normal profits.
• In the long-run, in a market with strong BTE, potential firms are unable to easily enter, hence firms making supernormal profits in the short run are less likely to be threathened by the loss of market share and demand in the long run.
• In markets where firms earn only normal profits in the long run, the distribution of income is said to be equitable as:

  • There is no sustained redistribution of income from households to firms
  • Revenue earned is just sufficient to compensate the firm for the opportunity cost in the use of resources
• In markets where firms earn supernormal profits in the long run, the distribution of income is said to be inequitable as:

  • There is sustained redistribution of income from households to firms
  • Revenue earned is beyond sufficient to compensate the firm for the opportunity cost in the use of resources
• Price setters are not allocatively efficient as a result of MR falling more rapidly than the fall of AR, which causes MC to always lie below P.
• The extent of allocative inefficiency is measured by the gap between P and MC.
• Productive efficiency is achieved when the output is produced with the least costly combinations of inputs given the current level of technology.
• From society's perspective, productive efficiency is achieved only if the firm is producing at the lowest point of the LRAC curve.
• From the firm's perspective, productive effieciency is achieved at any point of the LRAC curve.
• A firm is described as x-inefficient if it produces the same output at a higher cost when it operates at a point above the LRAC curve.
• Dynamic efficiency is a situation in which firms are technologically progressive to meet the changing needs and wants of customers over time.
• Product innovation gives rise to:

  • New products
  • Better quality products
• Process innovation gives rise to:

  • Productivity growth
  • Bring down costs and prices
• Dynamic efficiency always raises consumer welfare.