Contestable Market; A market in which the potential
exists for news firms to enter the market. Perfectly
contestable market has no entry/exit barriers + no
sunk costs. Incumbent firms & new firms have access
to same level of technology
Assumptions
Firms are short run profit maximisers,
producing where MC=MR
Number of firms in industry can
vary from one to many.
No single firm having big share of market
Firms compete & do not collude. Freedom of entry/exit
In contestable market theory, monopoly
power is not dependant upon the number of
firms/concentration ratio's but the difficulty
of which new firms can enter the market
For a market to
be perfectly
contestable there
must be no
barriers to
entry/exit hence
no sunk costs.
Sunk Costs;
Costs incurred
when entering
a market that
are
irrecoverable
Because of ease of entry
making a market contestable
the threat of hit & run
competition is sufficient to keep
prices & profits at lowest levels
Hit & Run Competition;
Occurs when a new entrant
can 'hit' the market, make
profits. then 'run; given
no/low exit barriers
Objectives of
Firms
Other objectives: 1) Providing good
quality & service especially
important for socially minded
owners/managers 2) Growth
maximisation through achieving
economies of scale. Growth can
mean a gain in monopoly
power/managerial prestige 3)
Survial = fear of losses & closure,
survial being a primary objective 4)
Revenue Maximisation occurs
through the level of output at
which managerial revenue is zero
through managerial pay linked to
revenue rather than profit 5)
Satisficing Principle = Satisfactory
outcome may help to resolve the
conflict between manager &
shareholders objectives,
attempting to satisfice aspirations
of many groups for a firm means
compromise & achieving minimum
rather than maximum targets
Profit Maximisation
Profit maximisation,
the firm produces the
level of output that TR -
TC is maximised
MR = MC means a firm's profits are greatest
when the addition to sales revenue from last
unit sold equals addition total cost from
production of last unit of output
MR > MC Profits rise when output increases
MR < MC Profits rise when output decreases
If succeeds in producing & selling the output
yielding the biggest possible profit, no incentive to
change level of output
Firms in all market structures can only maximise profit when MR = MC
Divorce of Ownership From
Control
Divorce of Ownership From Control; The owners & those who manage the firm are
different groups with different objectives
Conflicts may occur between the
agents & principals when the
incentives which effect their
behaviour are not the same. Agent
does not usually receive the full
benefit of their actions, destroys the
incentive for the agent to put same
effort into tasks
Reasons why an agent can
get away with not acting in
best interest of principle 1)
cost of sacking/punishment is
too high relative at any
benefit 2) information
asymmetry, the agent knows
more than the principle
Various methods
can be used to
realign the
incentives facing
the owners of
businesses &
managers, Profit
related pay, giving
company shares
etc...
Oligopoly
Concentration Ratio; Measures
the Market Share of the biggest
firms in the market
Good indicator of an
oligopolistic market.
Measures the market
structure % of the
biggest firms
Concentration
Ratio of 5=80,
largest five firms
possess 80% of
market share
while 20% is
smaller firms
• Competitive
oligopoly exists
when rival firms
are
interdependent
in the sense
they take into
account of other
firms reactions
when forming a
market strategy,
as result
uncertainty
occurs can
never be sure
how rivals react,
they are
non-collusive
Cartels
Collusive agreements to fix
prices, restrict output & deter
entry of new firms
Cartel agreements
enable inefficient
firms to stay in
business, while
more efficient
members enjoy
abnormal profits.
Some forms of co-operation or cartel may be justifiable, including
joint product development i.e. Ford & Volkswagen + improving health
& safety or to ensure product & labour standards are maintained.
Kinked Demand Schedule
Developed by Paul Sweezy in the late 1930's, model
assumes there will be asymmetric reaction
Criticisms:
1. Doesn’t explain
where market
clearing prices
come from
2. Theory only
deals with price
competition
3. No guarantee
that firms will
react the same
Cartel agreements
ensure the
protection of
inefficient firms &
to enjoy an easy
life protected from
competition
Price leadership
can occur in an
oligopoly when
a firm becomes
market leader
& other firms in
the industry
follow its
pricing example
Price Leadership;
Setting of prices
in a market
usually y a
dominant firm
which other
firms follow
known as
benchmark
Members of
a cartel
often fix the
prices that
all members
of cartel
charge,
these price
agreements
Price Agreement; An
agreement between
a firm and other
firms e.g. supplier
or customers
regarding the
pricing of a
good/service
Price wars take
place both in
monopolistic
competition &
oligopoly which
may be started
accidentally or
deliberate to
damage
competitors
Price Wars;
Occurs when
rival firms
continuously
lower price to
undercut each
other
Another
feature of
oligopoly is
the desire to
keep other
firms out of
industry, so
entry barriers
emerge
Firms in oligopolistic
market are observed to
keep prices at a
constant level this
known as price rigidity,
as prices are relatively
stable (Sticky Prices)
Most industries in
the UK are
oligopolistic since
dominated by few
firms
Oligopolstic Firms also compete using non price competition
Marketing
strategy
used to
distinguish
between
firm's
products &
services
Likely to increase expenditure for firms e.g. marketing as trying to promote its own product above competition
e.g. a supermarket issuing loyalty cards is a form of non price competition
Price Discrimination
Both monopolists & oligopolists may be in
a position to price discriminate
Firms who sell a product
at one price realise that
their profit could
increase if they could
appropriate more
consumer surplus
Conditions
The resale can be prevented from
one buyer to another
Different elasticity's of demand some buyers
prepared to pay more than others
The vendor can control whatever is
offered & no others firms present that can
sell at lower price in the area
Methods
Age
Time
Geographical
Types
First Degree
Known as perfect price
discrimination, each unit
sold at maximum price
Second
Degree
Consumers are charged different
prices for blocks of consumption
Third
Degree
Same product/service sold
at different prices to
different consumers in
different markets
Advantages
Price Discrimination allows firms to
increase profits by taking away
consumer surplus and converting into
abnormal profit
Allows firms to use up
spare capacity
Monopoly & Monopoly
Power
Disadvantages: Market
Failure & Resource
Allocation: Output falls,
price rises & under
consumption of the good
the monopoly produces
Advantages:
Economies of scale:
Because of limited
market size, there is
insufficient room for
more than one firm
benefitting from
economies of scale.
By assumption monopoly
able to produce output Q1
at a LRAC of AC1, whereas
competitive firms are
unable to produce this
output without destroying
the competitive market
Monopoly & Economic Efficiency
Assuming an
absence of
economies of
scale,
monopoly
equilibrium is
productively &
allocatively
effiecient
Monopoly is
also
allocatively
inefficient
since profit
maximising
price is above
marginal cost
Advantages: Dynamic
Efficiency:
Improvements in
productive efficiency
especially resulting
from technical
progress & innovation.
Monopolies can make
abnormal profits in
short & long run. This
profit invested in R&D
Monopoly
is often
used in a
much
looser way
to
describe
any
market in
which
there is a
dominant
firm
Monopoly; One firm
only in a market
A monopoly is
protected by
barriers to entry
which prevent new
firms entering the
market to share
abnormal profit.
Barriers enable the
monopolist to
preserve abnormal
profits in long run &
short run
Perfect Competition
Short Run Profit Maximisation
Each firm in a
perfectly
competitive
market
accepts the
ruling market
price, which
becomes each
firm's
average
revenue &
marginal
revenue curve
A perfectly
competitive
firm can sell
as much as
it wishes at
the
market's
ruling price
Lon Run Profit
Maximisation
Too many new
firms enter the
market since
abnormal profits
can be made,
supply curve shifts
to the right. Price
falls to P1. Firms
make a loss
(Supernormal
Profits) so firms
leave market
When firms
start leaving
the supply
curve shifts to
the left,
eventually the
price settles so
surviving firms
only make
normal profit
Perfect Competition &
Economic Efficiency
Productive efficiency & allocative efficiency occurs only if; 1) All the firms in market beenfit from all available economies of scale at low levels of output,
MES has to be small in relation to market size 2) Perfectly competitive Markets for all goods & services where P = MC in every market 3) No externalities
Market Structures
Market Structure;
the organisational &
other characteristics
of a market
Important features of Market
Structure include; *number of firms
in market, *market share of largest
firms, *Nature of the costs incurred
by the firms, *nature of sales
revenue earned by firms, *barriers
to entry/exit, *ease of access to
information about what is going on
in market, *price-setting & product
differentiation *how buyer's
behaviour effects firms
Distinguishing between different
market structures
Number of Firms -
a requirement for
a firm to be
perfectly
competitive is
large number of
buyers/sellers
whilst Monopoly
there is just one
firm. In oligopoly
there are only a
few firms in the
market
Market Entry Barriers - In the short run, where at least one factor of production is fixed (usually capital) firms cannot
enter or leave the market whatever the market structure. In the long run when all the factors of production are
variable firms can enter/leave competitive markets.
Market Entry Barriers (2) - Pure monopoly is protected by entry barriers in long & short run, in
Oligopolistic markets there may be significant barriers in long run
Market Entry Barriers (3) - An entry barrier is a cost of production which must be carried by a firm
that seeks to enter an industry. Not carried by businesses already in the industry. Closely related
to entry barriers are exit barriers
Limit Pricing/Predatory Pricing - when natural barriers to market entry
low/non-existent firms already in the market use limit prices to deter new firms
entering market, firms already in the market sacrafice short run profit
maximisation with this method but instead seek to maximise long run profits
Limit Pricing;
Prices set low
enough to make
it unprofitable
for other firms
to enter market
Limit Pricing/Predatory Pricing (2) - Predatory pricing occurs when a firm deliberately sets prices below
costs to force new market entrants out of business, once new entrants left the market, the firm may
decide to restore prices
Predatory Pricing; Prices set
below average cost with the
aim of forcing rival firms out
of business
Product Differentiation - Most firms large, medium or small engage in varying degrees of
product differentiation. Firms often produce a range of relatively similar products some of
which compete with each other but others aimed at different market segments
Product Differentiation; The marketing of
generally similar products with minor
variations or marketing of a range of
products
Monopolistic Competition
Monopolistic markets
resembles perfect
competition; Large
number of firms, no
barriers to entry/exit,
entry of new firms
attracted by short run
abnormal profits brings
down the price of each
firm can charge.
Monopolistic
markets also
resemble
monopoly;
Each firm
faces a
downward
sloping
demand curve
as each firm
produces a
slightly
different
product, Each
firm's MR
curve is below
AR curve
Short Run Profit
Maximisation
Average revenue curve
represents demand for
goods produced by just
one firm within market
rather than demand for
the output of whole
market
Profit Maximising
level of output, Q1
located below
point A where MC
= MR & abnormal
profits made
Long Run Profit
Maximisation
Absence of barriers to
entry/exit, new firms enter
causing AR curve to shift inward
Long Run profit maximisation occurs when AR curve
touches firm's ATC curve removing abnormal profit