3) Perfect Competition, Imperfectly Competitive Markets & Monopoly

Contestable & Non-Contestable Markets
1. 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
2. Assumptions
  1. Firms are short run profit maximisers, producing where MC=MR
  2. Number of firms in industry can vary from one to many.
  3. No single firm having big share of market
  4. Firms compete & do not collude. Freedom of entry/exit
  5. 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
  6. For a market to be perfectly contestable there must be no barriers to entry/exit hence no sunk costs.
    1. Sunk Costs; Costs incurred when entering a market that are irrecoverable
  7. Because of ease of entry making a market contestable the threat of hit & run competition is sufficient to keep prices & profits at lowest levels
    1. Hit & Run Competition; Occurs when a new entrant can 'hit' the market, make profits. then 'run; given no/low exit barriers
Objectives of Firms
1. 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
2. Profit Maximisation
  1. Profit maximisation, the firm produces the level of output that TR - TC is maximised
    1. 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
      1. MR > MC Profits rise when output increases
      2. MR < MC Profits rise when output decreases
  2. If succeeds in producing & selling the output yielding the biggest possible profit, no incentive to change level of output
  3. Firms in all market structures can only maximise profit when MR = MC
3. Divorce of Ownership From Control
  1. Divorce of Ownership From Control; The owners & those who manage the firm are different groups with different objectives
  2. 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
  3. 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
  4. Various methods can be used to realign the incentives facing the owners of businesses & managers, Profit related pay, giving company shares etc...
Oligopoly
1. Concentration Ratio; Measures the Market Share of the biggest firms in the market
  1. Good indicator of an oligopolistic market. Measures the market structure % of the biggest firms
  2. Concentration Ratio of 5=80, largest five firms possess 80% of market share while 20% is smaller firms
2. • 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
3. Cartels
  1. Collusive agreements to fix prices, restrict output & deter entry of new firms
  2. Cartel agreements enable inefficient firms to stay in business, while more efficient members enjoy abnormal profits.
  3. 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.
4. Kinked Demand Schedule
  1. Developed by Paul Sweezy in the late 1930's, model assumes there will be asymmetric reaction
  2. 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
5. Cartel agreements ensure the protection of inefficient firms & to enjoy an easy life protected from competition
6. Price leadership can occur in an oligopoly when a firm becomes market leader & other firms in the industry follow its pricing example
  1. Price Leadership; Setting of prices in a market usually y a dominant firm which other firms follow known as benchmark
7. Members of a cartel often fix the prices that all members of cartel charge, these price agreements
  1. Price Agreement; An agreement between a firm and other firms e.g. supplier or customers regarding the pricing of a good/service
8. Price wars take place both in monopolistic competition & oligopoly which may be started accidentally or deliberate to damage competitors
  1. Price Wars; Occurs when rival firms continuously lower price to undercut each other
9. Another feature of oligopoly is the desire to keep other firms out of industry, so entry barriers emerge
10. 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)
11. Most industries in the UK are oligopolistic since dominated by few firms
12. Oligopolstic Firms also compete using non price competition
  1. Marketing strategy used to distinguish between firm's products & services
  2. Likely to increase expenditure for firms e.g. marketing as trying to promote its own product above competition
  3. e.g. a supermarket issuing loyalty cards is a form of non price competition
Price Discrimination
1. Both monopolists & oligopolists may be in a position to price discriminate
2. Firms who sell a product at one price realise that their profit could increase if they could appropriate more consumer surplus
3. Conditions
  1. The resale can be prevented from one buyer to another
  2. Different elasticity's of demand some buyers prepared to pay more than others
  3. The vendor can control whatever is offered & no others firms present that can sell at lower price in the area
4. Methods
  1. Age
  2. Time
  3. Geographical
5. Types
  1. First Degree
    1. Known as perfect price discrimination, each unit sold at maximum price
  2. Second Degree
    1. Consumers are charged different prices for blocks of consumption
  3. Third Degree
    1. Same product/service sold at different prices to different consumers in different markets
6. Advantages
  1. Price Discrimination allows firms to increase profits by taking away consumer surplus and converting into abnormal profit
  2. Allows firms to use up spare capacity
Monopoly & Monopoly Power
1. Disadvantages: Market Failure & Resource Allocation: Output falls, price rises & under consumption of the good the monopoly produces
2. Advantages: Economies of scale: Because of limited market size, there is insufficient room for more than one firm benefitting from economies of scale.
  1. 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
    1. Monopoly & Economic Efficiency
      1. Assuming an absence of economies of scale, monopoly equilibrium is productively & allocatively effiecient
      2. Monopoly is also allocatively inefficient since profit maximising price is above marginal cost
3. 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
4. Monopoly is often used in a much looser way to describe any market in which there is a dominant firm
  1. Monopoly; One firm only in a market
5. 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
1. Short Run Profit Maximisation
  1. Each firm in a perfectly competitive market accepts the ruling market price, which becomes each firm's average revenue & marginal revenue curve
  2. A perfectly competitive firm can sell as much as it wishes at the market's ruling price
2. Lon Run Profit Maximisation
  1. 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
    1. When firms start leaving the supply curve shifts to the left, eventually the price settles so surviving firms only make normal profit
      1. 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
1. Market Structure; the organisational & other characteristics of a market
2. 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
3. Distinguishing between different market structures
  1. 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
  2. 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.
  3. 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
  4. 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
  5. 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
    1. Limit Pricing; Prices set low enough to make it unprofitable for other firms to enter market
  6. 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
    1. Predatory Pricing; Prices set below average cost with the aim of forcing rival firms out of business
  7. 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
    1. Product Differentiation; The marketing of generally similar products with minor variations or marketing of a range of products
Monopolistic Competition
1. 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.
  1. 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
    1. Short Run Profit Maximisation
      1. Average revenue curve represents demand for goods produced by just one firm within market rather than demand for the output of whole market
      2. Profit Maximising level of output, Q1 located below point A where MC = MR & abnormal profits made
2. Long Run Profit Maximisation
  1. Absence of barriers to entry/exit, new firms enter causing AR curve to shift inward
  2. Long Run profit maximisation occurs when AR curve touches firm's ATC curve removing abnormal profit

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3) Perfect Competition, Imperfectly Competitive Markets & Monopoly

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	Created by Kieran Deaville about 8 years ago