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Unit 2 Microeconomic(theory of the firm)HL only, Unit 2 Microeconomics（tho…
Unit 2 Microeconomic(theory of the firm)HL only
Perfect competition
Identical/homogenous products(many substitutes)
Low barriers to entry(easy for firms to enter and exit the market)
Many small firms
No market power = no control over price (Price Takers)
Types of Markets
Perfect Competition
Monopoly
Single/One dominant firm
Unique product (No close substitutes)
Extremely high barriers to entry (difficult for firms to enter and exit the market)
Dominant market power = control over price (Price Maker)
Natural Monopoly
A monopoly that can produce enough output to cover the entire needs of a market while still experiencing economies of scale. Its average costs will therefore be lower than those of two or more firms in the market
At times, a natural monopoly is preferred. When economies of scale make it impractical for multiple firms to participate, a natural monopoly is preferable.
Monopolistic Competition
Many firms
Differentiated products (“Same-Same but different”)
Low barriers to entry (easy for firms to enter and exit the market)
Limited market power
Rely heavily on branding and advertising
Oligopoly
Characteristics
A few large firms
Identical or Differentiated products
High barriers to entry (not easy for firms to enter and exit the market)
Limited market power
Strong interdependence between firms
Barriers to Entry
The term "Barriers to Entry" refer to the degree : of difficulty involved with firms entering or exiting a market.
Economies of Scale
Innovative Technology
Geography or Ownership of Raw Materials
Government Created Barriers
Revenue
Revenue is the amount of money that a firm earns. There are a few different types of revenue to consider.
Total Revenue = Price * Quantity
Marginal Revenue = The change in revenue of an additional quantity.
Imperfect Competitive firms are able to set the price and are therefore PRICE MAKERS. Typically they earn abnormal profits (>0)
Costs
Total Cost = Average Cost * Quantity
Marginal Cost = The cost of producing one additional unit.
Economies of Scale
As a firm gets larger and more efficient, it is able to lower its costs making it more profitable.
Profit and Loss
Normal Profit (also known as Zero Economic Profit/Break-Even) TR = TC
Definition
Short-Run
A period in time when at least one factor of production is fixed.
Long-Run
A period in time when all factors of production are variable.
The Law of Diminishing Marginal Returns
In the short run when at least one capital resource is fixed, the addition of inputs (typically labor) will initially result in an increase in marginal returns but will eventually diminish marginally.
The profit-maximizing rule is used by every firm in every market structure to determine the QUANTITY the firm should produce to maximize profits.
Efficiency
Allocative Efficiency
Each market structure is evaluated on its allocation efficiency.
Achieved when just the right amount of goods and services are produced from society’s point of view so that scarce resources are allocated in the best possible way.
It is achieved when, for the last unit produced, price (P) is equal to marginal cost (MC).
Market Power
Market Power is a measure of how much control a firm has over it's price.
Short-Run Profits/Loss
When firms make abnormal profits or losses in the short-run, other firms react by either leaving or entering the market.
Due to low barriers, firms are able to join, or leave, Perfect Competition with ease.
Adjustment to Long-Run
A bnormal profits attract new firms to join! As the numbers of firms increase, the market supply increases as the number of firms is a shifter.
As firms join, the equilibrium price in the market decreases, and quantity increases. As firms are Price Takers, they adjust to the new price until eventually, everyone in the market makes normal economic profit.
Long-Run
Firms can only make abnormal profits or losses in the SHORT-RUN
ALL firms will make Normal Profit in the long run.
Efficiency
Perfect Competitive firms are perfectly efficient.
Evaluation of Perfect Competition
advantages
Allocatively Efficient (P=MC)
Offers the lowest price possible for consumers
High competition ensures inefficient producers exit the market
The market is very responsive to consumers taste/demand
disadvantage
Unrealistic
There will always be imperfect information and products aren't truly identical
No economies of scale
Lack of product variety
Unable to engage in R&D to improve efficiency
Unit 2 Microeconomics（thoery of the firm)HL only
Sources of Market Power
Natural Monopoly
Only enough revenue and economies of scale to support one firm
Legal Barriers
Patents, Copyright, Licenses, etc.
Economies of Scale
Typically firms start small with limited expertise. Monopolists have the ability to charge a lower price than newcomers.
Branding
Customers may be loyal to a certain firm due to marketing. Kleenex, Band-Aid, etc.
Anti-Competitive Behavior
A monopolist can charge lower costs due to economies of scale. Therefore, they can lower their price to suffocate upcoming competitors.
Monopoly Making Profit
Unlike perfect competition, Monopolies are able to make abnormal profits in the short and long-run.
Natural Monopoly Diagram
Natural Monopolies MUST use economies of scale, therefore their AC and MC curves look different.
Evaluation of Monopoly
allocatively efficient?
Don't produce where P = MC (Not Allocatively Efficient)
Charge a higher price than they should
Purposely don't produce enough in order to charge a higher price
Evaluation of Monopoly
Disadvantages of Monopolies
Consumers pay a higher price and have a lower quantity available compared to perfect competition.
Loss of consumer surplus
Less Innovation as there is little incentive
Market Failure, Allocative Inefficiency
Lower quality of goods or services as no suitable alternatives are available
Advantages of Monopolies
Economies of scale can allow for lower production costs and lower price
Natural Monopolies - typically ensures basic utilities at affordable prices for communities
Research & Development (Abnormal profits allow for funding to research)
Traits of Monopolistic Competition
Monopoly
Some control over price
Similar looking graph (D > MR)
Not Allocatively Efficient
Perfect Competition
A large number of smaller firms
Low Barriers to Entry
In the Long-Run, Normal Profit.
Sources of Market Power
Economies of Scale
High Start-Up Costs
Ownership of Raw Materials
Interdependence
the dependence of two or more people or things on each other.
Oligopolies have an incentive to collude (work together to set prices). If Oligopolies collude, they essentially become a monopoly
Competing firms may try to always set the lowest prices, but this can trigger a price war, which would result in both firms losing profit.
Game Theory
The study of how individuals behave in strategic situations.
Dominant vs Non-Dominant
Dominant Strategy - There is one choice you should always make, regardless of your opponent's decision.
Non-Dominant Strategy - Your best choice is dependent upon your opponent's decision
Nash Equilibrium
When firms choose the optimal outcome with no incentive to change.
Non-Price Competition
Since firms in oligopolies prefer to avoid engaging in a price war, they must find alternative ways to gain market power and compete in alternative ways
Evaluation of Oligopoly
advantages
Economies of Scale can be achieved
Abnormal profit allows for Research and Development for technological innovation
disadvantage
Not allocatively efficient
Higher prices and lower quantities than perfect competition
Less innovative due to lack of competition
Potential for illegal collusion
Government Intervention
Legislation LAW：They could put laws in place to prevent the 4 largest companies from gaining more than 60% of the market share.
Government Ownership (Nationalisation)
Governments could take over an industry to reduce the abuse of market dominance. (Utilities)
Governments can set up regulations designed to limit market shares such as licensing, inspections, or the issuing of fines.