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​

Monopolistic Competition

Oligopoly​

click to edit

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)

click to edit

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

click to edit

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.

click to edit

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.

click to edit

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

click to edit

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​

Long-Run​

A period in time when at least one factor of production is fixed.​

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

click to edit

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

click to edit

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

Natural Monopoly​

click to edit

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.

Unit 2 Microeconomics（thoery of the firm)HL only

Sources of Market Power​

Natural Monopoly

Legal Barriers

Economies of Scale

Branding

Anti-Competitive Behavior

Typically firms start small with limited expertise. Monopolists have the ability to charge a lower price than newcomers.

Only enough revenue and economies of scale to support one firm​

Patents, Copyright, Licenses, etc.

Customers may be loyal to a certain firm due to marketing. Kleenex, Band-Aid, etc.​

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?

click to edit

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​

click to edit

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​

click to edit

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​

Perfect Competition​

click to edit

Some control over price​

Similar looking graph (D > MR)​

Not Allocatively Efficient​

click to edit

A large number of smaller firms​

Low Barriers to Entry​

In the Long-Run, Normal Profit. ​

Sources of Market Power​

click to edit

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

disadvantage

click to edit

Economies of Scale can be achieved ​

Abnormal profit allows for Research and Development for technological innovation​

click to edit

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)​

click to edit

Governments can set up regulations designed to limit market shares such as licensing, inspections, or the issuing of fines. ​