Market structures
Perfect competition
Assumptions
No barriers to entry
Firms are price takers
Homogenous products
Many buyers and sellers
Perfect information
able to buy/sell as much as they wish at the market price
Monopolistic competition
Assumptions
Slight product differential - partial substitution - slightly sloped demand curve, hence when firm raise price it will not lose all customers because of brand loyalty.
Barriers to entry in SR but not LR, hence it will attract firms to enter the market until price falls to where AR=AC.
Short run SNP; LR NP
perfect information
Oligopoly
Assumptions
Non-price competition
Some degree of price setting power
Interdependent on each other, without collusion or cooperation, hence uncertain on how other firms would react to a change in price.
If Supply is above and demand is below equilibrium price, firms will make a loss. This provides firms signals, incentivising some firms to leave the market. As a result, market supply falls, causing market price to rise, leading to the allocative efficient price.
In the short run, a firm have market power because there are barriers to entering the market. However, other/new firms have perfect information and therefore have knowledge of the whole market, including products from rivalry firms. In the long run, there are more and better substitutes - XED is more elastic, PED is more elastic. Firms are making normal profit.
Firms are too scared to change prices at equilibrium. Increasing in price means firm lose profit. Reducing price may lead to a price war - firms lose market share and revenue.
Monopoly
Assumptions
One firm dominates (only one firm)
High barriers to entry
Types
Natural monopoly
Articificial monopoly
Limited market size
High economies of scale
Unable to influence market price. The market price remains constant no matter the output.
Types of entry barriers
Natural barriers
High sunk cost - higher risks and therefore firms are not as willing to enter the market
Indivisibiliies - prevent goods and services from being produced below a certain price - eg. oil refinery and metal smelting.
Articifical barriers
Patents - prevent other firms from using the same/similar types of product of manufuturing techniques
Product differentiation - Differentiating products then obtain intellectual property rights, preventing "copy-cat" firms.
Huge spending on advertising and marketing
Encouraging consumers to choose their firm over others. To compete, competitors have to spend huge quantity on advertising and marketing, which are sunk cost that cannot be recovered. Firms are less likely to enter the market.
"First mover" advantage
Established brand image and customer base, loyal customers continue to spend on the firm despite competition. Potential entry firms may find it hard to obtain market share and business, hence will not enter the market.
Limited pricing
Reducing price and sacrifice short run profit to ensure it maintains its market share by DETERING new firms from entering the market to earn long-run profits
However, predatory is an anti-competitor practice and is against consumer welfare. It is the idea where firms undercut prices to drive out EXISTING recent entrants and then rising prices back to the original level.
The objectives of firms
Profit Max
MR=MC
No incentives to change output
MR>MC, marginal input increase profit; MC>MR, marginal input incur loss
Divorce of ownership - Economic agents aim to maximise their individual welfare, thus have different objectives. These objectives may conflict of each other.
In small firms, ownership belongs to one or a limited few shareholders. However, in larger businesses there are many shareholders, a director and corporate boards.
Conflicts of interest often arise between shareholders and managers. Managers may aim to maximise their future career prospect, rather than working at the interest of shareholders.
This is because managers bear the full cost of completing a task, but do not receive the full benefit from fulfilling it. They are not incentivised enough,
Managers know that the possibilities of being sacked or judged on the performance are low due to their difficulty. Moreover, being sacked often comes with substantial financial pay-off, which managers may be happy with; shareholders, who often suffer from asymmetric information, do not know how the details on how the business operates as well as the manager does, hence they cannot conclude whether underperformance is due to managerial problems or other economic factors.
Managers may therefore take excessive and unnecessary risks which may have higher reward, but comes with high risks of the business closing down and losing a lot of money. This is moral hazard where an agent takes more risks knowing that someone else promised to bear the burden of those risks. Shareholders, however, often want steady returns and in the long run growth of the business. They may not want to take high risks.
Other objectives
Sales revenue maximising - when bonuses are tied with sales figures, managers may have such objective. This occur where MR=0. An extra unit of factor input leads to negative marginal revenue which leads to fall in total revenue.
Growth maximising - expansion of businesses to improve their technology, capitals and brand images, creating artificial entry barriers to drive out smaller firms or prevent new entrants. Growth maximising is a means to the end, end being profit maximisation. New businesses may find themselves having survival as their business objective. They may "play safe" by investing in steady and lower risks project to just about cover their cost until the economy improves. These firms may then aim for growth or profit max
Satisficing - often when different groups of people in the firm have different objectives, sacrificing organised by the manager enable a satisfactory outcome. Managers may want to maximise profit so they minimise wages, however, workers want higher wages... etc.
However, managers when considering to compromise, may only do the minimum required. They may earn aim to earn minimum required profit to satisfy shareholders and raise wages just enough to ensure workers do not complain,
A firms manager may content themselves with a satisfactory amount of profit rather than profit maximising to have an easy life, which incurr unnecessary that can be prevented.
In perfect comp, firms that are initially happy with satisfactory profit and allow some degree of inefficiency may be forced to aim at profit max, otherwise they will make a loss.
How competitive is perfect comp?
Cannot reduce price to gain shares or sales. Advertising or any form of innovations destroys the model, because "homogenous products" The only possible way to compete is through cost-cutting competition. However, even then why would firms invest and research if they know other firms can gain instant access to all market information and that SNP from successful innovation in only temporary.
A firm owning all resources
Evaluation
Disadvantages
allocative inefficient - Underconsumption of goods because QPM>QAE, leading to welfare loss. - lowering consumer surplus
Excess supply because of high prices - rationing out consumers that are not willing and able to consume (cannot afford). They are often the lower income groups. Can lead to equity issues particularly when the good or service are necessities.,
productively inefficient because there is no competition
Monopsony power - single employer. Firm can set wages below the optimal quantity. This reduce workers' welfare.
Less choice for consumers, lower welfare
Advantages
Economies of scale
Possible dynamic efficiency, researching and developing which leads to better products and methods to produce with a lower cost. Consumers can benefit from better choices
The reward of patents may encourage investment
Efficiency
Productive efficiency
In the short run, the firm is productively efficient when producing at the lowest point of the SRAC curve.
In the long run, the firm is productively efficient when it is producing at the lowest point of the LRAC curve. This occurs when the firm has experienced full internal economies of scale.
Allocative efficiency
Allocative efficient occurs when it is not possible to improve economic welfare by reallocating resource in markets or industries
Therefore, when a market's P=MC, technically it doesn't mean allocative efficiency is achieved, because price may not equal marginal cost in other markets.
Dynamic efficiency
Occurs in the long run through investment which leads to the development of new products and better processes. This improve productive efficiency.
X-efficiency
The degree to which a monopoly is productive with a lack of competition
Externalities arise when P>MC, underconsumption; whereas when P<MC, overconsumption
The marginal cost/benefit only accounts for the MPC/MPB but not the external cost/benefit. This is because firms evade part of the true or real cost of production by dumping externality on third parties. Too much consumption, for example, leads to scared resources being misallocated to markets that produce negative externalities.
The economy can, theoretically, achieve AE when markets that has P<MC reallocating resources to markets where P>MC until all markets achieved P=MC
Many buyers and sellers
Evaluation
Productively inefficient
Allocatively inefficient
However, consumers may prefer the choices available in monopolistic competition to any improvements in productive efficiency that alternative market structures might provide.
Product differentiation - making firm a price maker
Imperfect information
Profit maximiser
Collusion vs Cooperation - collusion, often in the form of agreeing and fixing prices (convert), is often banned in most countries by the government because it is seen as against the public interest and anti-competitive. However, cooperation between firms may result in better inventions and innovations where both consumers and firms can benefit. (tacit collusion), which is allowed.
A rise in marginal cost does not change the profit maximising quantity, illustrating that firms compete through better packaging, quality and features of product, rather than price.
Cartel - oligopolies agreeing to together, producing at QPM, then split the production equally between them. This allow them to reduce uncertainty and earn supernormal profit. However, firms can choose to put their own interest before the group interest, increasing their output secretly (below agreed price but above MC) to earn extra SNP. This, however, will break the cartel.