4.1.5 Perfect competition, imperfectly competitive markets and monopoly

what is market structure?

the number and size of firms within a market for a particular good or service

illustrate the spectrum of competition

what is each market structure characterised by?

1. no. of firms in the market

2. the degree of product differentiation

3. ease of entry into the market

what is assumed to be the main objective of firms?

profit maximisation

what is profit maximisation?

when a firm seeks to make the largest positive difference between TR and TC

when are profits maximised?

when MC = MR

it’s the only point where no further gain can be made by increasing or decreasing output

show where a price taker maximises profits

show where a price maker maximises profits

what other objectives might a firm pursue instead of profit maximisation?

1. revenue maximisation

2. sales maximisation

3. survival

4. growth

5. increasing market share

6. quality

when is revenue maximised?

when MR = 0

at output level Q₁ (higher than the profit maximising output Q)

why does a revenue-maximising firm produce beyond the profit-maximising output?

it keeps increasing output past the point where profit is maximised, as long as adding more output leads to greater revenue

when are sales maximised?

when AR = AC (normal profit)

at output Q₂ (the highest output sustainable in the long run)

why can’t a sales-maximising firm increase output beyond Q₂?

it would be making a loss

why might a firm sacrifice short-run profit to maximise sales or revenue?

• to grow market share

• gain monopoly power

• or make it easier to borrow money

→ which can lead to supernormal profit in the long run

why might a firm operate at a loss in the short run?

it may expect future revenue to increase as brand recognition grows

or expect costs to fall through EOS

what are “not for profit” firms and what’s their main aim?

firms that don’t pay out profit to owners

their main aim is to “do good” or provide a public benefit, while still making at least normal profit

what is corporate social responsibility (CSR)

when firms operate in a way that benefits society e.g.

• using sustainable resources

• supporting local suppliers

• pay workers above market rate

while still seeking supernormal profit

how can CSR increase a firm’s profits?

by encouraging consumers to buy from them, building brand loyalty and reputation

what is divorce of ownership from control?

when a firm’s owners (shareholders) are no longer in day-to-day control

instead, appointed directors run the business

how does the divorce of ownership from control arise?

as firms grow, owners raise finance by selling shares

new shareholders become part-owners

but directors are appointed to manage the firm

what is the principal-agent problem?

when a principal (e.g. shareholder) pays an agent (e.g. managing director) to act in their interests, but the agent acts in their own self-interest instead

example: shareholders want profit maximisation, but if a director’s pay is linked to revenue or sales, they may pursue those objectives instead

who are a firm’s stakeholders?

everyone with an interest in or affected by the firm

e.g. employees, managers, suppliers, customers and shareholders

how can owners tackle the principal-agent problem?

by holding directors accountable

requiring them to justify past decisions and explain future plans

shareholders can also vote to remove directors

why is accountability alone not always enough to control directors?

shareholders often lack the information needed to judge whether director’s decisions were truly in the firm’s best interests

how can incentives help align directors’ objectives with owners’ objectives?

owners can offer bonuses linked to profits, or free/discounted company shares, making profit maximisation attractive for directors

what is satisficing?

doing just enough to satisfy important stakeholders rather than fully maximising or minimising any one objective

why does satisficing occur?

when different stakeholders have conflicting objectives, firms may settle for outcomes that keep everyone sufficiently content

show profit satisficing on a diagram

• profit maximisation occurs at a single, specific output, Q₁, which will be hard to achieve

• a satisfactory level of profit (P_sat) that most shareholders will be happy with can be achieved at any level of output between Q₂ and Q₃

what is perfect competition?

a market structure that has a large number of buyers and sellers who have perfect information about the market, identical products and few, if any, barriers to entry

what are the characteristics of perfect competition

• many/infinite buyers and sellers (sellers are price takers)

• no barriers to entry

• perfect information (consumers + firms have perfect knowledge of all goods and prices in a market

• homogenous goods (identical)

• firms are short run profit maximisers

• FOPs are perfectly mobile