F&D P2: Assessing Performance Across Different Market Structures

What are the Criteria for Assessing Market Performance/Desirability?

Economic (static) efficiency (allocative, productive), dynamic efficiency, equity, and consumer choice.

What is Allocative Efficiency? (Performance Criterion)

Society produces and consumes the combination of goods/services that maximises welfare (P=MC, no externalities).

How does the Perfectly Competitive Firm achieve Allocative Efficiency?

In long run equilibrium, P=AR=MR=MC, so P=MC, achieving allocative efficiency.

How does Imperfect Competition affect Allocative Efficiency?

Firm is a price-setter, so P > MR. At profit-maximising output (MR=MC), P > MC -> allocatively inefficient (under-produced, deadweight loss).

How does Market Power affect Allocative Inefficiency?

Greater market power -> less price elastic demand -> greater divergence between P and MC (larger mark-up) -> greater allocative inefficiency.

What is Productive Efficiency? (Performance Criterion)

Achieved when all resources are fully and efficiently utilized, producing goods/services at the lowest possible average cost.

How does Productive Efficiency relate to PPC? (Macro Perspective)

Achieved when resources are fully and efficiently employed, meaning output is on the PPC.

How does Productive Efficiency relate to LRAC? (Micro Perspective)

Achieved when a firm operates at its minimum LRAC, i.e., at its MES.

How does the Perfectly Competitive Firm achieve Productive Efficiency?

In long run equilibrium, it operates at its minimum efficient scale (lowest LRAC).

How does Monopolistic Competition achieve Productive Efficiency?

From firm's perspective, productively efficient if operating on LRAC. From society's perspective, productively inefficient due to excess capacity (not producing at MES).

How does Oligopoly and Monopoly achieve Productive Efficiency?

Can afford to be X-inefficient (operate above LRAC) due to supernormal profits/high BTE. From society's view, may be productively efficient if scale is large enough to reap significant IEOS.

What is Wasteful Duplication of Resources?

Competition may lead to multiple firms producing similar services where one could suffice (e.g., TV channels screening same event) -> inefficient.

What is Dynamic Efficiency? (Performance Criterion)

Firms' willingness and ability to innovate (R&D for product/process innovation) to reduce costs or meet changing wants.

Why does the Perfectly Competitive Firm NOT achieve Dynamic Efficiency? (Reasons for lack of Dynamic Efficiency)

Assumption of perfect information (innovations quickly replicated -> no incentive for R&D). Long-run normal profits (limited ability to fund R&D). Homogeneous products (innovation to improve quality irrelevant).

How does Monopolistic Competition achieve Dynamic Efficiency?

Firms differentiate products to gain market power, but limited ability for huge R&D due to low BTE and normal LR profits. Focus on superficial differentiation.

How does Oligopoly and Monopoly achieve Dynamic Efficiency?

Enjoy supernormal profits and have BTE -> ability to engage in R&D. Oligopolies may have greater incentive due to existing competition. Monopolies may be complacent without threat.

What is Equity? (Performance Criterion)

Fairness in distribution of wealth, income, opportunities, and profits (a normative concept).

How does the Perfectly Competitive Firm achieve Equity?

Spreads opportunities and wealth widely and more evenly due to no barriers to entry (profits spread among small firms). Maximises consumer surplus.

How does Imperfect Competition affect Equity?

Monopolies/Oligopolies exacerbate inequity by concentrating supernormal profits, potentially blocking new entrants, and charging higher prices -> redistribution from consumers to producers. Price discrimination by monopolies/oligopolies further reduces CS.

What is Consumer Choice? (Performance Criterion)

Freedom to choose from a variety of goods/services and from different producers.

How does the Perfectly Competitive Firm affect Consumer Choice?

Does NOT offer product variety due to homogeneous goods.

How does Monopolistic Competition affect Consumer Choice?

Enhances choice due to differentiated products and many firms.

How does Oligopoly affect Consumer Choice?

Can engage in product proliferation (many product lines), but may have less choice if high market concentration limits diversity. Monopolies offer no choice of variant.

What is Theory of Contestable Markets?

Argues that the threat of competition (ease of entry/exit) determines firm behavior (price/output strategy), not just the number of existing firms.

What are Key Conditions for a Perfectly Contestable Market? (Conditions for Contestability)

Costless and rapid entry/exit (no sunk costs); perfect information for all suppliers; low consumer loyalty.

What is the Impact of Contestability on Firms?

Inefficient firms cannot survive. Incumbent firms (even monopolies) are forced to keep profits down to normal levels to deter entry.

What is "Hit and Run" Competition?

Firms enter a market for a short period when profits are high, then quickly withdraw.

What are the Benefits of Price Discrimination to Public Interest?

Greater equity for lower-income consumers (lower prices). Higher profits for firms may be reinvested into R&D or cross-subsidise socially beneficial but loss-making activities.

What are the Costs of Price Discrimination to Public Interest?

Less equitable (producer surplus ↑ at expense of consumer surplus). Unfair strategy to keep potential entrants out.