micro economics topic 5- market structures

define for price discrimination

price discrimination means charging higher prices to different consumer groups for the same product

why do firms use price discrimination and how do they benefit (typically what firms do this?)

firms maximise profits and revenue by hijacking consumer surplus and converting it into producer surplus

• typically firms offering services price discriminate

what is consumer surplus

the difference between what consumers were willing to pay and the actual price they pay

how do firms hijack consumer surplus

by offering varying price points, firms can extract more value from a wider range of consumers therefore maximise their revenue

explain the types of price discrimination

• first degree- all consumers are charged the highest price they are willing to pay

• second degree- charging different prices based on quantity purchased

• third degree- charging different prices to certain consumer groups or for different time periods

first degree price discrimination examples

all consumers are charged the maximum price they are willing to pay.

for example at an auction

2nd degree price discrimination example

consumers charged different prices based on quantity purchased

eg- bulk buying,

third degree price discrimination

charging different prices to different consumer groups based on different elasticities of demand

eg- student discounts, old age pensioners, child vs adult

conditions required for price discrimination

• firms must have monopoly power/ firms are price makers

• the must be no seepage/ reselling - consumers charged lower prices can’t resell to those charged higher prices

• different groups must have different price elasticities of demand- consumers with less elastic demand charged higher prices than consumers with elastic demand

advantages of price discrimination

• price discrimination allows firms to provide a service or good to consumers that would not otherwise be able to consume the good

• price discrimination increases producer surplus as it allows firms to charge higher prices to consumers willing to pay higher prices

• more producer surplus increases revenue

• higher output of firms leads to more efficient allocation of resources because distribution of goods and services align with what consumers are willing to pay

• reduce overcrowding and helps spread out demand ie: students pay less for cinema tickets on a Monday

disadvantages of price discrimination

• consumers are exploited

• unfair for certain groups groups with inelastic demand are charged much higher prices which can lead to increased income inquality

• not allocative efficient as price is greater than MC

• disproportionately effects those with less bargaining power

• market segmentation issues- if firms incorrectly segment the market than it could lead to a reduction in sales and market share

solutions to price discrimination

• government intervention

• governments can implement laws to prevent price gauging (significantly raising prices to unfair levels)

• encouraging higher levels of competition

why is price discrimination effected in contestable markets

the threat of new entrants reduces firms monopoly power. this is because is firms rise prices to high than rival firms can undercut these prices and quickly gain market share.

eg- firms can target overpriced consumers like families during school holidays and charge lower prices compared to monopoly firms.

when does profit max occur

MC=MR

what is a contestable market

firms face a high threat of potential competition from new firms entering the market

what is important for contestable markets

there is freedom to entry and exit (ie; there are no barriers to entry)

there are also no sunk costs in contestable markets

what are sunk costs

sunk costs are costs that can’t be recovered if a new firm leaves the market

give an example of a sunk cost

• advertising costs

• salaries already paid

• rent or property costs

• employee training costs

• research costs

what are firms already existing in the market called

incumbent

conditions for contestable markets

• incumbent firms must have no competitive advantage over new entrants

• all firms must have equal access to technology

• there must be no brand loyalty

• firms and consumers must posses perfect information

diagram of a contestable market

hit and run competition exists in contestable markets

this means firms enter a market temporarily and then leave once abnormal profits have been exhausted

what happens to prices in contestable markets

non-contestable markets allow firms to maximise profits (MC=MR), in contestable firms the threat of competition forces firms to lower their prices to the point where AC=AR so they can only achieve normal profits

benefits of contestable markets

• lower prices for consumers

• better customer service

• firms have incentives to reduce costs and satisfy consumer preferences which brings the market closer to productive and allocative efficiency.

where does productive efficiency occur

productive efficiency occurs when AC is minimised, AC=MC

how can markets become more contestable

• governments can intervene to reduce monopoly power

• privatisation and deregulation make markets more contestable by allowing more competition and making it easier for new entrants to enter the market

an example of a barrier that restricts contestability in a market

for example the national grid is a natural monopoly so new entrants who wish to sell electricity domestically may not get equal access to the grid. this is because large vertically integrated companies have information and cost advantages.

• the energy crisis of 2021/22. led to many small firms failing and in turn market concentration increased and monopoly firms gained more market share.

what are the 4 market structures

• monopoly

• oligopoly

• monopolistic competition

• perfect competition

features of monopolies

• price makers - possess pricing power

• monopoly power - there can raise prices and reduce output (profit max) or they can increase output and lower price (sales max)

• highly concentrated - market dominated by one firm that has a high market share

• technical monopoly - 25% market share

• pure monopoly 1 firms dominates entire market

• no/ little competition

• high barriers to entry

causes of monopoly power

• geographical monopoly ie- one local shop supplies rural area

• public sector monopolies formed for essential goods and services

• legal barriers like patents

factors that increase monopoly power

• barriers to entry- eg- large economies of scale, high r&d costs

• mergers and acquisitions - firms can combine with other firms which would increase market share

• advertisement- large firms can promote their brand and build strong brand loyalty

• limit pricing- monopolies can set prices low enough to deter new entrants

• product differentiation- firms can make their product unique from others- gain brand loyalty

give examples of natural barriers to entry

• high research and development costs

• high start up costs

• economies of scale

• high sunk costs

what are some strategic barriers to entry

• patents and copyrights

• product differentiation

• brand loyalty

• limit pricing

• predatory pricing

perfect competition is..

the most competitive market. it is a market where a large number of small firms operate in strong competition

features of perfect competition

• lots of small firms

• least concentrated firms each posses little market share

• no brand loyalty

• no barriers to entry

• firms sell homogenous products

• consumers and firms possess perfect information - ie- they know exactly what quality and prices to expect.

• each firm is a price taker

• no pricing power firms accept ruling market price determined by supply and demand

compare the demand curve for perfect competition and other markets demand curve

• perfect competition is the only market structure with no pricing power and a perfectly elastic price

• monopolies, oligopolies, monopolistic competition have a downwards sloping demand curve and posses monopoly power

discuss efficiency with regard to perfectly competitive market structures

• perfect competition is the most efficient market due to strong competition— firms achieve productive efficiency because they minimise average costs in order to survive. they also achieve allocative efficiency because firms produce optimal amount to satisfy consumer preferences.

what is market concentration

measures how one or more firms dominate the market in terms of sales

what is the most concentrated structure and describe imperfect competition

a monopoly. market concentration is much higher in imperfect competition. firms are less efficient because they are not perfectly competitive.

firms in imperfect competition engage in price competition, what is price competition

price competition is when firms lower prices to take market share from rivals

firms also engage in non-price competition to build customer loyalty what is non-price competition

• improved quality and customer service

• loyalty cards

• reward programs

• successful advertising campaigns

• better locations

• better opening times

• warranties