Edexcel Economics A-level Theme 3: Market Structures

Flashcards covering the efficiency, competition, oligopoly, monopoly, monopsony, and contestability.

Define allocative efficiency.

Resources are distributed to goods and services consumers want, maximizing utility at P = MC.

Define productive efficiency.

Firms produce at the lowest point on the short run or long run average cost curve (MC = AC).

Define dynamic efficiency.

Resources are allocated efficiently over time, with optimal innovation leading to falling long-run average costs.

What short run factors affect dynamic efficiency?

Demand, interest rates, and past profitability.

Define X-inefficiency.

A firm producing within the AC boundary, resulting in higher costs than with market competition, caused by factors like organizational slack or poor management.

What are the 7 characteristics of perfect competition?

Many buyers and sellers, sellers are price takers, free entry/exit, perfect knowledge, homogeneous goods, short run profit maximisers, factors of production are perfectly mobile.

In a perfectly competitive market, are profits higher or lower than a market with only a few large firms?

Lower, because each firm has a very small market share and therefore, very little market power.

In the short-run, can firms in perfect competition make supernormal profits?

Yes, but in the long run, new firms enter, increasing supply and lowering the price, which leads to normal profits only.

What is an advantage of perfect competition in the long run?

Lower prices and allocative efficiency (P=MC) and productive efficiency.

What is a disadvantage of perfect competition in the long run?

Limited dynamic efficiency due to lack of supernormal profits, and few/no economies of scale.

List 4 characteristics of monopolistic competition?

Imperfect competition, firms are short run profit maximisers, non-homogeneous products, many buyers and sellers, no barriers to entry and exit, downward sloping demand curve

What type of profits are made in the short run in a monopolistically competitive market?

Supernormal profits are possible.

How do firms in monopolistic competition attempt to stay in the short-run?

Differentiating their products and innovating.

List 2 disadvantages of monopolistically competitive markets.

Allocatively inefficient (P>MC), limited dynamic efficiency, excess capacity.

What are 3 characteristics of an oligopoly?

High barriers to entry/exit, high concentration ratio, interdependence of firms, product differentiation.

How do you calculate an n-firm concentration ratio?

Add the market shares of the top n firms in the market.

In an oligopoly, does collusion lead to a lower or higher consumer surplus?

Collusion leads to a lower consumer surplus, higher prices, and greater profits for colluding firms.

List 4 factors that make collusion more likely.

Few firms, similar costs, high entry barriers, ineffective competition policy, consumer inertia.

What is the difference between overt and tacit collusion?

Overt collusion is a formal agreement; tacit collusion is an informal understanding.

Define cartel

A group of firms that agree to control prices, limit output, or prevent new firms from entering the market.

Define price leadership.

When one firm changes its prices, and other firms follow.

Explain game theory and the prisoner's dilemma.

Game theory predicts the outcome of a decision by one firm with incomplete information about another; the Prisoner's Dilemma illustrates this with two prisoners choosing to confess or deny a crime.

Define Nash equilibrium.

The optimal strategy for all players, taking into account what opponents have chosen where no player can improve their position given others' choices.

Briefly describe predatory pricing

Setting low prices to drive out existing firms, even at a loss in the short run.

What is limit pricing?

Setting prices low to discourage new firms from entering.

What is the aim of non-price competition?

Increase loyalty to a brand and make demand more price inelastic.

List 3 characteristics of a monopoly.

Profit maximisation, sole seller, high barriers to entry, price maker, price discrimination.

List 3 barriers to entry that can maintain monopoly power.

Economies of scale, limit pricing, owning a resource, sunk costs, brand loyalty, high set-up costs.

Monopolies are allocatively inefficient, why?

P > MC due to profit maximisation at MC = MR.

What condition is necessary for a monopolist to price discriminate?

Different groups of consumers must have different price elasticities of demand, and it must be inexpensive for the firm to split the market.

What is third degree price discrimination?

Charging different prices to different groups of consumers for the same good or service.

What is one way a consumer can benefit from price discrimination?

Consumers could benefit from a net welfare gain because of cross subsidisation, if they receive a lower price.

List one benefit to firms from price discrimination

Firms make better use of spare capacity and gain higher supernormal profits.

How can monopolies be dynamically efficient?

Significant supernormal profits, encourage investment in research and development. This result can yield positive externalities.

What is a natural monopoly?

Arises when high fixed costs, usually in the form of infrastructure are involved.

Define monopsony.

A single buyer in a market.

How does a monopsony affect its suppliers?

Firms with monopsony power are able to set the market price and negotiate lower prices because suppliers are limited with alternative buyers.

What determines a contestable market?

Actual and potential competition, free access to production techniques/technology, low entry/exit barriers, low consumer loyalty.

List 3 implications of contestable markets for the behavior of firms.

Allocatively and productively efficient, wary of new entrants, could be supernormal profits in the short run and normal profits in the long run.

Provide 3 examples of barriers to entry.

Economies of scale, legal barriers (patents, exclusive rights), consumer loyalty/branding, predatory pricing, limit pricing, anti-competitive practices, vertical integration, brand proliferation.

What are 2 barriers to exit from a market?

Cost to write off assets/pay leases/contracts, loss of brand/consumer loyalty, redundancy costs.

How do sunk costs impact contestability?

Sunk costs are a barrier to contestability, because they cannot be recovered once spent. A market with high sunk costs is less favorable to enter, because the risks associated with entering the market are high.

How has globalization impacted contestability?

Increased the ease with which foreign firms can sell to domestic consumers at a competitive price. This has made it easier for foreign firms to successfully enter domestic markets.