Market Structures
Types of market structures: Monopoly, Oligopoly, Monopolistic competition, Perfect competition
Monopoly: Market structures that have only one dominant firm, which can set prices for the market.
Oligopoly: Market structure in which there are only a few large firms. There are high barriers to entry and fierce competition between the few firms operating.
Monopolistic competition: A market structure with many relatively small firms that sell slightly differentiated products. Goods are differentiated by branding, or quality, or differences in service. They will rely heavily on advertising their brand to attract consumers.
Perfect competition: Hypothetical market structure in which there are many firms, each with a small market share, that all sell an identical product. We assume that there is perfect information available to firms and consumers about prices and quality of goods, and that firms can freely enter and exit the market.
Profit maximisation: The process by which a firm determines the price, input, and output levels that result in the highest profit.
Implicit costs: Risks are taken and sacrifices are made by a person or people starting a new business, so there is an opportunity cost or implicit cost to doing business
Explicit costs: Costs directly related to production. The physical payments for the factors of production, such as wages, rent and interest.
Total cost = Fixed costs + Variable costs + Opportunity cost
Total profit = Revenue - Total Costs
Normal profit: When total revenue is equal to the total economic cost.
Abnormal profit: When total revenue exceeds economic cost
Fixed costs: Costs that do not vary with levels of output, such as rent on a factory.
Variable costs: Costs that do vary when output changes.
Average cost: Cost per unit of output (TC/Q)
Marginal cost: The cost of producing one more unit of a good. (∆TC/∆Q)
Law of diminishing marginal returns: The principle that adding more of one factor of production (input), while holding at least one other factor of production constant, will at some point yield lower marginal returns (output/product).
Marginal revenue: Additional of revenue from each additional unit of output
Average revenue: Total revenue divided by quantity, which is equal to price.
Breaking even: When total revenue is equal to total costs, and the firm makes no abnormal profit.
When does abnormal profit occur in costs and revenues diagram?: When AR (Average Revenue) is higher than ATC (Average Total Cost)
When does a loss occur in costs and revenues diagram?: When AR (Average Revenue) is lower than ATC (Average Total Cost)
Productive efficiency: When output is produced using the fewest possible amount of resources; when output is produced at the lowest possible cost. (lowest point of AC curve)
Allocative efficiency: A situation when the marginal cost equals the average revenue, or MC = AR.
Characteristics of a perfectly competitive market: There are many small firms. There is perfect mobility of resources. There is perfect information. Goods are identical or homogenous. There is free entry and exit.
How does a perfectly competitive market affect a firm’s profit?: It is possible for a perfectly competitive firm to earn economic profits in the short run. However in the long run, the market will find an equilibrium in which the firm's demand curve will naturally sit at the bottom of the average cost curve, where no economic profit can be earned.
Why is perfect competition the most desirable market structure? In the short run, firms are able to earn abnormal profits, while being allocatively efficient. Prices and output will be lower than in other market structures and in the long run firms will be productively efficient.
Characteristics of a monopoly: One large firm operates in the market so the firm is the market. There are no close substitutes. There are strong barriers to entry and exit.
Imperfect competition/market: A market structure where firms have some price setting ability and consumers are limited in some way from switching between firms.
When does Profit-maximizing output occur? When marginal cost equals marginal revenue (MC=MR)
Why is PED > 1 for a profit-maximizing firm?: Since profit maximizing output occurs when MC = MR where MR and MC always equal to positive values, positive values of MR indicate that TR is increasing and thus PED > 1 along a linear demand curve.
Natural monopoly: Exists in a particular market if a single firm can serve that market at lower cost than any combination of two or more firms. This is because of the large investments needed to provide this good or service, so economies of scale won't be achieved until much greater levels of output are produced.
Strengths of a monopoly: Firms have a high potential for economies of scale, research and development due to high profits available for reinvestment. As for natural monopolies, they avoid wasteful duplication of resources such as water utilities, railroad infrastructure etc.
Limitations of a monopoly: Firms can have high prices and exploit and abuse their market power. Limited consumer choice and no allocative efficiency. High barriers for other firms to enter the market.
Interdependence: When different parties rely on each other (pricing decisions of firm A impacts firm B)
Cartel: A group of stakeholders in the market, usually businesses, who collude to improve their profits and dominate the market.
Formal collusion: Occurs when businesses make formal agreements to stick to high prices. This can involve or lead to the creation of a cartel. ex: Organisation for Petroleum Exporting Countries (OPEC)
Tacit/Informal collusion: Occurs when businesses make informal agreements or collude without actually speaking to the other, rival businesses. Informal collusion can be used to avoid attention from governments and regulators.
Non-collusive oligopoly: Because of the existence of interdependence between firms, it is unlikely that firms will engage in price competition. Firms tend not to compete with each other on prices as the risk of a price war is too great. Instead, we tend to see large advertising campaigns, and other promotional activities like loyalty programmes.
Collusive oligopoly: A collusion of businesses that operates essentially like a monopoly.
Characteristics of Monopolistic competition: There are many small firms. Goods are similar and slightly differentiated. Each firm has some ability to set the price. There are low barriers to entry. There is high advertising and branding involved with firms.
Legislation as a response to market power abuse: Government can prohibit takeovers or mergers of firms that would give one individual firm more than a certain percentage of the market share. They may also pass laws that restrict the market share that the largest firms of an oligopoly can have
Regulation as a response to market power abuse: Governments can investigate markets and ensure that monopoly power is not being used against public interests. This involves a process of licensing, setting of standards, Inspections and the issuing of fines
Nationalisation as a response to market power abuse: A government may take control of a private sector industry in order to run it as part of the public sector for the best interests of the public.
Equity: Refers to the concept of fairness or evenness and is considered an economic objective.
Stock market: A collection of markets and exchanges where buying, selling, and issuance of shares of publicly-held companies takes place.
Financial Investment: When firms or investors buy assets in financial markets, such as stocks or bonds, in the hope of earning a return on that investment.
Industrialisation: The process that countries go through when a manufacturing sector grows in size, while at the same time the agricultural sector shrinks, and people move away from rural areas to cities.
Kuznets curve: A curve depicting that income inequality will worsen before it improves during the process of industrialisation. X-axis: GDP per capita, Y-Axis: Income inequality