Market Structures - Perfect Competition and Monopoly

One of the quickest ways of determining what kind of market structure exists in a particular industry is to use concentration ratiosCONCENTRATION RATIO'S a measure of the extent to which a market is in the hands of a given/particular number of firmsCHARACTERISTICS OF PERFECT COMPETITION:- INFINITE NUMBER OF SMALL FIRMS each firm has no influence over market price GOODS ARE HOMOGENEOUS identical output from all firms ALL FIRMS ARE PRICE TAKERS there is consumer sovereignty PERFECT KNOWLEDGE consumers are aware of which firm charges the lowest price/transparency ALL FIRMS SEEK MAXIMISE PROFITS MC=MR PERFECT FACTOR MOBILITY factors of production can easily switch rules - perfect substitutes ABNORMAL PROFITS IN THE SHORT RUN average revenue > average cost NO BARRIERS TO ENTRY AND/OR EXIT

Abnormal profit is AR>AC Profit max is MC=MR As abnormal profit is being earned this would encourage other firms to enter the industry. As they do market price decreases and abnormal profit is competed away until firms in the industry make only normal profit NORMAL PROFIT the minimum level of profit required to keep a firm operating within an industryABNORMAL PROFIT any level of profit over and above normal profit

Normal profit is AC=AR MC=MR Profit max - MC=MR Short run to long run:- Abnormal profits act as a signal New firms enter the industry and increase supply Price falls and abnormal profits are "competed away" BARRIERS TO ENTRYBARRIERS TO ENTRY anything that stops new firms entering a particular market; they tend to be more prevalent as the degree of competition in the market decreasesThe main barriers to entry include:- HIGH SUNK COSTS costs that a firm cant recover when leaving a market eg advertising, licencing fee HIGH INITIAL COSTS includes capital investment eg equipment, buildings CONTROL OF RETAIL OUTLETS eg Tesco buying plots of land and old premises CONTROL OF THE SUPPLY OF RAW MATERIALS eg Tesco buying farms to produce raw materials ECONOMIES OF SCALE incumbent firms (already in the market) may have grown and experienced decreases in LRAC (meaning they charge lower prices and can protect their profit margins) EXISTENCE OF BRAND LOYALTY incumbents reputation may mean new entrants face higher costs of persuasive advertising Where barriers to entry are low the market is sometimes described as being contestable. In this situation there are potential competitors even if few actually appearCONTESTABILITY AND BARRIERS TO ENTRY AND EXITCONTESTABILITY the extent to which barriers to entry and exit in a market are free and costlessINCUMBENT FIRM a firm that is already operating in a marketMost argue its the degree of contestability that determines the level of competition rather than the number of firmsA contestable market occurd when the behaviour of incumbent firms is influenced by both existing and potential competitors , who can enter the industry at:- Relatively low cost Take advantage of abnormal profit while available Leave the industry at low cost (hit and run) The existence of barriers to entry and/or exit therefore influences the level of contestability within an industryA perfectly contestable market exists where:- All firms are subject to the same regulations and the same state of technology Mechanisms are in place which prevent entry, limit pricing by incumbent firms Incumbent firms are vulnerable to "hit and run" competition Contestability is more likely to be found in a perfectly competitive market than any otherIncumbent firms in a perfectly contestable market may moderate their behaviour in an attempt to discourage potential entrants eg just making normal profit even if abnormal profit is obtainableIncumbent firms may also seek to erect artificial barriers to entry such as increasing levels of consumer loyalty which deter potential entrants when incumbent firms change their strategy and seek to maximise profits in the short runTHE OBJECTIVES OF FIRMS: PROFIT MAXIMISATION The break even point is usually whether a profit or loss is made Abnormal profit is the reward for risk taking and managing resources

At this point the difference between TR and TC will be greatest (profit is maximised)

There is profit for unit 9 - MR is £20 but the MC is only £10 There is a loss for unit 11 - MR is £12 and MC is £20 For unit 10 MC = MR ar £15 Any output below MC=MR, MR>MC and the firm sacrificing potential profit which could be earned by increasing output to the point where MC=MRAny output above MC=MR, MRMARGINAL REVENUE addition to TR from selling an additional unit of outputMARGINAL COST addition to cost from producing an additional unit of output an is therefore a variable costCHARACTERISTICS OF MONOPOLY:- One large firm dominates the industry - pure monopoly is one firm with 100% market share (firm with 25% market share can exert monopoly power) Dominant firm is the price maker (consumers may experience a decrease in consumer surplus due to increases in price) Abnormal profits in the short and long run - AC High barriers to entry and/or exit Profit maximiser where MC=MR

The main case against a monopoly is that abnormal profits at the expense of economic efficiency. The monopolist can extract a price from consumers increasing the cost of resources used in making the product leading to decreased amounts of consumer surplus

Consumers needs and wants aren't being satisfied as the product is being under-consumed because the price is above the cost, leading to what is known as market failure - allocative efficiency (P=MC) - this only exists in perfect competition (not in the real world) Little pressure for a firm with monopoly power to maximise their efficiency/ minimise costs of production - limited incentives to adopt cost reducing process innovations THE CASE FOR COMPETITION (F581 - THE BASIC ECONOMIC PROBLEM) Competitive markets provide the best means of ensuring that the economy's resources are put to their best use by encouraging enterprise and efficiency and widening choice Where workers work well, they provide strong incentives for good performance - encouraging firms to improve productivity to reduce prices and to innovate; whilst rewarding consumers with lower prices, higher quality and wider choice - increasing consumer surplus

Increasing AD at spare capacity increases AS but the price level remains the same however an increase in AD at YFC doesn't increase AS just the price levelBy encouraging efficiency, competition in the domestic market - whether between domestic firms alone or between those and overseas firms - also contributes to out international competitiveness THE POTENTIAL ADVANTAGES OF MONOPOLY R+D spending - profits can find investment and R+D projects. Also the positive spill-over effects of research can be seen through increased innovation The exploitation of economies of scale - monopolies can exploit economies of scale. Also gains in productive efficiency may lead to lower prices and improvements in economic welfare - lowest point of LRAC (MES - Q*)

Monopolies and international competitiveness - British economy needs multi-national companies operating on a sclae large enough to compete effectively in global markets International competition and market contestability - a firm may enjoy domestic monopoly power in the home economy but face intense competition in overseas markets Social welfare contributions - some monopolists invest in "good works" such as sponsoring arts, museums, research eg Sainsburys, Welcome Trust, Leverhulme