Type Perfect Competition Monopoly Monopolistic Competition Oligopoly
Number of buyers / sellers
Large
No one buyer / seller can influence price Firm price taker
Only one firm Firm price setter
Large
FOP relatively mobile When firm makes
decisions, does not have to worry how its rivals will react
Few large firms Interdependent
Barriers to entry
None
FOP perfectly mobile No transaction /
transportation costs Minimal sunk costs
High
Natural: huge sunk costs (AFC falls over very large output – AC falls continuously – enjoys huge IEOS), exclusive ownership of essential raw materials
Artificial: non-price competition, contrived barriers (cartel), legal protection: exclusive rights (patents, tariffs to block foreign firms)
No / Low
Firm lowers price – profits spread thinly over many rivals – rivals suffer negligibly Retaliation unlikely No collusion – keen competition Substantial Natural Artificial: legislation, collusion / mergers, non-price competition, advertising Nature of products Homogeneous Buyers no preference for any firm
No close substitutes CED and PED very low
Differentiated: quality, design, location, promotion Demand price elastic
Homogeneous / differentiated
33 Knowledge Perfect
Seller knows rivals’ prices, market costs and available technology Buyers know all sellers’
prices, quality and availability of products – will not purchase at a higher price than equilibrium price
Imperfect
Consumers not fully aware of COP
Imperfect
Production methods and prices
Cost structures differ as some firms enjoy more favourable locations / rentals
Imperfect
Firm’s curve
P = AR = MR P > MR
Cannot increase both output and price at the same time as curve is downward sloping
P > MR
Some degree of control over own prices
No single equilibrium price in market – no market demand curve
P > MR
Firm increases price – other firms will not Firm decreases price
– other firms follow – may lead to price war Price rigidity: menu
costs, fear of harming firm’s image (fall in price – fall in quality)
Examples Stock market Forex market
Agricultural products: many farmers in LDCs
Utilities
Starhub’s EPL coverage SMRT for NS and EW
lines
Bubble tea UK brewery industry Taxi companies OPEC Mobile service provision Firm’s SR equilibrium
Supernormal, normal / subnormal profits MC = MR and MC must be rising Firm’s LR
equilibrium
Normal profits New firms will enter
industry to erode supernormal profits
Normal / supernormal profits
Firm will shut down if subnormal profits
Normal profits Normal / supernormal LR equilibrium curve Productive efficiency Efficient
Firm produces at MES
Inefficient unless by coincidence
Inefficient
Will settle at LRAC that is not necessarily at MES
Inefficient unless by coincidence
Firm’s POV: all points on LRAC Society’s POV: MES Allocative efficiency Efficient P = MC Inefficient P > MC
35 2. Analysis of Imperfect Market Structures
Type Monopoly Monopolistic Competition Oligopoly
Economic efficiency
Allocative inefficiency: P > MC, output below optimum
Productive inefficiency X-inefficiency but increasingly
reduced due to globalisation, reduced customs duties and barriers to trade
Dynamic efficiency: r+d
Allocative inefficiency: P > MC Productive inefficiency: do not
utilise optimal plant capacity, do not exhaust potential for further EOS because all small firms Dynamic inefficiency: no r+d
Allocative inefficiency: P > MC, output below optimum
Productive inefficiency Dynamic efficiency: r+d
Variety of products
Unique
Possible innovation and new products: BTE stimulus to the creativity required to destroy barriers – monopoly profits stimulates new entrants producing new and competing products
Large variety – increase in consumer welfare
Differentiated
R+d and new profits
Profits lead to unequal income distribution: dollar votes + shift of consumer surplus to producer Supernormal profits – plough into
r+d – better quality products + better methods of production – lower AC but there is no
guarantee that monopolies will do this
More equity: no redistribution of income from consumers to shareholders
Normal profits: no additional profits to plough into r+d
Supernormal profits ploughed into r+d
Theory vs empirical evidence
MES high – IEOS – lower MC than PC industry – lower P and higher o/p but monopolies charge high prices by restricting output
Practise price discrimination [has both costs and benefits]
Natural monopolies
Perfectly contestable markets: costs of entry and exit by
potential rivals are zero, and when such entries can be made very rapidly eg. deregulation of airline industry in 1978
Hit and run competition: market contestable for certain seasons eg. parcels service during festivals Reduces wasteful competition
(instead of extensive advertising, money can be spent to produce more goods)
Wasteful competition Advertising provides better
consumer information which helps move market structure closer to PC model but loss of consumer sovereignty
High price rigidity: price stability Wasteful competition: more likely
to engage in extensive advertising – encourages price competition, with increased sales volume and reaping of EOS, price reduce further
But possible monopoly power through collusion
But multiple branding gives
consumers misguided information in thinking products are from different firms P/R/C Q AR MCm MR MCpc Pc Pm 0 Q Q
37 3. Price Discrimination
Producer sells specific commodity to different buyers at two or more different prices Same consumer charged different prices for same product for reasons not
associated with cost differences Conditions
Possible
Seller has control over market supply
Market segmentation and identifiable groups + no resale Profitable: each market as different PED
First degree
Practice of charging each customer his reservation price Captures all consumer surplus as revenue
Eg. auction sites
Impractical to charge each customer a different price Firm usually does not know the reservation price of each
customer: consumers do not tell and producers may not want to spend time and resources to find out
Second degree
Charge different prices for different blocks of the same product to the same buyer
Eg. photocopying shops Third degree
Sells same product at different prices to different customers Conditions
Two or more markets which can be separated PED of each market must be different
Higher price charged in market with more price inelastic demand
Cost: loss of consumer surplus Benefits
Firm: higher profits and may use these profits from one market to withstand possible price war in breaking into another market
Consumer
Higher profits may be reinvested into r+d – better quality products + better methods of production
Provision of goods that would otherwise not be produced due to high costs if production and consumption of good is one that confers positive externalities on society
• Additional profits might exceed losses such that firm will still continue producing the good
39 Discuss the view that the profit motive will always lead to a few large firms dominating the market for each and every type of product. [15m]
1) Barriers to entry
Few large firms merge – greater market share – reap EOS – fall in LRAC – fall in price – ward off rivals / block new entrants (natural BTE) – able to maintain supernormal profits
If plough into r+d – better methods of production – further fall in AC - make more profits
But some industries have low BTE (technology easily replicated) – low sunk cost eg. retail, grocery
2) Market size
Small: eg. Singapore television broadcasting Mediacorp vs. Mediaworks
Firms will eat into each other’s market share – erode profits – so to keep profits just let one firm dominate
Market big: eg. US then can afford to have few large firms 3) Nature of product
Large firms: unique products with no close substitutes
Small firms: availability of substitutes, prestige market / services, localized demand, perishables, limited MES – fashion, specialization, personalized services 4) Government Intervention / public’s desire
Few large firms will help to reduce price – increase in consumer surplus – increase in consumer welfare
Supernormal profits – plough into r+d to produce better quality products
Will still have competition unlike monopoly – still have the incentive to be more cost-efficient / innovative
Explain what is meant by productive and allocative efficiency. [10m] 1. Allocative efficiency
Definition: situation in which it is impossible to change the allocation of resources in such a way as to make someone better off without making someone else worse off
Assumption: no externalities / public goods – P = MC – right amount + type of good produced to maximize societal welfare
If MB < MC, last unit of good less than opportunity cost of producing that unit – society benefits from not producing that last unit
If MB > MC, last unit of good more than opportunity cost of producing that unit – society benefits from producing that last unit
Assumption aside, MSB = MSC
Perfect competition: firm price taker MR = MC = P – allocatively efficient Price Quantity 0 S (MC) D (MB) P/R/C Quantity MR MC Q1 0 P1
41 2. Productive efficiency
Long run concept Firm’s POV
Any given level of firm’s output produced at lowest possible AC – all points on LRAC curve are productively efficient
Society’s POV
LRAC minimum – firm is at optimum size / MES – all IEOS exploited P/R/C Quantity MR LRAC Q1 0 P1
‘A firm should be encouraged to maximize profits because this makes it efficient.’ Discuss whether this argument is true for a firm operating in an imperfect market. [15m]
*When comparing efficiency, only talk about long run
1) Allocative efficiency: P > MC true for all imperfect markets because they are price setters – deadweight loss to society – allocatively inefficient
2) Productive efficiency: Not operating at MES (where LRAC cuts MC) – not fully exploited all IEOS – productively inefficient
PC industry needs to be at MES because it needs to be as cost-effective as possible – price taker – cannot pass cost increase to consumers
Vs. imperfect market need not be at MES because price setter – can pass cost increase to consumers
3) X-inefficiency
Monopoly: lax in cost control – no existing competition – can pass cost increase as price increase
But monopoly can also be cost efficient due to fear of new entrants Globalisation and international competition
If market is contestable
Force monopoly to be cost efficient
Oligopoly more likely to be cost-efficient compared to monopoly but wastage of resources – large scale advertising / promotion – increase cost for firm and opportunity cost to society as the money could have been used to produce more goods
4) Dynamic efficiency
Supernormal profits in long run – able to invest in r+d – better methods of production – fall in AC in very long run
Vs. PC industry: no dynamic efficiency P/R/C Quantity AR MR MC LRAC Pm Pc Qc Qm 0 Triangle = DWL
43 Distinguish between monopolistic competition and oligopoly. [10m]
Type Monopolistic competition Oligopoly Number of
sellers
Many – one firm’s action less likely to affect others
A few large firms – interdependence – one firm’s action likely to evoke responses from rivals
Nature of product
Differentiated eg. retail: restaurants – affect demand curve – demand price elastic
Homogeneous / differentiated eg. mobile service provision, petrol companies / taxi companies, OPEC – kinked demand curve
Firm increase price: rivals will not follow – quantity demanded for firm’s product falls more than proportionately – demand price elastic
Firm reduces price: rivals likely to follow – price war + quantity demanded for firm’s product increases less than
proportionately – demand price inelastic Non-pricing
competition
Smaller scale Larger scale Likelihood
of colluding
Less More: large market share
BTE Low / no – low sunk cost + technology easily replicated – long run normal profits
High – natural: high sunk cost eg. utilities, telecomm – TFC very huge – LRAC keeps falling – enjoys huge EOS – very low LRAC– new entrants cannot produce at such low LRAC
Artificial: patents
Ensure supernormal profits in long run P/R/C Quantity 0 AR P/R/C Quantity 0 AR Pe
Explain why oligopoly is a common market structure in many economies. [15m] 1) Firms want to be big to maximize profits
Merger of small firms – EOS – fall in LRAC – fall in price – ward off rivals + block new entrants
Monopoly – attracted by supernormal profits – monopoly loses its power 2) Society may desire oligopolies
Oligopoly – competition – greater innovation through r+d which monopolistic competition cannot afford since it only makes normal profits
Vs. monopoly – lax – X-inefficiency 3) Government’s intervention
Singapore government – face of international competition in a free market, local firms have to be big eg. banking – go regional – liberalization and deregulation of industries: mobile service industry, taxi companies
Firms prefer operate in oligopolistic structure rather than monopolistic: monopolies more closely watched by government vs. oligopolies harder to observe whether they are colluding
4) Some industries due to huge sunk cost – oligopolistic / even natural monopoly eg. utilities, telecommunications, transport, TV broadcasting in Singapore since market size is too small – one single player most efficient
45 Explain why governments throughout the world have been involved in the supply of services such as electricity. [12m]
Introduction
Government – social benefits + social costs which private firms unlikely to take into account
Electricity – essential good for households and businesses Body
1) Could be a natural monopoly
Market size cannot operate with more than one player at MES: huge sunk cost – AC keeps falling – private firms likely to be monopolistic – charge very high prices – need for regulation
2) Private – does not cater to lower income group vs. government more likely to do so 3) Huge initial investment – private firm likely to charge higher price to cover costs vs. government can subsidise from revenue / taxes
4) If there is competition among a few private firms – wastage + duplication of resources vs. government: save costs for advertising
5) Earns revenue for government since it is essential Conclusion
Main point is that government does not want to risk anything because electricity and similar services are so essential
P/R/C Quantity 0 AR MR MC Pm Pc Qm Qc AC
Chapter 8: Government Intervention in the Market II