Revision Booklet

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Perf ect competition
S1 Price and costs Pm MC ATC AC D Q1 Q2 Q/t O
= Supernormal prof its

Monopolistic competition
S2 Price MC ATC and costs Pml Ppc

Non-collusive oligopoly

Collusive oligopoly
• I nf ormal/tacit collusion:price leadership theories. MC leader
Price PL,PT is set using the leader’ s MC curve and the market AR = D curve.

I ndividual firm Short run Long run

Market

This is the seventh version ofthis document,created 23rd January 2005.
Qm MR D=AR=P Q/t O MR D= AR=P Qml Qpc Q/t
= Loss ofconsumer surplus under MC compared to PC

U nit cost

MC

Price AC

P1

A

Price and costs PL,T

P1 D1=AR 1=MR 1

P2

E

B

D2=AR 2=MR 2

P2

O

QL

AR market=Dmarket ARleader= Dleader MR leader QT Q/t

O

O2 O1 Output

O

• A small number oflarge f irms,and a large number ofsmall f irms of f ering to a niche market. • Perf ect oligopolies of f er homogeneous products such as sugar. I mperf ect oligopolies of f er slightly dif f erentiated products. • This leads to kinked-demand curve theory and explains price stability w ithin the oligopoly as any change in output/price causes a f all in TR. Prices Prices and and costs costs P1 Pe Pe P2 O Q1 Qe = Loss in TR Prices and costs Pe Q/t O QeQ2 Q/t = G ain in TR MC’ formed from the tw o MR MC
The broken MR curve is

S1 is the market supply curve in the short run,w hich due to supernormal prof its show n by the shaded area by each f irm,w hich attracts new entrants shif ting the supply curve to S2 in the long run and removing supernormal prof its.

I n the short run f irms make supernormal prof its show n by the shaded area in the lef t hand diagram. Supernormal prof its attract new entrants causing demand f or each individual f irm’ s product to decrease in the long run until only one level of output does not make losses.

• Many buyers and many sellers. All are small f irms. • H omogeneous products so buyers purchase purely on price making all f irms price takers. • No barriers to entry or exit. • Perf ect know ledge f or both suppliers and buyers so all f irms have the same cost structure. • Productive and allocatively ef f icient.

• As perf ect competition but products are slightly dif f erentiated. This gives f irms some pricing pow er. • I nef f icient both allocatively and productively.

O

curves associated w ith the tw o parts ofthe demand curve. The MC can move D= AR betw een the tw o broken MR point and have no impact Qe Q/t on price.

• Firms f ollow a price leader in the market,either a dominant f irm or a barometric f irm ( f irm w ith better know ledge/ability to f orecast the market) . The price is set high enough to allow all f irms to make prof its,and low enough to avoid attention f rom the competition commission. • This leads to f ierce competition to gain market share and interdependence competing on price, place,promotion and product. • Formal w here the f irms act as a monopoly supplier ( see Monopoly) ,but the cost curves represent the industry not the individual f irm. • This is illegal in the U K,EU and U SA. OPEC is a good example ofa cartel ofoil producers. By G areth Jones – http: //cyro.cs-territories.com/

P+ C

Prices and costs

Prices and costs P1

MR T DT MR A DA MR B DB Q/t Q/t Q/t Third d egree:The f irm charges dif f erent prices to tw o or more dif f erent markets w hich have dif f erent PEDs to exploit that SNPA+SNPB bigger than SNPT.

Price discrimination

SNPA

P2

Qm Qfc Market A

First degree:Where a MC f irm has perf ect know ledge ofthe market and is D= AR able to eliminate con= P= MR sumer surplus entirely by f erent price Qm Q/t charging a dif f or every unit. Second d egree:Where MC af irm sells the f irst Qm units at P1,then sells of its remaining units D=AR=P QmQfc at price P2. Typical ofthe air travel market. Q/t Market B Markets A+B

P+ C

SNPB

P+ C

SNPT

(entire market)

MC

ATC

G areth Jones – http: //cyro.cs-territories.com

Unit 4:The Econom ics of W ork and Leisure

By G areth Jones http: //cyro.cs-territories.com/

AS/A2 Economics

Revi si on

• • • • • •

Pm and Qm Prices MC represent the and equilibrium under costs ATC perf ect monopoly Pm Po and the shaded AC area the superMC D= AR=P normal prof its in oflast MR unit both the long and O Qm Qo Q/t short run. The social optimum output is Qo,and Po the socially optimum price. The monopolist theref ore over charges consumers and produces a low er output.

Perf ect Monopoly

One f irm in the market,a sole supplier. Barriers to entry are suf f icient to prevent any new entrants to the market in the short and long run. The market is neither productive nor allocatively ef f icient. Supernormal prof its can be used to f und research and development and avoid duplication ofresearch. Can reduce or eliminate consumer choice. Some industries are natural monopolies ( gas, electricity and w ater)and a monopoly allow s these markets to exist.

Characteristic/I ndustry N ature offirm s – the number of f irms,their size and market share

Package hol id ays 4f irms have 75% market share;many smaller f irms also operate of f ering unique holidays to niche markets.

A ir travel 3f irms have 65% + market share oftonnekilometres by U K airlines. Many small budget f irms are now entering the market. The recent entrance ofbudget airlines has caused segregation as f irms target dif f erent consumers w ithin the market.

Sp ectator sp orts Many small local f irms in diverse sports w ith a f ew large international f irms in some sports such as Manchester U nited in f ootball. I n the view off ans each team of f ers a unique product,and no other sport or team acts as a good substitute.

Tel evision b road casting Large f irms dominate the terrestrial,satellite and cable netw orks. Changing market structure as lots ofnew smaller f irms enter. Close substitutes available as many new f irms enter the market. I n the long run it is likely product dif f erentiation w ill increase. Little price competition as channels are not purchased individually,instead lots ofnonprice competition to gain market share.

f erentiation w ith many small f irms D ifferentiation – the availability of Much dif rom a w ide substitute products of f ered by other giving consumers lots ofchoice f variety ofholidays. f irms.

irms have New entrants have caused a price w ar to Large clubs charge much higher prices,but Price control– the ability off irms to Very contestable market means f little control over their prices. Second degree break out in the budget sector. Second degree are limited to allow ‘ true’f ans to be able to control they charge price discrimination is common in this market. price discrimination is common in this market. buy tickets. Potentially f irms are monopolies.

nternet an individual w ith a Decreased by the open skies and use ofrented Very strong club loyalty,limited places in Economies ofscale exist,it is impossible to B arriers to entry/exit – the ability Low as over the I f ective competitor. aircraf t but there are very high start-up costs leagues and television rights make competing enter the terrestrial market but many new f or new f irms to enter the market or w ebsite can become an ef Some brand loyalty exists. w ith the large f irms very hard. stations are entering the digital TV market. and state-subsidised airlines in Europe. existing f irms to leave the market Sup ernorm alprofits – revenue over Possible in the long run but due to price w ars losses are possible in the short run. and above that necessary to pay costs in the long and short run irms gained their market share M ergers and acquisitions – w hen The dominant f tw o f irms collude or buy out another through takeovers and vertical integration. f irm to gain market share f icient due to contestability and Efficiency – Allocative:P=MC,w hat Allocatively ef productively ef f icient due to economies of consumers w ant is produced. irms. Productive:low est point on the ATC. scale achieved by large f Competition commission investigated the Col l usion – w hen f irms make market f or insurance bundling. Collusion agreements to reduce f uture unlikely as f irms desire a unique brand. uncertainty in a market Some prof its can be made but price Wages and self -imposed limits on ticket prices Large f irms are prof itable,but the large competition is reducing these,possibly some mean only very large clubs make large number ofnew entrants may decrease their losses in the short run due to price w ars. supernormal prof its in the long run. market share and so their prof itability. New low -cost entrants are liable to merge to stop the price w ar and allow prof its to be made,so horizontal integration is likely. U nlikely due to the unique product supplied by each club. Large f irms have marketed themselves as a brand and diversif ied. May occur as small new f irms of f ering similar products compete f or market share and to ef f ectively compete against Sky.

New entrants have caused allocative ef f iciency G enerally non-prof it motives so clubs are not in allocative ef f iciency as choice leads to to improve and combined w ith privatisation allocatively ef f icient. Economies ofscale help low er quality and productive ef f iciency as has improved productive ef f iciency. large f irms to be productively ef f icient. gains f rom economies ofscale diminish. H ighly unlikely due to the nature ofthe Not likely as f irms aim to dif f erentiate their Agreements exist,but collusion unlikely. More brand f rom other airlines,though partnerships spectator sport market w ith such f ierce brand likely are mergers,as mentioned above. exist. loyalty. Partnerships possible.

Demand f or labour

I nequalities Dif f erences in pay exist because ofskills/qualif ications, I m m obil ity of w orkers:O ccupati onal:corrected by imperf ect mobility,imperf ect training;G eographi cal:subsidised housing costs or know ledge and closed shop better provision ofinf ormation. agreements ( now illegal) . The I nform ation fail ures:Subsidised advertising and use Lorenz curve show s income oftechnology like the I nternet. Wage equality. The G ini coef f icient D iscrim ination:Due to prej udice demand moves f rom rate We ies dif f erences as the D1 to D2 causing w age rate to low er f rom W1 to W2. A B 100% quantif L1 L2 H ours 0 Proportion ofincome shaded area divided by the The equal pay act Wage w orked area ofthe triangle. S means that this is rate Wage Doctors have a higher illegal. This reduces rate SD Supply f or labour is upw ard sloping f or the economy W1 MPP than shop the employment as a w hole. assistants so have a MRP level to L3,a similar W2 W D PED & PES af f ect the size O ef f ect to that ofthe L1 SS higher and more L3 L2 Number ofw orkers Wage D2 D1 of ,transf er earnings S inelastic demand. Skills minimum w age. rate WS O L3 L2 L1 No ofw orkers necessary f or a w orker to The law ofdiminishing returns means the MRP f alls required f or a doctor , remain in a j ob and ect af ter a given output,L1. The MRP show s,in a perf Trad e unions:An organisation aiming to get better W1 DS make supply low and DD economic rent the market,the equilibrium level ofemployment. The . pay and w orking conditions f or its members ( NMW) inelastic compared to LS LD payment above transf er shaded area represents prof its,revenue received that M onopsony:Where only a single employer exists. No ofw orkers shop assistants. earnings. D L L show s j ob loss under D ;L L is not spent on labour meaning the dow nw ard sloping MC Bil ateral Wage show s those unable to fund w ork Benef Wage its ( universal,means O L1 Number ofw orkers part ofthe curve represents the demand f or labour. A m onopsony:Where rate under D ;D to D as MPP rate tested,in kind) ,the new increases due to motivation. AC= W=S a trade union can Demand f or labour is determined by the w age rate,the deal and NMW are policies VMP = MPP x P. I n a perf ect market P=MR,so WE MPP,demand f or a product,the PED f or labour. negotiate an WT used to combat poverty WM MRP = MPP x P,meaning VMP = MRP. I n imperf ect B increase in w age rate ( absolute:cannot af f ord markets VMP > MRP. W E D=MRP and employment Supply oflabour is determined by mobility oflabour, basic necessities;relative: time period considered and many non-pecuniary L M LE level to LE and WE Problem s w i th MRP:MPP is hard to measure;it is short less w ell of fthan 60% of actors summarised in the term ‘ net advantages’ofa Number ofw orkers f rom LM and WM S D1 D2 run only theory,ignores supply and assumes a perf ect f population) . given occupation. under monopsony. LT LE LL Q ofw orkers AB = Workers’exploitation market.
Proportion ofpopulation

MRP= MPP x MR,the additional physical product created by the additional w orker multiplied by the revenue gained f rom those additional units ofoutput

Wage I ndividual w orkers experience a backw ard rate bending supply curve due W2 to the substitution ef f ect, W1 w here a rising w age encourages the w orker to w ork more,and the income O ef f ect w here the w orker chooses leisure time instead.

Supply oflabour

Labour market f ailures

100%

T E

1

E L

1

1

2

By G areth Jones – http: //cyro.cs-territories.com/

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