5. Perfect & Imperfectly Competitive Markets & Monopolies (AQA A Level Economics): Flashcards

True.

Governments regulate markets through competition policy to prevent firms abusing their market power.

Profit maximisation is the business objective of achieving the greatest possible profit, produced where marginal cost equals marginal revenue.

A firm maximises profit at the output where marginal cost (MC) equals marginal revenue (MR).

True.

While MC < MR, additional profit can still be extracted by producing an extra unit of output.

At the profit maximising level of output, marginal cost is equal to marginal revenue.

A firm may not know where the level is, and constant price changes as marginal cost varies would be disruptive to customers.

Satisficing is when a firm aims for a satisfactory rather than maximum level of profit, enough to keep its owners or shareholders happy.

Alternatives include growth, survival and social welfare, as well as satisficing.

True.

In the short term many new firms focus on survival, as a large share fail in their first year.

In the short term many new firms focus solely on business survival before pursuing other objectives.

The divorce of ownership from control occurs when there is a clear split between those who own a firm and those who run it day to day.

It arises when owners (principals) appoint managers (agents) whose differing goals create conflicts of interest.

False.

It usually occurs in larger firms, where there is a distinction between ownership and management.

Perfect competition is a market structure with many buyers and sellers, no barriers to entry or exit, perfect knowledge and homogeneous products.

Many buyers and sellers, no barriers to entry or exit, perfect knowledge of prices, and homogeneous products.

False.

Products are homogeneous, so perfect substitutes exist and firms cannot build brand loyalty.

A price taker is a firm that must accept the market price because it has no power to influence price or quantity.

Firms in perfect competition have low market power, low market share and a low industry concentration ratio.

Where marginal cost equals marginal revenue (MC = MR).

True.

A firm may gain a short-lived competitive advantage that lets it earn abnormal profit in the short run.

Abnormal profit attracts new entrants; with no barriers to entry, supply rises, price falls and only normal profit remains.

Normal profit is earned in the long run where average revenue equals average cost (AR = AC).

True.

When AR < AC at the profit maximising output, the firm makes a short-run loss.

Some firms leave the industry, supply falls, price rises and the remaining firms return to normal profit.

Allocative efficiency occurs where average revenue equals marginal cost (AR = MC), giving consumers and producers the maximum possible benefit.

Productive efficiency occurs where marginal cost equals average cost (MC = AC), so average costs are minimised with no wasted resources.

Productive efficiency occurs at the output where marginal cost equals average cost.

False.

Perfect competition is a theoretical model that acts as a benchmark for judging efficiency in real markets.

Monopolistic competition is a market structure with many small firms offering similar but differentiated products, and low barriers to entry.

There are a large number of small firms, each relatively small and able to act independently of the market.

False.

Product differentiation gives them some price-setting ability, though only a low degree of market power.

In the long run, monopolistic competition is allocatively inefficient because price is greater than marginal cost.

Product differentiation makes a product distinct from rivals', such as a nail bar offering express or pampered service.

It can make abnormal (supernormal) profit, where AR is greater than AC at the profit maximising output.

True.

Because the firm must lower price to sell more, marginal revenue falls twice as fast as average revenue.

It has some market power from product differentiation, so it must lower its price to sell an additional unit.

True.

A short-run loss occurs when AR is below AC at the profit maximising output.

Low barriers to entry attract new firms, increasing supply until only normal profit remains.

Non-price competition means competing through methods other than price, such as quality, location and branding, to raise differentiation and loyalty.

Examples include choosing a good location in a high-traffic area and encouraging word-of-mouth advertising through positive reviews.

In the long run, firms in monopolistic competition make normal profit as new entrants erode any abnormal profit.

An oligopoly is a market structure in which a few large firms dominate the industry, with each firm having significant market power.

An oligopoly has a few large firms, high barriers to entry and exit, a high concentration ratio and strong interdependence between firms.

True.

With few competitors, firms study each other's behaviour and are highly interdependent in their decisions.

A concentration ratio measures the percentage of total market share held by a specific number of the largest firms in an industry.

The higher the concentration ratio and the fewer the firms, the more concentrated the market power in an industry.

Collusion is an illegal agreement between rival firms to control price or output, effectively acting like a monopoly to maximise profits.

In a collusive oligopoly firms cooperate to fix prices and restrict output, whereas in a non-collusive oligopoly firms actively compete to maintain or increase market share.

False.

Cooperation is a legal agreement to share resources, whereas collusion is an illegal agreement to control price or output.

Overt collusion occurs when firms explicitly agree to limit competition or raise prices, for example through a cartel.

Tacit collusion occurs when firms avoid formal agreements but closely monitor each other, usually following the lead of the largest firm in the industry.

A cartel is the most restrictive form of overt collusion, where firms formally agree to fix prices or output, and is illegal in most countries.

The most common form of tacit collusion is price leadership, where smaller firms follow a dominant firm's price.

A price cut is quickly matched by rivals, so market share changes little while all firms suffer lower profits.

Non-price competition is competition through methods other than price, such as advertising, branding and product differentiation, to build brand loyalty.

Firms want to avoid a price war, because goods are close substitutes and a price cut is quickly matched by rivals, reducing profits for all.

True.

The change in elasticity above and below the current price creates price rigidity, so firms rarely change their price.

Price rigidity is the tendency for prices to remain stable in an oligopoly because firms anticipate their rivals' reactions to any price change.

If a firm raises its price above the kink, rivals are unlikely to follow, so this section of the demand curve is elastic.

Rivals also lower their prices, so market share stays the same but total revenue falls for all firms; this section of demand is inelastic.

A price war occurs when competitors repeatedly lower prices to undercut each other in an attempt to gain or increase market share.

Firms compete through advertising, branding, packaging, improved customer service and loyalty schemes.

True.

Established brand loyalty makes it difficult for new firms to compete, which raises barriers to entry.

Large-scale firms can achieve economies of scale, reducing average costs and potentially lowering prices, and may reinvest profits into innovation.

Price leadership occurs when a dominant firm sets the price and smaller firms set a price close to it.

A disadvantage of oligopoly is the potential for firms to engage in illegal collusion or operate as cartels.

A monopoly is a market structure with a single seller, no close substitute products and complete market power over price and output.

A monopoly has a single seller, no substitute products, complete market power to set price and output, and high barriers to entry.

True.

The Competition and Markets Authority treats any firm with more than 25% market share as a monopoly.

Supernormal profit is the profit earned when average revenue exceeds average cost, calculated as (P − AC) × Q.

A monopoly profit maximises where marginal cost equals marginal revenue (MC = MR).

On the monopoly diagram, supernormal profit is earned because average revenue is greater than average cost at the profit-maximising output.

High barriers to entry prevent competitors from entering the market, so supernormal profit is not eroded over time.

False.

A monopoly causes a misallocation of resources because it sets price above marginal cost (P > MC).

A price maker is a firm with enough market power to set its own price rather than accept the market price.

A lack of competition can lead to higher prices, less innovation, poorer product quality or worse customer service.

Supernormal profits may fund product innovation, and economies of scale could lower average costs and prices.

A monopoly is a price maker, so its revenue curves are downward sloping.

Price discrimination occurs when a firm charges different prices for the same good or service in order to maximise its revenue.

The firm must have market power to set prices, be able to separate consumers with different price elasticity of demand, and be able to prevent resale between sub-markets.

True.

Without the ability to prevent resale, consumers could buy in the low-price market and resell in the high-price one.

Third degree price discrimination is when a firm charges different prices to different consumer groups for the same good or service.

For price discrimination to work, the firm must be able to separate consumers who have a different price elasticity of demand.

First degree price discrimination occurs when a firm charges each consumer the maximum price they are willing and able to pay.

Second degree price discrimination occurs when a firm offers discounts for bulk buying, such as '3 for 2' offers.

Peak demand is price inelastic, so raising the price increases total revenue; off-peak demand is elastic, so a lower price is set.

True.

Firms raise total revenue and producer surplus, while consumer surplus falls.

Some consumers gain access to lower prices, and higher peak prices can reduce over-crowding, for example on train services.

Many consumers pay higher prices, and setting up and enforcing price discrimination can raise a firm's average costs.

A firm using price discrimination profit maximises where marginal cost equals marginal revenue.

Competition is the rivalry between firms in a market, based on the number of firms competing for market share.

The degree of competition falls as the market structure moves closer to monopoly.

True.

Firms cut prices in the short run to try to gain market share, benefiting consumers.

In the long run, only the most efficient firms survive, making the market more allocatively efficient.

Non-price competition refers to strategies used to attract customers without changing price, such as after-sales service, packaging and improved quality.

After-sales service, such as technical support, is a non-price strategy that encourages repeat purchases.

False.

CSR is a form of non-price competition that attracts socially-conscious consumers.

Creative destruction is the process, described by Schumpeter, in which innovation replaces old technologies and business models with newer, more efficient ones.

The Austrian economist Schumpeter coined the term creative destruction.

In the entertainment market, Netflix adapted to changing consumer wants while Blockbuster failed and exited.

Abnormal profits can be invested into research and development, funding innovation that improves quality over time.

True.

Firms that fail to adapt are made obsolete by newer, more efficient rivals and exit the market.

A contestable market is one with freedom of entry and low costs of exit, leaving it under constant threat from new entrants.

A contestable market is based on the threat of new entrants, not the number of firms competing.

False.

Contestable markets have low or non-existent barriers to entry and exit.

A sunk cost is an investment that has been made and cannot be recovered.

A sunk cost is an investment that has been made and cannot be recovered, such as spending on specialised assets or advertising.

High sunk costs reduce contestability, as firms are more hesitant to enter or leave the market.

Hit-and-run competition occurs when a firm enters an industry quickly to capture short-run supernormal profit, then exits just as quickly.

True.

The lower the sunk costs, the easier it is for firms to enter and exit, raising contestability.

It may switch from profit maximisation to limit pricing, even setting price equal to average cost to deter entry.

The more contestable a market, the more the behaviour of firms resembles perfect competition.

Low sunk costs and freedom of entry and exit must exist for hit-and-run competition to occur.

True.

Contestable markets have no competitive disadvantages on entry, so new firms can access the same technology.

Allocative efficiency occurs where average revenue equals marginal cost (AR = MC), so resources give consumers and producers the maximum possible benefit.

Productive efficiency occurs where marginal cost equals average cost (MC = AC), so average costs are minimised with no wastage of resources.

Dynamic efficiency is long-term efficiency that arises as a firm reinvests its profits in innovation, lowering average costs over time.

False.

That describes productive efficiency; allocative efficiency occurs where AR = MC.

Productive efficiency occurs at the level of output where average costs are minimised.

It is unlikely to earn supernormal profits to reinvest, so it struggles to fund innovation.

Static efficiency is efficiency at a particular point in time, resulting from allocative or productive efficiency.

False.

At profit maximisation AR is greater than MC, so the firm is not allocatively efficient.

A firm that reinvests its profits into research and development can achieve dynamic efficiency.

Investing in research and development helps firms allocate resources optimally and cut long-term costs.

Productive efficiency would occur where MC = AC, not at the profit-maximising level of output.

True.

Training and rewarding employees incentivises higher labour productivity, supporting dynamic efficiency.

Consumer surplus is the difference between the amount a consumer is willing to pay for a product and the price they actually pay.

Producer surplus is the difference between the amount a producer is willing to sell a product for and the price they actually receive.

Consumer surplus lies below the demand curve and above the equilibrium price.

True.

Producer surplus is the area between the equilibrium price and the supply curve, lying above it.

Consumer surplus plus producer surplus equals social surplus.

At equilibrium, both consumer and producer surplus are maximised.

True.

A monopoly's higher prices and lower output reduce consumer surplus and raise producer surplus.

A monopoly charges a higher price and restricts output, transferring some consumer surplus to producers.

Welfare loss is the cost to society caused by the inefficient allocation of resources, such as under a monopoly.

A monopolist produces where MC equals MR, known as the profit maximisation level of output.

Price discrimination reduces overall consumer surplus, as producer surplus rises; some consumers gain while others lose out.

True.

Off-peak (elastic) consumers pay a lower price, so their consumer surplus increases.