Microeconomics 2

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Microeconomics 2 by Mind Map: Microeconomics 2

1. 5. Concentrated Markets

1.1. Degree of concentration

1.1.1. The percentage of total market sales accounted for by a given number of leading firms

1.2. CR5

1.2.1. Value of output from the 5 largest firms / value of output for the industry

1.3. Why do firms grow larger?

1.3.1. Market power motive

1.3.1.1. Increase market dominance

1.3.1.2. Increased pricing power

1.3.1.2.1. Price discrimination

1.3.2. Objective of managers

1.3.3. Profit motive

1.3.3.1. Stock market valuation of a firm is influced by expectations of future profits

1.3.3.2. Disappointing growth figures

1.3.3.2.1. Risk of hostile takeover

1.3.4. Economies of scale

1.3.4.1. Increases productive capacity

1.3.4.1.1. Help to raise profit margins

1.3.4.2. Give businesses a competitive edge

1.3.5. Risk motive

1.3.5.1. Diversify production

1.4. External growth

1.4.1. Horizontal integration

1.4.1.1. When two businesses in the same industry at the same stage of production become one

1.4.2. Vertical integration

1.4.2.1. Acquiring a business in the same industry but at different stages of the supply chain

1.4.3. Lateral merger

1.4.3.1. Between companies that are related but not identical

1.4.4. Conglomerate merger

1.4.4.1. Between firms in unrelated business

1.4.5. Monopoly power also comes from ...

1.4.5.1. Owning patents and copyright protection

1.4.5.2. Exclusive ownership of productive assets

1.4.5.3. Exclusive agreements

1.4.5.4. Frnchises and licenses

1.4.5.5. Internal growth where a firm takes advantage of economies of scale

1.5. Outsourcing

1.5.1. Technological change

1.5.1.1. Information, communication adn telecommunication costs are falling

1.5.1.1.1. Easier to outsource both manufacturing operations and service

1.5.1.2. Just in time delivery inventory strageties

1.5.2. Increased competition

1.5.2.1. Pressure on businesses to chieve lower costs

1.5.3. Pressure from financial markets for business to improve their profitability

2. 6. Price Dicrimination

2.1. Occurs when a producer sells an identical product to different buyers at ifferent prices for reasons unrelated to costs

2.2. Product differentiation

2.2.1. Charge consumers a premium price due to actual / perceived differences in the quality or performance of a good or service

2.2.1.1. NOT price discrimination

2.3. Two conditions

2.3.1. Differences in price elasticity of demand

2.3.1.1. Charging difference prices would allow the firm to increase total revenue and profits

2.3.1.2. MC = MR in each separate market

2.3.2. Barriers to prevent market seepage

2.3.2.1. Easier to achieve with unique service such as haircut

2.4. First degree

2.4.1. Transaction cost is the main barrier

2.4.1.1. In reality uses price lists and menus

2.4.2. Separates the market into each indivudual customer - Extract consumer surplus in full

2.4.2.1. Impossible to achieve unless firm knows every customer's indivudual perferences and willingness to pay

2.4.3. E.g. buying a car, haggling at flea market

2.5. Second degree

2.5.1. Selling batches of a product at lower prices

2.5.1.1. Supplemenatary profit

2.5.2. Securing additional market share within an 0ligopoly

2.5.3. E.g. photocopying booklets

2.6. Third degree

2.6.1. Charing different prices for the same product in different segments of the market

2.6.1.1. By time (Peak and off-peak)

2.6.1.1.1. Off-peak - Plenty of spare capacity, MC is low, elastic supply curve

2.6.1.1.2. Peak - Demand is high, inelastic supply curve due to capacity constraints

2.6.1.2. By geography (exporters in overseas market)

2.6.1.3. By status (pensioners and students v. full time work)

2.6.2. E.g. Freaknomics, happy hour at pub, Oxbridge club, West Wing, Dell, teacher software

2.7. Impact on consumer welfare

2.7.1. Reduction in consumer welfare / surplus

2.7.1.1. For a majority of buyers - price charged well above MC of production

2.7.2. Lower income consumers may be priced into the market

2.7.2.1. Greater access may yield external benefits

2.7.2.1.1. Increase in social welfare

2.8. Producer surplus and profit

2.8.1. Discriminating monopoly - extracting consumer surplus, turning it into supernormal profit

2.8.2. Profits reinvested to improve dynamic efficiency

2.8.3. Price discrimination - Used as a predatory pricing tactic

3. 7. Monopoly

3.1. Only one firm in industry, the firm is the industry

3.2. Definition used by Competition Commission - > 25% of market share

3.3. We look at the following factors in determining whether a firm can be classed as a monopoly

3.3.1. Number and closenesss of subsitutes

3.3.2. Level of barries to entry

3.3.3. Degree of product differentiation

3.4. Barriers to entry - designed to block potential entrants, protect power of existing firms and maintain supernormal profits, make a market less contestable

3.4.1. Examples of barriers to entry are as follows

3.4.1.1. High fixed cost

3.4.1.2. Economies of scale - high MES - natural monopoly

3.4.1.3. Brand loyalty

3.4.1.4. Control over factors of production

3.4.1.5. Control over retail outlets

3.4.1.6. Predatory pricing

3.4.1.6.1. If existing business can exploit economies of scale and can develop cost advantage, they can use that to cut prices. Monopolists can revert back to profit maximisation afterwards

3.4.1.6.2. Dominant comapany sustaining losses in the SR with the knowledge that it will be able to recoup once compeititon is forced to exit

3.5. First mover advantage - sizeable advantages to being first into a market, establish themselves, build customer base etc

3.6. Stragetic entry deterrence - deemend anti-competitive by British and EU compeitition authorities, sued businesses involved in practices such as price-fixing cartels

3.6.1. Hostile takeover

3.6.2. Product differentiation - brand proliferation

3.6.3. Capacity expansion

3.7. Allocatively inefficient P > MC

3.8. Productively inefficient as it is not producing on the lowest point of AC

3.9. X inefficient - Protected by entry barriers

3.10. Deadweight welfare loss / social cost of monopoly - refer to diagram in notes

3.11. Likely to be dynamically fficient as supernormal profits can be reinvested into R&D

3.12. Costs of monopoly

3.12.1. Earn supernormal profits at expense of efficiency

3.12.2. Loss of allocative efficiency - failure of the market

3.12.3. Both productive and X inefficieny

3.13. Benefits of monopoly

3.13.1. Exploit economies of scale

3.14. Natural monopoly - Internal economies of scale, reach minimum efficient scale, huge fixed cost of maintaining nationwide networks of pipes - distinction between supply and distribution of services - Ofgem regulates through price controls

3.15. Supernormal profits in LR - faster rate of technological development - increase dynamic efficiency

3.16. Large scale operation - Scope to be internationally competitive

4. 8. Oligopoly

4.1. Market dominated by a few producers, exists when top 5 firms account for more than 60% of total market demand / sales

4.2. Behaviour categorised by strageic interdependence in pricing, R&D, market and investment, must take into account of likely reactions of rivals

4.3. Difficult to anticipate rivals' actions - uncertainty

4.4. Entry barriers - Scope for product differntiation

4.4.1. Contractural relationships with suppliers - exclusive distribution

4.5. Non-price competition

4.5.1. Better quality of service

4.5.2. Longer opening hours

4.5.3. Discounts on product upgrades

4.5.4. An increased range of services

4.5.5. Advertising and loyalty cards

4.6. Compete or collude? Compete - decision still based on stragetic interdependence, collusive - promote price stability

4.7. Criticism of kinked demand curve theory

4.7.1. No explaination on how original price arrived at

4.7.2. Model assume given rection by rivals

4.7.3. Firm could benefit from price war if it believes they are the strongest firm

4.7.4. Theory deals only with price competition, not non-price factors

4.8. Kinded demand curve - based on lilely reactions of other firms, looking to protect and maintain market share, rival firms unlikely to match another's price increase, but will match a price fall, price rigidity assumed - stable profit-maximising equlibrium - little incentive to alter price - or periods of price stability - limited real world experience for the kinked demand curve model

4.9. Price leadership

4.9.1. Prices and price changes are established by a dominant firm

4.9.2. Adopted to facilitate tacit collusion

4.9.3. Barometric - Firm that respond fastest to changing costs and demand acts as price leader, despite not having significant market power

4.10. Explicit collusion - price fixing cartels. Objective is to achieve joint-profit maximisation. Price fixing - restrict market supply

4.11. Collusion is easier to achieve when

4.11.1. Only a small number of firms in the industry

4.11.2. Market demand is not too variable

4.11.3. Demand is fairly price inelastic

4.11.4. Each firm's output can easily be monitored by the cartel

4.12. Factors which may lead to difficulties within a collusive agreement include

4.12.1. Enforcement problems - Expanding production is profitable for each indivudual seller. Also there may be disputes over spliting profits.

4.12.2. Falling market demand - Excess capacity in industry, puts pressure on firms to cut price to maintain revenue

4.12.3. Successful entry of non-cartel firms into industry

4.12.4. Exposure of illegal price fixing by market regulators

4.13. Benefits from collusion

4.13.1. Joint research and development projects

4.13.2. Shared use of common facilities and beneficial exchange of information

4.13.3. Adoption of common standard - Network externalities (More people use the same standard the better)

4.14. Game theory

4.14.1. Interacting decision takers

4.14.2. Games of strategy

4.14.3. Incomplete information

4.14.4. Interdependence and uncertainty

4.14.5. Incentive to cheat

4.14.6. Punishment strategy

4.14.6.1. Credible threat

5. 9. Contestable markets

5.1. Existing firms in a contestable market are faced with the threat of hit-and-run entry by firms outside of the industry

5.1.1. Firms are forced to set their prices at the compeititive level on a permanenet basis because of this

5.2. A market is perfety contestable when the costs of entry and exit by potential rivals are zero

5.3. Sunk costs - Cannot be recovered if a business decides to leave an industry, e.g.

5.3.1. When sunk costs are high, a market becomes less contestable, barriers of entry to new firms

5.3.1.1. Training of staff

5.3.1.2. Money spent on advertising, marketing - Cannot be carried forward to another market

5.3.1.3. Capital inputs specific to an industry, no resale value

5.4. If a market is contestable, there is downward pressure on price

5.4.1. Increase in consumer surplus, lower profit margins then when a monopoly operates without compeititon

5.5. Evaluation

5.5.1. No market is prefectly contestable

5.5.2. Whether threat of hit and run is sufficient to make existing firms to change their behaviour

5.5.3. Existing firms may protect themselves using patents and strategic entry barriers

5.6. Increasing contestability of markets

5.6.1. Entrepreneurial Zeal

5.6.1.1. Persistence of entrepreneurs who don't accept the existing market structure, more willing to take risks. New supplier may have advantage of product innovation, more competitive business model based on different pricing strategies

5.6.2. De-regulation of markets / Market liberalisation

5.6.2.1. Opening up of markets to competition by reducing statutory barriers of entry, e.g. postal services in EU, telecommunications

5.6.3. Competition policy

5.6.3.1. Tougher compeitition laws against predatory behaviour

5.6.3.2. Rules against price fixing cartels

5.6.4. European Single Market

5.6.5. Technological change (emergence of e-commerce)

6. 10. Market Structure & Technology

6.1. Most important features

6.1.1. Number of firms

6.1.2. Market share of the largest firms

6.1.3. Nature of costs

6.1.4. Degree to which the industry is vertically integrated

6.1.5. Extent of product differentiation

6.1.6. Structure of buyers in the industry

6.1.7. The turnover of customers

6.2. Government policy and innovation in economy

6.2.1. Improvements in competitiveness of UK producers at home or abroad

6.2.2. Innovation helping to develop comparative advantage

6.2.3. Higher productivity to keep labour costs low, UK faces low cost competition from LEDC

6.2.4. Innovation as a source of higher long-term trend growth

6.2.5. Innovation can also create many new jobs

6.2.6. Significant social benefits from innovative behaviour, e.g. delivery of new medical treatments

6.3. Two main driving forces

6.3.1. Market structure

6.3.1.1. Perfect compeititon

6.3.1.1.1. Price taking firms - No influence over ruling market price

6.3.1.1.2. Free entry and exit of businesses in LR removes supernormal profit

6.3.1.1.3. Each supplier produces homogenous products

6.3.1.2. Pure monopoly

6.3.1.2.1. Can earn supernormal profits in SR and LR

6.3.1.2.2. Market position protected through entry barriers

6.3.1.2.3. Frequent use of price discrimination

6.3.1.3. Oligopoly

6.3.1.3.1. Compeititon among the few

6.3.1.3.2. Each firm has some market power, supplying branded goods

6.3.1.3.3. Entry barriers exist

6.3.1.3.4. Interdependent nature of pricing decisions

6.3.1.3.5. Strategic behaviour of other players in the market

6.3.1.3.6. Protect market share rather than profit maximisation

6.3.1.4. Contestable markets

6.3.1.4.1. Entry and exit costs are low

6.3.1.4.2. Potential for hit and run entry

6.3.1.4.3. Threat of new entry affects behaviour of existing firms

6.3.1.4.4. Barriers to contestability, higher barriers = greater pricing power

6.3.2. Business objective

6.4. Price and Cross elasticity of demand

6.4.1. If D is inelastic, business can raise price without losing a lot of sales

6.4.2. If D is elastic, potential to raise price is reduced

6.4.3. If XED is low consumers are less likley to switch their demand - greater price power

6.5. Product differntiation

6.5.1. Consumers willing to pay premium for new products

6.5.2. Products towards end of life cycle - More elasticity

6.5.3. Impact of marketing and advertisting on brand loyalty

6.6. Regulatory system

6.6.1. Regulatory agencies cover privatised utilities, they intervene directly or indirectly in price-setting process

6.7. International environment

6.7.1. Globalisation means more competition from overseas suppliers

6.8. Economic Cycle

6.9. Technology can enhance both production and consumption possibilities

6.9.1. Difference between invention and innovation

6.9.2. Not only reduce AC, but may also influence optimal methods of production, more capital intensive, less labour needed

6.9.3. Outward shift in supply curve means lower prices, higher output, more consumer surplus

6.9.4. Technological advancement - rise in quaity of new products / embodied

6.9.5. Technology leads to gains in dynamic efficieny - More R&D, shift AC curve downward, may also influence the degree of allocative efficiency

6.9.6. Features of competitive and monopolistic markets upon which technology might have some impact include

6.9.6.1. Nature of product

6.9.6.2. Number of buyers for product

6.9.6.3. Number of firms in industry

6.9.6.4. Level of barriers to entry

6.9.6.5. Amount of information / knowledge available

6.9.7. Technology can promote competition by

6.9.7.1. Reducing entry barriers

6.9.7.2. Reducing concentration

6.9.7.3. Increasing degree of market contestability

6.9.7.4. Better information for both consumer and producer via internet

6.9.7.5. Emergence of new, competing products that may challenge power of established monopolies

6.9.7.6. If firms patent their innovations