Allocative efficiency: when consumer and producer surplus (total welfare) is maximised. This happens when MC = AR (supply = demand).
Productive efficiency: when costs are minimised. MC = AC (bottom of AC).
Dynamic efficiency: when there are supernormal profits in the long run
X-inefficiency: if a firm is not productively efficient by choice.
Perfect competition: free entry and exit, perfect information, price takers, identical products, many buyers and sellers.
AR (the demand curve) is perfectly elastic because firms are price takers and there are many sellers with identical subsitutes. Firms cannot raise or reduce price because they would lose demand, or other firms would copy them.
In the short run, firms make some supernoraml profit.
In the long run, since other firms have perfect information and no barriers to entry, they copy the existing firm. Industry supply increases so each firm's demand falls. As a result, they can only make normal profit.
Monopolistic competition: when there are no barriers to entry and slight product differentiation.
In the short run, the outcome is similar to that of a monopoly.
In the long run, new firms join because they see supernormal profit and because there are no barriers to entry. Then, each firm's AR curve shifts to the left because they get a lower share of the industry's demand. So there are no more supernormal profits.
There is hit and run competition: if there are supernormal profits, new firms enter and firms only make normal profit in the long run.
Monopolistic competition is contestable as there is hit and run competition.
Oligopolies are markets with a few firms.
Oligopolies have high barriers to entry and exit, high concentration ratios, interdependence of firms, and product differentiation.
Concentration ratio is the market share of the top x firms.
Oligopolies can be collusive or non-collusive (competitive).
Collusion is more likely if: only a few firms, similar costs,high entry barriers, ineffective competition policy, consumer inertia.
Collusion leads to the outcomes in a monopoly.
Cartel: a group of two or more firms agreeing to fix prices or limit output.
Overt collusion: formal agreement made between firms. Tacit: informal.
Competition is more likely if there are many firms and one has a large cost advantage.
Game theory explains interdependence: the outcomes of your choice depend on what the other prisoner chooses.
Prisoner's Dilemma: if both players think rationally by themselves, the outcome is worse than if they were able to communicate and decide together.
Overt collusion is illegal.
Price wars: firms undercut each other.
Predatory pricing: set low prices to cause competitors to leave (illegal).
Limit pricing: keep prices low enough that it is not tempting for new entrants.
Price leadership: market leader changes prices and other firms copy.
Monopolies: price makers, product differentiation, high barriers to entry, imperfect information.
Monopolies profit maximise (MC=MR) and set a high price and low quantity.
Price discrimination is when firms charge different consumers different prices for the same good or service.
Price discrimination can only happen if: firms can identify different consumer groups, the consumers show different elasticities, it is possible to prevent resale e.g. using ID.
Third degree price discrimination: when two different groups have different AR curves due to different PEDs so they get charged different prices when MC=MR e.g. student vs normal cinema tickets, peak vs off peak train tickets.
Natural Monopoly: a market where economies of scale are so large that they cannot be fully exploited e.g. national rail, water, energy.
In a natural monopoly, it is more efficient to have one firm in the market because there are very high fixed costs. So, new entrants would raise every firm's average costs.
But, this gives the existing firm to profit maximise and set high prices.
Monopsony: a sole buyer e.g. sole employer in the labour market.
Contestability: hit and run competition prevents firms from making supernormal profits in the long run.
