CT7 Part 2

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CT7 Part 2
2013-09-05 05:35:58

CT7 Chapters 7-11
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  1. Perfect Competition
    • Market structure with many firms
    • Freedom of entry into industry
    • All firms produce same product and are price takers
  2. Monopolistic Competition
    • many firms / freedom of entry
    • differentiated product
    • some control over price
    • only normal profits are made in LR
    • part of imperfect competition
  3. Oligopoly
    • few enough firms so barriers against entry can be erected
    • part of imperfect competition
  4. Monopoly
    • only one firm in industry
    • part of imperfect competition
  5. Factors determining degree of market power of firms
    • Depends on degree of competition within individual firms in industry, which in turn depends on
    • # firms in industry
    • freedom of entry
    • nature of product
    • degree of control firms have over price
  6. Assumptions of Perfectly Competitive (PC) Market
    • Each firm has tiny fraction of market, so all firms are price takers
    • Complete freedom of entry into industry
    • Firms product identical / homogeneous product
    • Perfect knowledge in market (both producers and consumers)
    • also assumes consumers act rationally
  7. SR under PC
    • period during which there is too little time for new firms to enter industry
    • Price determined by industry supply and demand
    • Output determined by MR=MC
    • Profit / Loss determined by diff b/t AR and AC
  8. LR under PC
    • period of time long enough for new firms to enter
    • Price and output determined just as in SR BUT if supernormal profits are made, new firms will enter to bring supply up and price down
  9. Natural Monopoly
    arises where LRAC would be lower if an industry were under monopoly than if it were shared between 2+ competitors
  10. Natural / Innocent Barriers to Entry
    • economies of scale
    • economies of scope
    • lower costs for established firm
  11. Strategic / Deliberate Barriers to Entry
    • product differentiation and brand loyalty
    • ownership/control over key inputs or outlets
    • threat of merger / takeover
    • aggressive tactics (selling loss leaders)
    • legal protection (patents)
  12. Productive Efficiency
    • achieved if firms produce at minimum AC
    • firms in PC do produce at this level while monopolists usually do not
  13. Social Optimum
    • level of output where maxed welfare, i.e. where there is allocative efficiency
    • output level where P = MC
  14. Economic Efficiency
    • achieved when each good produced at minimum cost (productive efficiency)
    • AND consumers get max benefit from income (allocative efficiency)
  15. Potential Competition
    theory of contestable markets suggest prices and output determined more by the threat of competition than actual existence of competition
  16. Perfectly Contestable Market
    • market where there is free / costless entry AND exit
    • firms in perfectly contestable markets will 1. keep prices down (normal profits only) and 2. produce as efficiently as possible
  17. Independence (of firms in market)
    occurs when decisions of one firm in a market will not have any significant effect on demand curve of other firms
  18. Monopolistic Competition Assumptions
    • many firms in market, each small enough market share to be independent of each other
    • freedom of entry into market
    • each sells differentiated product
  19. Product Differentiation
    • when one firm's product sufficiently differs from its rivals'
    • can raise price of product without all customers switching
    • each firm faces downward sloping demand curve
  20. Limitations of Monopolistic Competition Model (when moncomp firm can make supernormal profits)
    • information not perfect, other firms don't enter market
    • firms different in size & cost structure, not just product
    • not complete freedom of entry
    • entry of new firms reduce profit of all firms below normal level
  21. Excess Capacity
    in LR firms under monopolistic competition will produce at output below their minimum cost point
  22. MonComp versus PerComp
    • Firms in MonComp typically:
    • produce less than firms in percomp
    • produce at higher price than PC firms
    • have excess capacity
  23. MonComp versus Monopoly
    • Firums in MonComp may:
    • charge lower prices than monopolists
    • be more efficient (due to competition)
    • monopolists may benefit from economies of scale, and be able to invest in R&D to improve efficiency
  24. Two key oligopoly features
    • barriers to entry (extent varies b/t different industries)
    • interdependence of firms (each firm affected by rivals' decisions)
  25. Collusive Oligopoly
    • where firms agree (formally or not) to limit competition between themselves by:
    • set output quotas
    • fix prices
    • limit product promotion or development
    • agree not to poach each others markets
  26. Non-collusive Oligopoly
    exists when oligopolists have no agreements of any kind
  27. Oligopoly Benefits and Costs to Consumer
    • Not in consumer's best interests if oligopolists:
    • collude to max industry profits
    • are individually too small to benefit from economies of scale
    • engage in excessive advertising

    • Oligopoly may benefit customers since:
    • firms have incentive to spend supernormal profit on R&D to improve efficiency / innovation
    • product differentiation increases consumer choice
  28. Factors minimizing Oligopoly Problems
    • when oligopolists do not collude
    • there is some degree of price competition
    • barriers to entry are weak
    • countervailing power exists (power of sellers offset by powerful buyers who can prevent price rising)
  29. Cartel
    formal collusive agreement
  30. Tacit Collusion
    • more informal form of collusion
    • firms may take care to not price cut or excessively advertise
    • may have certain unwritten rules such as price leadership
  31. Conditions which make Collusion more likely
    • Few firms exist, who know each other well
    • firms have similar cost / production methods or are open about them
    • similar products
    • one dominant firm exists
    • significant barriers to entry
    • stable market
    • no government measures to curb collusion
  32. Dominant Firm Price Leadership
    • firms choose same price set by dominant firm (leader) in industry
    • leader assumes maintain constant market share (competition likely to follow price, for fear of entering price war)
  33. Barometric Firm Price Leadership
    • price leader is one believed to reflect market conditions in most satisfactory way
    • barometer firm may change
  34. Average Cost Pricing
    • firm sets price by adding x% for (average) profit on top of AC
    • useful in inflationary times
  35. Price Benchmark
    • when raising prices firms will raise from one benchmark to another
    • eg with benchmarks 10, 11, 12, firms know when price rises go to next level, not  to 10.50 etc
  36. Forms of Tacit Collusion
    • dominant firm price leadership
    • barometric firm price leadership
    • average cost pricing
    • price benchmarks
    • advertising (rules of thumb may apply)
    • shadow pricing (firms observe each other, ensure all similar levels)
  37. Collusion Breakdown
    may occur if few factors favor collusion, or if individual firms "cheat"
  38. Cournot Model
    • duopoly model where each firm produces and prices assuming rival will produce certain quantity
    • most likely when market stable, both producing stable quantities for a while
    • industry profit will be less than monopoly or cartel
    • non-collusive oligopoly model
  39. Bertrand Model
    • each firm assumed to set particular price and stick to it
    • most likely when firms want to avoid changing price to often
    • results in price war until supernormal profit competed away
    • firms likely to 1. collude before supernormal profits disappear, or 2. put in takeover bid for rival
  40. Kinked Demand Theory
    • assumes oligopolists face demand curve kinked at current price
    • demand sig more elastic above current price than below
    • creates price stability, resulting from reluctance to raise / lower prices
    • assumes if firm raises price, rivals will NOT follow suit, but if firms cuts price rivals WILL follow suit
  41. Game Theory
    study of alternative strategies players may choose to adopt, depending on assumptions about rivals' behaviour
  42. Maximin / Maximax
    maxes minimum payout (cautious) and payout (optimistic) respectively
  43. Dominant Strategy Game
    • occurs when all approaches (maximin or maximax) lead to the same strategy
    • "best" strategy no matter what rival does
  44. Nash Equilibrium
    • position resulting from everyone making their optimal decision based on actual decisions made by rivals
    • without collusion, neither can improve payoff given other firm's strategy
    • a dominant strategy equilibrium must be a Nash equilibrium
  45. Prisoners' Dilemma
    scenario where 2+ players end up in worse position acting independently based on what other person likely to do, than if they worked together
  46. Tit for tat
    • in a tit for tat game firms cut price or act aggressively if and only if rival does first
    • if firm can make credible threat/promise can influence rivals' behaviour
  47. First-mover advantage
    when firm can gain from being first to act
  48. Decision / Game Tree
    • diagram showing sequence of possible decisions by competitor firms and the outcome of each combination of decisions
    • illustrates different choices, but can become very complex
  49. Game Theory Advantages and Disadvantages
    • +: useful as considers all scenarios, so firm does not need to know what response rival actually makes
    • -: resticted to relatively simple scenarios as need estimate profit
    • -: oligopolists behaviour may also change
  50. Product Differentiation
    • involves distinguishing product from rival products, involves attractive combo of:
    • technical standards
    • quality standards
    • design characteristics
    • service characteristics
    • Vertical: products differ in quality
    • Horizontal: products similar quality / cost but reflect different consumer tastes
  51. Market niche
    segment of market not met by existing product choices
  52. Non-Price Competition
    competing on products, marketing and / or advertising
  53. Four choices of product / market strategy (Growth Vector / Ansoff Matrix)
    • market penetration: current product current market (least risky), incr. competition if market size not expanding
    • product development: new product current market
    • market development: current product new market, may be new physical location or different market segment (or how use product)
    • diversification: new product new market, most risky
  54. Four Ps of Marketing Mix
    • Product - branding, packaging, service
    • Price - vs competition, credit terms, discounts
    • Place (distribution) - where sold / stored
    • Promotion - advertising, offers, PR
  55. Advertising / Sales Ratio
    • total expense on advertising product / total value of sales of product
    • indicates advertising intensity
    • varies widely between products
    • depends largely on market structure / product characteristics
  56. Advertising Advantages (for Society)
    • provides information to customers
    • breaks down barriers to entry (aids intro of new products / firms)
    • enables firms to emphasize product features
    • more competition in price
    • incr. sales leading to economies of scale
  57. Advertising Disadvantages (for Society)
    • distorts consumers' decisions (due to imperfect info may prefer inferior but more advertised good)
    • creates wants, increases scarcity
    • opportunity cost of resources
    • increases materialism
    • increases costs -> prices
    • creates barriers to entry by promoting loyalty
    • unwanted side effects in shape of unwanted, unsightly, tasteless ads
  58. Firm Size Constraints
    • managerial diseconomies of scale (avoid by multidiv org)
    • downward-sloping demand curves (limits sales)
  59. Internal Funds
    Retained profits used specifically to fund new investments
  60. Takeover Constraint
    effect fear of takeover has on firm's willingness to undertake projects that reduce distributed profits
  61. Five Constraints on Growth
    • difficult financial conditions
    • lack of shareholder confidence
    • adverse demand conditions
    • poor managerial conditions
    • government policy
  62. Valuation Ratio
    • stock market value of firm shares divided by book value of assets
    • low ratio may indicate lack of shareholder confidence (restraint on growth)
  63. Internal Expansion
    • increasing size of existing operations
    • achieved by horizontal expansion, vertical integration, or diversification
  64. Vertical Integration
    • setting up operations at different stage of production process in same market
    • backward / forward = towards start / retail direction
  65. Strategic Alliance
    • two plus firms working together to achieve strategic goal, while maintaining separate legal entities
    • method of external expansion
  66. External Expansion
    achieved by merger or takeover, or by forming strategic alliance
  67. Vertical Integration Motives
    • greater efficiency (economies of scale) due to production, coordination, managerial and financial economies
    • reduced uncertainty
    • increased monopoly power
    • creation of barriers to entry
  68. Vertical Integration Problems
    • may reduce firm's ability to adapt to changing market conditions / flexibility
    • may also preclude spreading of risk gained by diversification
  69. Tapered Vertical Integration
    • firm produces some of input itself whilst still buying from other firms (partial integration)
    • enjoys control over supply, gains more bargaining power, and requires less investment than full integration
  70. Three Influences on Diversification
    • nature of technology used and possible adaptations
    • available market opportunities
    • skills & expertise of management
  71. Three Motives for Diversification
    • stability (spreads business risk)
    • maintaining profitability (expanding into new & growing markets)
    • maintaining growth (if current market offers limited growth prospects)
  72. Merger
    • occurs when two firms agree to combined business operations
    • form of external growth
  73. Takeover / Acquisition
    • occurs when one firm buys sufficient shares in another to take control of that firm
    • form of external growth
  74. Merger and Takeover Differences
    • mergers are agreed, takeovers can be either friendly or hostile
    • mergers don't require finance whereas takeover does (to purchase shares)
    • merger usually retains managers of both firms, while takeover usually dismisses
  75. Three types of M&As
    • Horizontal merger: involves 2 firms at same stage of production process
    • Vertical merger: involves 2 firms at different stages of production process
    • Conglomerate Merger: involves 2 firms in unrelated industries
  76. Six Primary Motives for M&As
    • Growth (quicker than internal growth, new business and new consumer demand)
    • Economies of Scale
    • Monopoly Power
    • Increased Market Valuation
    • Reduction in Uncertainty (less rivals)
    • Taking advantage of opportunities
  77. Five Other Motives for M&As
    • reduces possibility of takeover by becoming larger
    • merge with white knight company (thwart unwanted predator)
    • asset stripping (taking over firm, sell assets for profit)
    • empire building (taking over firms to increase power)
    • geographical expansion
  78. Strategic Alliance Types
    • Horizontal strategic alliances - agreements to co-op on particular activity at same stage of production process (joint venture, franchise, licensing)
    • Vertical strategic alliances - agreements between firms at different stages of same production process to jointly produce a G/S (consortium, outsourcing)
    • Networks - in/formal alliance between multiple firms across sectors
  79. Joint Venture
    • involves setting up and joint owning independent firm
    • form of horizontal strategic alliance
  80. Franchise
    • one firm (for fee) sells products of another
    • form of horizontal strategic alliance
  81. Licensing
    • owner of patented product allows another to produce (for fee)
    • form of horizontal strategic alliance
  82. Logistics
    • management of supply on inputs to firms & outputs to customers
    • vertical strategic alliance is one approach to this
  83. Consortium
    several firms working together on specific project (usually indp company created)
  84. Outsourcing / Subcontracting
    one firm employs another to do all / part of some process
  85. Vertical Restraints
    agreements between dealer and manufacturer which limit how dealer can sell product in a licensing agreement
  86. Reasons for forming Strategic Alliance
    • new markets (efficient way to enter new, take advance of expertise of firms)
    • risk sharing
    • capital pooling
    • cost (quick/cheap way to grow/enter new market)
  87. Transactions Cost Approach to External Firm Growth
    • mergers / alliances may be appropriate when there are large sunk costs and uncertain transaction costs between firms
    • can lead to greater cooperation between parties involved
    • reduces chance of opportunistic behaviour arising from information assymmetry
  88. Limit Pricing
    • where existing firm deliberately keeps prices low so as to deter new entrants
    • reduces SR profits but may lead to more LR profits if new entrants deterred
    • relies on existing firm having lower AC than potential new entrants
  89. Average Cost or Mark Up Pricing
    • adds fixed percentage markup to AC
    • price = AFC + AVC + mark up
    • removes firms need to know MC and MR curves, but still need to know AC at each output level
    • usually based over range where AVC constant, i.e. over normal output range
  90. Reserve Capacity
    if a firm has reserve capacity, then its AVC is constant over this range
  91. Factors affecting Product Mark Up
    • sales and profit targets
    • possible response of rival firms
    • how firm wishes to spread overhead over different products
    • (generally higher in growing markets or where there are fewer rival firms)
  92. Conditions necessary for Price Discrimination to Operate
    • firm has to have degree of market power (Faces downward sloping DC)
    • it is not possible to resell the product for a higher price
    • elasticity of demand differs between different markets (for TDPD)
  93. First Degree Price Discrimination (FDPD)
    • firm charges each customer the max price that he/she prepared to pay for G/S
    • happens when some scope for bargaining over price
    • enables firm to incr profits to entire area below demand curve and above MC curve
  94. Second Degree Price Discrimination (SDPD)
    • charges different price to consumers depending on number of units purchased
    • typically average price paid falls with units purchased
    • encourages consumers to purchase more, therefore useful when firm's AC decreases with output
  95. Third Degree Price Discrimination (TDPD)
    • firm divides customers into different groups and charges a different price to each group of consumers, though all consumers within particular group pay same price
    • total profit maxes when MR = MC in "total" market
  96. Predatory Pricing
    • where firm sets price below its AC in order to drive other firms out of business
    • may do so by cross-subsidising losses in one market with profits from elsewhere
  97. Peak-load Pricing
    • where consumers charged more for a service at peak times than at off-peak
    • higher peak may reflect higher demand, or higher costs due to supply constraints
    • another form of price discrimination
  98. Inter-temporal Pricing
    • occurs where different groups of consumers have different price elasticities of demand at different points of time, so are charged different prices at different points of time (eg mobile phone release)
    • form of price discrimination
  99. Two-part Tariff
    • pricing system where consumer pays a fixed fee for access to service and then separate charge for usage
    • form of price discrimination
  100. Loss Leader
    good which has its price cut (often to below AC) in order to attract customers into a store
  101. Full-range Pricing
    • is where firm determines prices for all products collectively, so as to max total profits across its full range of products
    • may involve loss leaders
    • relevant when firm sells substitutes and/or complements
  102. By-product
    • G/S produced as a result of producing another G/S
    • costs and revenues should be set where combined  MR= MC
    • price for each then determined from individual demand curve for each
  103. Transfer Pricing
    • pricing system used in large organisations such as multinationals, where intermediate goods are transferred between different divisions of organisation
    • charge each intermediate product at marginal cost, so end price of product reflects total MC of production
  104. Product Life Cycle Stages
    • Launch Stage (lack of substitutes / inelastic demand leads to high prices, OR can charge low prices to establish market share)
    • Growth Stage (rapid sales growth likely to attract new entrants, leads to oligopolistic market)
    • Maturity Stage (more firms, more competition, collusion may break down, price wars)
    • Decline Stage (competition increases and firms struggle to retain sales, sales either level out at replacement level, or fall to zero - obsolete product)