Is Perfect Competition economically efficient?

Efficiency Put together a definition of “efficiency” in your own words Now define what you understand by the term “productive efficiency” Now define what you understand by the term “allocative efficiency”

Productive efficiency Attained when a firm… operates at minimum average total cost Choosing an appropriate combination of inputs (cost efficiency) Producing the maximum output possible from those inputs (technical efficiency) AC In the LONG run! P The best resource mix! O Q1 Q To attain productive efficiency, both technical AND cost efficiency need to be achieved

Allocative efficiency Firms can be productively efficient producing loads of stuff nobody wants! Achieved when society is producing an appropriate bundle of goods relative to consumer preferences Under Perfect Competition the ‘Consumer is King’ and ultimately determine which resources are used to produce which goods and services Allocative efficiency is achieved when the marginal benefit to society is equal to the marginal cost, in other words where price is set equal to marginal cost In both the SHORT and the LONG run

Dynamic Efficiency This is to do with the rate of investment…would it be better if the firm invested money over time rather than profits? Dynamic efficiency occurs over time. (as opposed to Productive and Allocative which are at a point in time – static efficiency) It focuses on changes in the consumer choice available in a market together with the quality / performance of goods and services that we buy Dynamic efficiency: We assume that a perfectly competitive market produces homogeneous products – in other words, there is little scope for innovation designed to make products differentiated from each other and thereby allow a supplier to develop and then exploit a competitive advantage in the market to establish some monopoly power.

Benefits of PC Lower prices Low barriers to entry Large number of competing firms High elastic demand curve Low barriers to entry New firms enter and keep prices low Greater entrepreneurial activity In SR entrepreneurs strive for profit – finding ways to outdo other businesses Economic efficiency competition will ensure that firms attempt to minimise their costs and move towards productive efficiency The threat of competition should lead to a faster rate of technological diffusion as firms have to be particularly responsive to the changing needs of consumers….dynamic efficiency.

Monopolistic competition Imperfect competition

What are the characteristics of this marketplace?

Syllabus aims Understand the characteristics of a monopolistically competitive market and be able to use these to explain the behaviour of firms in this market structure Students should be able to carry out diagrammatic analysis of the market structure in both the short and long run. Students should understand the importance of advertising and differentiation for the model of monopolistic competition and be able to contrast this with other market structures. Students should be able to explain and evaluate the efficiency of monopolistic competition.

Monopolistic competition Monopolistic Competition - Intro Monopolistic competition Monopolistic competition is a market that shares some characteristics of monopoly and some of perfect competition. There are many firms producing similar, but not identical products. Mr Mercer's Notes

Examples of monopolistic competition Sandwich bars Local takeaway restaurants Coffee stores Pizza delivery Hairdressers Small-scale children’s nurseries Care homes Independent hotels Coach companies There are many firms producing similar, but not identical products.

Overview of a monopolistic market

Sandwich bars Panini, Baps, Baguettes, Wraps and Bagels!!!! The total sandwich market in the UK is worth approximately £3.2bn and is growing at 5%. Over 30 million people have bought a sandwich on the go this year with the average person buying a sandwich once per week. 1.8 billion sandwiches are purchased outside the home each year Despite tough competition, sandwich and snack bars have forged ahead with volume growth of over 12% Source: TNS 2008

How can you differentiate a sandwich ?

How can you differentiate a sandwich? Hot and cold sandwiches Different styles – e.g. a bap, baguette, wraps and filled bagels Speciality breads such as focaccia and ciabatta Product range - including Organic ingredients Healthy options (e.g. non-mayo) Packaging and branding Quality of ingredients Different fillings Made to order in the store / off the shelf / home or work delivery of sandwiches Finest range / value sandwiches

Sandwich market Q’s How many buyers & how many sellers are there in this market? What type of concentration ratio is there in this market? What’s the ease of entry / exit to this market? What type of knowledge do consumers have? To what extent is there product differentiation or product branding? Does the company have some control over the price? Are they price makers or takers? Are they capable of making short term profits?

Key theory to know…

Key characteristics of Monopolistic Competition What’s the difference to PC? There are many producers and many consumers in a market - the concentration ratio is low & they act independently. The barriers to entry and exit into and out of the market are low The firms are short run profit maximisers. Consumers see that there are non-price differences among the competitors’ products i.e. there is product differentiation Producers have some control over price - they are “price makers” rather than “price takers.”

Key characteristics In detail….

Product differentiation Firms produce differentiated products, although there are substitutes for each firm’s products. There is a downward sloping D curve – and elastic! Each firm tries to build brand loyalty to create loyal customers. There tends to be heavy advertising

Ease of entry & exit There are ‘no’ barriers to entry & exit. The existence of short term abnormal profits gives incentives for other companies to start up. The existence of short term losses give incentives for companies to close down!

Low concentration ratios Monopolistic Competition - Intro Low concentration ratios What is the concentration ratio of a monopoly? What is the concentration ratio of a duopoly? What is the concentration ratio of a oligopoly? What concentration ratio ‘border line’ will there be for a monopolistic competitive market? No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. • Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. • Low concentration: 0% to 50% This category ranges from perfect competition to oligopoly. • Medium concentration: 50% to 80% An industry in this range is likely an oligopoly. • High concentration: 80% to 100% This category ranges from oligopoly to monopoly Mr Mercer's Notes

Low concentration ratios Monopolistic Competition - Intro Low concentration ratios No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. Low concentration: 0% to 50%. This category ranges from perfect competition to oligopoly. Medium concentration: 50% to 80%. An industry in this range is likely an oligopoly. High concentration: 80% to 100%. This category ranges from oligopoly to monopoly No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share. • Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly. • Low concentration: 0% to 50% This category ranges from perfect competition to oligopoly. • Medium concentration: 50% to 80% An industry in this range is likely an oligopoly. • High concentration: 80% to 100% This category ranges from oligopoly to monopoly Mr Mercer's Notes

Low concentration ratios What will a low concentration ratio mean for the market conduct? Is there any interdependence? Is there any chance of collusion?

HOMEWORK Questions EITHER use The Economist article on Tablet computers OR Think about a local area that you know well… Choose one of the following ‘business areas’ and complete the Q’s opposite… Local restaurants Coffee shops Hairdressers Small-scale children’s nurseries Independent hotels Local Coach Companies How many buyers & how many sellers are there in this market? Give examples. Approximately, what type of concentration ratio is there in this market? How easy do you think it is for someone to enter & exit this market? What type of knowledge do consumers have? To what extent is there product differentiation or product branding? Give examples. Do the companies have some control over the price? Are they price makers or takers? Give examples. Is there evidence that they capable of making short term profits?