A2 econ session 2

A Level Economics – Year 2 (A2) Revision Workshop

Session 2Concentrated Markets and Government Intervention

12


Session 2 OutlineConcentrated Markets: Key Terms

Characteristics of Concentrated Markets

Evaluating Monopoly

Examining Natural Monopoly

Analysing Oligopoly, and Exploring Game Theory

Competition Policy and Regulation

12


Key Term Match12

Match the Concentrated Markets Key Terms to their correct definitions


Concentration Ratios13

64.8 74 61.4



13

One dominant firm

High barriers to entry (and exit)

Price-making power

Aim to profit-maximise



13

A small number of dominant firms

Interdependence

High barriers to entry (and exit)

Collusion or price competition; differentiated or homogeneous goods


Monopoly examples13

Local train services (regional monopoly)

Google Chrome (working monopoly)

London Underground (pure monopoly)

Rural pubs (local monopoly)


Analysing Monopoly14

Q

P


Evaluating Monopoly: Productive Efficiency

14

No – not producing at lowest average costPossibly – average costs may be LOWER than in a competitive market due to ECONOMIES OF SCALE

Monopoly AC

Competitive AC

Qm

Cm

Qc

Cc


Evaluating Monopoly: Allocative Efficiency

14

No – not producing where AR = MCPossibly – there may be legal barriers to entry (eg safety regulations) which protect the consumer; may be complete market failure without the monopoly


Evaluating Monopoly: Dynamic Efficiency

14

Possibly – supernormal profits can be used to fund R&D, and innovation to lower costs

Possibly not – many monopolies have not managed to innovate, and some had to leave the market


Evaluating Monopoly: X-Efficiency

14

No – lack of competitive pressure means no incentive to lower costs

AC1

Possibly – tight profit margins in recession drive efficiency; shareholders reduce complacency etc


What is a Natural Monopoly?14

Only one firm

Large sunk costs / large

networks

Difficult to achieve

economies of scale


Analysing Natural Monopoly14

Average Costs always falling

P

Q

Profit Max: MC = MR

Tiny supernormal profit

Highly inefficient – long way from productive efficiency

and barely any market demand met


Analysing Natural Monopoly14

OPTIONS

P

Q

Provide a subsidy to operate at allocative efficiency

Nationalise and operate as not-for-profit

Q1

P1


15

Read the Royal Mail case study and identify evidence that supports the view that the Royal

Mail is a natural monopoly


Examples of Oligopoly15

Can you think of 3 more examples of your own?


How do firms behave in oligopoly?

15

• Homogeneous goods• Price wars• Price leadership

Price Competition

• Homogeneous goods• Illegal, if not tacit collusion• Maximise joint profits

Collusion

• Anything other than price• Differentiated products• Brand proliferation

Non-Price Competition


Stable Prices in Oligopoly15

Kinked Demand Curve• Price elastic demand if the price is raised –

competitors do not copy• Price inelastic demand if the price is lowered – all

competitors copy• Implies a discontinuous MR curve

Stable price• Costs can change but the profit-maximising point

does not change

P


Stable Prices in Oligopoly15

Kinked Demand Curve

• Price elastic demand if the price is raised – competitors do not copy• Price inelastic demand if the price is lowered – all competitors copy• Implies a discontinuous MR curve

Stable price

• Costs can change but the profit-maximising point does not change

MC

ACMC1

AC1P


Evaluating the kinked demand curve model

15

It ignores

…

Product differentiation

Collusion (tacit or real)

Dynamics of reaching the stable price


Oligopoly Behaviour16

San Francisco – Hawaii flights (Nov 2015)

Supermarket Petrol Prices (Jan 2016)

Pizza Chain voucher codes (Feb 2016)


Oligopoly Behaviour16

LIBOR rate fixing (banking, up to 2012)

Modelling agencies & model fees (Aug 2015)

Air Cargo price fixing (2000 to 2006)


Explaining Collusion16

Why?• Maximise joint profits

How?• Restrict output / set prices high

Conditions

• Homogeneous goods• Easy to detect if a firm breaks the agreement (small number of firms, high trust)• Firms must have price-making power


Game Theory and Collusion 16

Papa Joe’s Pizza

High Price Low Price

Dynamo’s Pizza High Price (10 , 10) (3 , 12)

Low Price (12 , 3) (6 , 6)

Work out Dynamo’s Dominant Strategy

Work out Papa Joe’s Dominant Strategy

Work out the Nash Equilibrium



Papa Joe’s Pizza



Low Price (12 , 3) (6 , 6)

Is there a “better” option for each firm, other than the Nash equilibrium?

YES!Each firm charges a HIGH PRICE in order to

maximise joint profitsREQUIRES COLLUSION!



Papa Joe’s Pizza



Low Price (12 , 3) (6 , 6)

Why is this option “unstable”?

Because each firm could individually earn 12 by “defecting” and charging a low

price, compared to 10 by colluding and charging a high price



Papa Joe’s Pizza



Low Price (12 , 3) (6 , 6)

How can competition authorities take advantage of this instability to help tackle

collusion?

Encourage firms to defect by whistleblowing so avoiding fines


Non-Price Competition17

Legroom, flight times, entertainment, food Quality of ingredients, ambience, seasonality

Location, range of products, other services in store Durability, battery life, weight, style

Quality of ingredients, branding, availability


Anti-competitive practices18

Types

Collusion

Bid-Rigging

Full Line Forcing

Refusal to Supply

Predatory Pricing


Tools of competition policy18

Price Controls (RPI – X, RIIO, RPI – X + Y)

Reducing or eliminating barriers to entry (deregulation)

Monopoly break-up / prevent mergers

Taxation / windfall taxes / fines

Changing ownership (nationalisation / privatisation)


Regulators 19

Services that care for, and provide education for, children & young people

• School inspections – sets and monitors standards

• Funding removal for inadequate pre-school care

Firms that provide financial services to consumers (banks, mutual societies and financial advisors)

• Ban financial institutions from operating• Fine firms/individuals that break the rules

(e.g. Millburn Insurance, the boss of the London Whale)

Creating better places for people and wildlife, and supporting sustainable development

• Fines and imprisonment (e.g. Melksham Metals)

• Advice and guidance on how to meet standards

The UK’s water supply and sewerage services

• Price-capping (RPI – X + K)• Fines (e.g. Thames Water and false

flooding risk reports)• Force investment (e.g. anti-leakage)


Reasons for regulatory failure20

Reasons

Regulatory Capture

Non-experts

Lack of Funding

Bureaucracy burdens /

costly

Too close to politicians


20Regulatory

Capture?


Additional Activities21

Game theory analysis

Analysis of types of monopoly, with examples

Are concentrated markets always bad? Essay practice

Evaluating the impact of freezing energy prices – essay planning

Rail fare regulation – data response

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A2 econ session 2

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