Types of markets

Worked example 14 marks

1. 1

   Characteristic 1: Number of firms. This refers to how many producers are supplying the market. A market can range from having many firms (like in perfect competition) to just one single firm (a monopoly). [2 marks]

2. 2

   Characteristic 2: Barriers to entry. This refers to the obstacles that make it difficult for new firms to enter a market. In some markets, like a local café, barriers are low. In others, like car manufacturing, barriers such as high start-up costs are very high. [2 marks]

Worked example 14 marks

1. 1
   1. Many buyers and sellers: There are so many participants that no single firm or consumer can influence the market price.
2. 2
   1. Homogenous products: All firms produce identical products, making them perfect substitutes for one another.
3. 3
   1. No barriers to entry or exit: Firms can freely enter the market if it's profitable and leave if it's not.
4. 4
   1. Perfect knowledge: All buyers and sellers have full information about prices and products.

Worked example 26 marks

1. 1

   In the short run, a firm in perfect competition can make supernormal profits if the market price is above its average cost.

2. 2

   However, because there are no barriers to entry, these profits act as a signal to new firms.

3. 3

   New firms will enter the market, attracted by the profitability.

4. 4

   The entry of new firms increases the total industry supply, shifting the market supply curve to the right.

5. 5

   This increase in supply causes the market price to fall.

6. 6

   Firms will continue to enter and the price will continue to fall until it is equal to the average cost, at which point firms only make normal profit and the incentive to enter is gone.

Worked example 14 marks

1. 1
   1. Legal Barriers: The government can grant a firm exclusive rights to produce a good, for example, through a patent which protects an invention, or a license to be the sole provider, like a national railway service. This legally prevents any other firm from competing. [2 marks]
2. 2
   1. Natural Barriers / Economies of Scale: In some industries, the cost per unit of production falls as output increases. A single large firm can supply the entire market at a lower cost than multiple smaller firms could. This creates a natural monopoly, as any new, smaller entrant would have higher costs and be unable to compete on price. [2 marks]

Worked example 26 marks

1. 1

   Advantage: A key advantage is the potential for economies of scale. Because a monopolist is the sole producer, it can operate on a very large scale, leading to lower average costs. These cost savings could potentially be passed on to consumers in the form of lower prices than if the market were supplied by many small firms. [3 marks]

2. 2

   Disadvantage: A major disadvantage for consumers is the likelihood of higher prices and reduced output. With no competition, a monopolist can restrict supply to push up the price and maximise its profit, leading to consumers paying more for less. There is also less incentive for the firm to be efficient or innovate, which can lead to poor quality and limited choice. [3 marks]

Worked example 16 marks

1. 1

   Firms in monopolistic competition use two main methods of competition: non-price competition and price competition.

2. 2

   The most important method is non-price competition. Firms focus on differentiating their product through branding, advertising, packaging, and quality of service. For example, a coffee shop might focus on its unique ethical sourcing or cozy atmosphere. The goal is to build brand loyalty and make demand for their product less sensitive to price. [3 marks]

3. 3

   Firms also engage in price competition, but to a lesser extent. Because each product is slightly different, a firm has some power to set its own price. However, this power is limited because there are many close substitutes. If a firm raises its price too much, consumers will likely switch to a rival brand. Therefore, pricing decisions must always consider the prices of competitors. [3 marks]

Worked example 16 marks

1. 1

   The key reason is interdependence. Each firm knows that its pricing decision will provoke a reaction from its few, large rivals.

2. 2

   If one firm lowers its price to gain market share, other firms are likely to match the price cut immediately to avoid losing customers. This can trigger a 'price war', where firms repeatedly cut prices.

3. 3

   A price war can lead to drastically lower prices for all firms in the market, severely reducing the profits for everyone involved. No firm is better off.

4. 4

   Conversely, if one firm raises its price, rivals are unlikely to follow. They will keep their prices lower to attract customers away from the firm that raised its price.

5. 5

   Therefore, firms see little to gain from cutting prices and much to lose from raising them.

6. 6

   As a result, prices in an oligopoly tend to be 'sticky' or rigid, and firms prefer to compete using non-price methods like advertising and product development.