Essay about 8 Efficiencies Markets

Submitted By ryankeogan
Words: 1926
Pages: 8

Hand-out 8: Efficiencies and Market Structures
-The concept of an efficient market structure in terms of costs, prices, output and profit
-The models of market structure: monopoly; oligopoly; monopolistic competition.
Key Concepts

You need to be able to:
Define the different efficiencies and apply to 3 market structures
Explain the impact of competition / concentration on efficiencies
Draw each of the market structures diagrammatically
Explain each market structure diagram analytically
Evaluate the impact that more or less competition will have on a market in terms of efficiency
Allocative Efficiency
Allocative efficiency occurs when consumers pay a market price that reflects the private marginal cost of production. The condition for allocative efficiency for a firm is to produce an output where marginal cost, MC, just equals price, P. We can show it on a diagram where MC = AR.

Productive Efficiency
Productive efficiency occurs when a firm is combining resources in such a way as to produce a given output at the lowest possible average total cost. Costs will be minimised at the lowest point on a firm's short run average total cost curve.

This also means that AC = MC, because MC always cuts ATC at the lowest point on the ATC curve.

Dynamic Efficiency
The concept of dynamic efficiency is commonly associated with the Austrian Economist Joseph Schumpeter and means technological progressiveness and innovation.

Firms that are highly protected are more likely to undertake risky innovation, and generate dynamic efficiency. Firms can reinvest supernormal profits to cement their dominant market position.

Firms can benefit from two types of innovation:
1. Process innovation occurs when new production techniques are applied to an existing product. For example, this is common in the production of motor vehicles with firms constantly looking to develop new methods and production processes.
2. Product innovation occurs when firms generate new or improved products. For example, this is common in many consumer product markets, including electronics and communications.

X Efficiency
X efficiency can be applied specifically to situations where there is more or less motivation of management to maximise output, or not.

X efficiency occurs when the output of firms, from a given amount of input, is the greatest it can be. It is likely to arise when firms operate in highly competitive markets where managers are motivated to produce as much as possible.
A pure monopoly is a single supplier in a market. For the purposes of regulation, monopoly power exists when a single firm controls 25% or more of a particular market.

Monopolies can maintain super-normal profits in the long run.
Monopolies are profit maximisers and produce where MC = MR.
Monopolies are the single sellers of a product,
There is a lack of close substitute goods
Hence in a pure monopoly there is zero competition.
At profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC).
High barriers to entry and exit prevent competitors from entering the market
They are not allocatively efficient (production is not where MC = AR / P)
They are not productively efficient (Q is lower than where MC = AC)
Not X efficient
There is an argument to say that monopolies may be dynamically efficient

Evaluation of monopolies

The advantages of monopolies:

Monopolies can be defended on the following grounds:
1. They can benefit from economies of scale, and may be ‘natural’ monopolies, so it may be argued that it is best for them to remain monopolies to avoid the wasteful duplication of infrastructure that would happen if new firms were encouraged to build their own infrastructure.
2. Domestic monopolies can become dominant in their own territory and then penetrate overseas markets, earning a country valuable export revenues. This is certainly the case with Microsoft.