ALISHBA NAVEED BS V MICRO ECONOMICS ASSIGNMENT

What is economics? Economics is the study of how people choose to use resources. Resources include the time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services. Important choices involve how much time to devote to work, to school, and to leisure, how many dollars to spend and how many to save, how to combine resources to produce goods and services, and how to vote and shape the level of taxes and the role of government. Often, people appear to use their resources to improve their well-being. Wellbeing includes the satisfaction people gain from the products and services they choose to consume, from their time spent in leisure and with family and community as well as in jobs, and the security and services provided by effective governments. Sometimes, however, people appear to use their resources in ways that don't improve their well-being. In short, economics includes the study of labor, land, and investments, of money, income, and production, and of taxes and government expenditures. Economists seek to measure well-being, to learn how well-being may increase over time, and to evaluate the well-being of the rich and the poor. Although the behavior of individuals is important, economics also addresses the collective behavior of businesses and industries, governments and countries, and the globe as a whole. Microeconomics starts by thinking about how individuals make decisions. Macroeconomics considers aggregate outcomes. The two points of view are essential in understanding most economic phenomena. What is micro economics?
Microeconomics "deals with economics decisions made at a low, or micro, level. How does the change of a price of good influence a family's purchasing decisions? If my wages rise, will I be inclined to work more hours or less hours?" What is macro economics? Contrast the above definition to the study of macroeconomics, which deals with the sum total of the decisions made by individuals in a society, such as "how does a change in interest rates influence national savings?"

Oligopoly: Features of Oligopoly

An industry which is dominated by a few firms. UK definition of an oligopoly is a five firm concentration ratio of more than 50% (this means they have more than 50% of the market share) Interdependence of Firms, firms will be effected by how other firms set price and output Barriers To Entry, but less than Monopoly Differentiated Products, advertising is often important Most Common Market Structure Definition of Concentration Ratios: This is a tool for measuring the market share of the 5 biggest firms in the industry. E.g. the 5 firm concentration ratio for supermarkets is about 58%

How Firms In Oligopoly are Expected to behave There are different possible ways that firms in oligopoly will compete and behave this will depend upon:

the objectives of the firms e.g. profit max or sales max the degree of contestability i.e. barriers to entry

government regulation The Kinked Demand Curve Model The Kinked Demand Curve Graph

This assumes that firms seek to maximise profits If they increase price, then they will lose a large share of the market because they become uncompetitive compared to other firms, therefore demand is elastic for price increases. If firms cut price then they would gain a big increase in Market share, however it is unlikely that firms will allow this. Therefore other firms follow suit and cut price as well. Therefore demand will only increase by a small amount: Demand is inelastic for a price cut Therefore this suggests that prices will be rigid in Oligopoly

Monopoly A monopoly is exclusive control of the market by one business because there is no other group selling the product or offering the service. A true monopoly rarely exists because if there is no competition, business will increase the price while reducing output to increase profits. Antitrust laws keep this type of market condition from existing. A natural monopoly exists where having more than one supplier is inefficient, like in public utilities, but these are regulated by the government. Not only does a monopoly cause higher prices; it can also lead to inferior products and services.

Capitalism Capitalism is a condition where there is open competition, a free market, and private ownership of production. This encourages private businesses and investments, as compared to a government-run system. With capitalism, the market is regulated through the dictates of supply and demand, price, and distribution which are controlled by business owners and investors. Profits are distributed among the owners and shareholders; these shareholders in private companies are called capitalists. Pros and Cons

Pro: Prices in an oligopoly are usually lower than in a monopoly, but higher than it would be in a competitive market. Pro: Prices tend to remain stable because if one company lowers the price too much, then the others will do the same. The result lowers the profit margin for all the companies, but is great for the consumer.

Con: Output would be less than in a competitive market and more than in a monopoly. Most competition between companies in an oligopoly is by means of research and development (or innovation), location, packaging, marketing, and the production of a product that is slightly different than the other company makes. Con: Major barriers keep companies from joining oligopolies. The major barriers are economies of scale, access to technology, patents, and actions of the businesses in the oligopoly. Barriers can also be imposed by the government, such as limiting the number of licenses that are issued. Con: Oligopolies develop in industries that require a large sum of money to start. Existing companies in oligopolies discourage new companies because of exclusive access to resources or patented processes, cost advantages as the result of mass production, and the cost of convincing consumers to try a new product. Lastly, companies in oligopolies establish exclusive dealerships, have agreements to get lower prices from suppliers, and lower prices with the intention of keeping new companies out.

Monopolistic competition The model of monopolistic competition describes a common market structure in which firms have many competitors, but each one sells a slightly different product. Monopolistic competition as a market structure was first identified in the 1930s by American economist Edward Chamberlin, and English economist Joan Robinson. Many small businesses operate under conditions of monopolistic competition, including independently owned and operated high-street stores and restaurants. In the case of restaurants, each one offers something different and possesses an element of uniqueness, but all are essentially competing for the same customers. Characteristics Monopolistically competitive markets exhibit the following characteristics: 1. Each firm makes independent decisions about price and output, based on its product, its market, and itscosts of production. 2. Knowledge is widely spread between participants, but it is unlikely to be perfect. For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.

3. The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making. 4. There is freedom to enter or leave the market, as there are no major barriers to entry or exit. 5. A central feature of monopolistic competition is that products are differentiated. There are four main types of differentiation: 1. Physical product differentiation, where firms use size, design, colour, shape, performance, and features to make their products different. For example, consumer electronics can easily be physically differentiated. 2. Marketing differentiation, where firms try to differentiate their product by distinctive packaging and other promotional techniques. For example, breakfast cereals can easily be differentiated through packaging. 3. Human capital differentiation, where the firm creates differences through the skill of its employees, the level of training received, distinctive uniforms, and so on. 4. Differentiation through distribution, including distribution via mail order or through internet shopping, such as Amazon.com, which differentiates itself from traditional bookstores by selling online. 6. Firms are price makers and are faced with a downward sloping demand curve. Because each firm makes a unique product, it can charge a higher or lower price than its rivals. The firm can set its own price and does not have to take' it from the industry as a whole, though the industry price may be a guideline, or becomes a constraint. This also means that the demand curve will slope downwards. 7. Firms operating under monopolistic competition usually have to engage in advertising. Firms are often in fierce competition with other (local) firms offering a similar product or service, and may need to advertise on a local basis, to let customers know their differences. Common methods of advertising for these firms are through local press and radio, local cinema, posters, leaflets and special promotions. 9. Monopolistically competitive firms are assumed to be profit maximisers because firms tend to be small with entrepreneurs actively involved in managing the business. 10. There are usually a large numbers of independent firms competing in the market.

Equilibrium under monopolistic competition In the short run supernormal profits are possible, but in the long run new firms are attracted into the industry, because of low barriers to entry, good knowledge and an opportunity to differentiate. Monopolistic competition in the short run 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).

As new firms enter the market, demand for the existing firms products becomes more elastic and the demand curve shifts to the left, driving down price. Eventually, all super-normal profits are eroded away. Monopolistic competition in the long run Super-normal profits attract in new entrants, which shifts the demand curve for existing firm to the left. New entrants continue until only normal profit is available. At this point, firms have reached their long run equilibrium.

Clearly, the firm benefits most when it is in its short run and will try to stay in the short run by innovating, and further product differentiation. Examples of monopolistic competition Examples of monopolistic competition can be found in every high street. Monopolistically competitive firms are most common in industries where differentiation is possible, such as:

The restaurant business Hotels and pubs General specialist retailing Consumer services, such as hairdressing

The survival of small firms The existence of monopolistic competition partly explains the survival of small firms in modern economies. The majority of small firms in the real world operate in markets that could be said to be monopolistically competitive. Evaluation The advantages of monopolistic competition Monopolistic competition can bring the following advantages: 1. There are no significant barriers to entry; therefore markets are relatively contestable.

2. Differentiation creates diversity, choice and utility. For example, a typical high street in any town will have a number of different restaurants from which to choose. 3. The market is more efficient than monopoly but less efficient than perfect competition - less allocatively and less productively efficient. However, they may be dynamically efficient, innovative in terms of new production processes or new products. For example, retailers often constantly have to develop new ways to attract and retain local custom. The disadvantages of monopolistic competition There are several potential disadvantages associated with monopolistic competition, including: 1. Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive. 2. As the diagram illustrates, assuming profit maximisation, there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases. In the long run the firm is less allocatively inefficient, but it is still inefficient.