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2. (a) (i) State and explain the assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2009
Question 2
2. (a) (i) State and explain the assumptions underlying the theory of imperfect competition. (ii) Outline the advantages imperfect competition may offer consumers.... show full transcript
Worked Solution & Example Answer:2. (a) (i) State and explain the assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2009
Step 1
State and explain the assumptions underlying the theory of imperfect competition.
Answer
The theory of imperfect competition is based on several key assumptions:
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There are many buyers in the industry.
- An individual buyer cannot influence the market price of the good.
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There are many sellers in the industry.
- Each seller has some control over the quantity of goods sold and can influence prices.
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Product differentiation exists.
- Goods offered by different firms are not identical but are close substitutes. This differentiation allows firms to establish brand loyalty.
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Freedom of entry and exit.
- Firms can freely enter or exit the industry, ensuring competition remains dynamic.
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Reasonable knowledge.
- Buyers and sellers have a reasonable understanding of prices and profits within the market, promoting informed decision-making.
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Each firm attempts to maximize profits.
- Firms aim to balance their production costs with the price at which they sell their products.
Step 2
Outline the advantages imperfect competition may offer consumers.
Answer
Imperfect competition can provide several benefits to consumers:
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Greater choice.
- Consumers enjoy a variety of products as firms differentiate their offerings.
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Normal Profit.
- In this environment, firms earn normal profits, which leads to competitive pricing strategies.
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Lower prices.
- Competition among firms typically results in lower prices for consumers.
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Innovative goods/services.
- Firms may invest in innovation to differentiate their products, leading to new and improved offerings.
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Access to information.
- Consumers often have more information due to extensive advertising and marketing efforts by firms.
Step 3
Explain with the aid of a diagram in each case the conditions for a profit maximizing firm to be in equilibrium under imperfect competition: in the short run.
Answer
In the short run, the conditions for equilibrium for a profit-maximizing firm are:
- Equilibrium/Profit Maximization Point: This occurs at the point where Marginal Cost (MC) equals Marginal Revenue (MR).
- Assume the price set by the market is P1, with output Q1 dictated by the point of intersection.
- At this output, the average cost (AC) is below the average revenue (AR), indicating the firm is earning super normal profits.
A typical diagram would show:
- The intersection of MC and MR at point W.
- The price set at P1 and output at Q1.
- The area between AR and AC indicates super normal profits.
Step 4
Explain with the aid of a diagram in each case the conditions for a profit maximizing firm to be in equilibrium under imperfect competition: in the long run.
Answer
In the long run, the equilibrium conditions change:
- Equilibrium/Profit Maximization Point: This still occurs where MC equals MR, but now the effects of competition come into play, shifting the average cost to align with average revenue.
- Assume the new price at P2 with output at Q2.
- Unlike the short run, in the long run, firms will not be earning super normal profits as the average cost equals average revenue, indicating that the firm is covering all costs.
In the long-run diagram:
- Display the intersection of MC and MR at point X.
- Show the output level Q2 at the price P2, where AC equals AR, indicating normal profits.
Step 5
Do you agree with the statement? Give reasons for your answer, referring to major food retailers in the Irish market mentioned above.
Answer
I do not agree with the statement that food retailers such as Aldi, Dunnes, SuperValu, and Tesco operate under conditions of Imperfect Competition. This market resembles an oligopolistic structure for several reasons:
- Market Dominance: A few large retailers, like Tesco and Dunnes, dominate the market, exhibiting significant market power.
- Barriers to Entry: New entrants face challenges such as economies of scale and established distribution channels, hindering competition.
- Interdependence: These firms closely monitor each other's strategies, maintaining their market share through competitive practices.
- Product Substitutability: The goods sold by these retailers are generally similar, leading to competitive advertising as a strategy to maintain consumer loyalty.