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2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2014
Question 2
2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition. (ii) Explain why a firm’s demand curve under imperfect competition di... show full transcript
Worked Solution & Example Answer:2. (a) (i) State and explain three assumptions underlying the theory of imperfect competition - Leaving Cert Economics - Question 2 - 2014
Step 1
State and explain three assumptions underlying the theory of imperfect competition.
Answer
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Many Sellers: In imperfect competition, there are numerous sellers, each of whom cannot individually impact the overall market price due to their small size relative to the market.
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Product Differentiation: The goods sold by firms in imperfect competition are not homogeneous; rather, they are differentiated. Firms use branding to distinguish their products, which leads to consumer choice based on perceived differences.
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Freedom of Entry and Exit: Firms can freely enter or exit the industry, which helps maintain competition. Existing firms face potential competition from new entrants, contributing to market dynamics.
Step 2
Explain why a firm’s demand curve under imperfect competition differs from a firm’s demand curve under perfect competition.
Answer
The demand curve for a firm in perfect competition is perfectly elastic (horizontal) because the firm's product is identical to that of other firms. Thus, it cannot influence the market price and must accept it.
In contrast, a firm in imperfect competition faces a downward-sloping demand curve. This is because it sells a differentiated product, allowing it to gain some degree of market power. If a firm raises its price, it will lose some, but not all, of its customers, demonstrating that the firm has some control over its pricing.
Step 3
Explain, with the aid of a diagram, the long run equilibrium of a firm in imperfect competition.
Answer
In the long-run equilibrium for a firm in imperfect competition, the firm produces at the output level where marginal cost (MC) equals marginal revenue (MR), at point X on the diagram. The intersecting point at this level determines the price (P2) where the firm sells its output.
The average cost (AC) at this output level is also shown as line W. The firm makes normal profits since average revenue (AR) equals average cost (AC), indicating that it is covering its costs fully but making no economic profit.
Step 4
With reference to your diagram in (b) (i) explain why the firm is not making socially efficient use of scarce resources.
Answer
The firm is not producing at the socially efficient level because it is not operating at the lowest point on its average cost curve, W. This inefficiency arises from product differentiation and the resulting markup over marginal cost. Specifically, the price (P2) exceeds the marginal cost (MC), meaning that the firm is not producing at the point that would minimize the total cost of production. The gap between P2 and MC indicates a loss of consumer surplus and a misallocation of resources.
Step 5
Suggest a market structure which most closely reflects this situation. Explain your answer.
Answer
The market structure that best reflects the dominance of large retailers like Tesco, SuperValu, Dunnes Stores, Aldi, and Lidl in the Irish grocery market is Oligopoly. This is characterized by:
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Few Large Sellers: The industry is dominated by a small number of large retailers, resulting in significant market concentration.
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Interdependence: These firms are interdependent, meaning the actions of one, whether in pricing or product offerings, can significantly influence the others.
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Barriers to Entry: While firms can enter the market, significant barriers exist due to economies of scale and the established brand loyalty these large retailers maintain.