NYJC_H2_ECONS_Q2

Question 2 a) Explain how the level of competition influences firms’ price and output decisions. 10m b) Assess whether a firm’s behaviour is always dependent on the actions of its rivals. 15m a) Explain how the level of competition influences firms’ price and output decisions. 1. Intro : Level of Competition and Market Structure Level of competition is determined by the presence of barriers to entry - Barriers to entry refer to any impediment that prevents new firms from comp eting on an equal basis with existing firms in an industry. Identify PC as a market structure that has no BTE and hence high level of competition. The higher the barriers the lower the level of competition faced by the firms. Barriers to entry determine the degree of competition faced by firms in an industry and hence the degree to which they can influence price and output decisions. Identify monopoly as a market structure that has high BTE and hence low levels of competition. Assume that firms operate under profit maximisatio n motive. 2. Explain how high levels of competition affects firms’ pricing and output decisions In a perfectly competitive market - no barriers to entry - existing firms are unable to stop new firms from entering the market - no restrictions on existing firms leaving the market - no single firm has the market power to influence the market price of the product –product is identical - each firm is a price taker eg shares of listed companies in the stock markets….. Figure 1a above, shows how the intersection between the market demand and supply curves of a perfectly competitive market determines the eq uilibrium price P 0, and output Q 0. Each firm in the perfectly competitive market will then take the market price P0, as each firm in the perfectly competitive market is a price taker. The demand curve faced by each firm is thus perfectly price elastic (see Figure 1b). Each firm will then produce at its profit-maximising output, Q 2, where marginal revenue (MR 0) cuts the marginal cost (MC) curves. Here, the perfectly competitive firm is initially earning supernormal profits ,area P 0ABC. High competition, no barriers to entry, potential profit s entice new entrants into the industry leading to a shift in the market supply curve to it s right, lowering its market price as a result.

The price of the perfectly competitive firm will thus follow the price determined by the market. The output however will be determined by the indivi dual firm depending on its cost curves set. The firm will eventually earn normal profits. 2: Explain how no competition affect firms’ pricing and output decisions On the other end of the spectrum, where there is no competition due to high barriers to entry a monopoly will develop. A monopoly is one in which there exists only a single firm in the market. There is no competition as a result of the high barriers that can be classified into two categories, namely