Cambridge International as and a level Economics Ebook

Comparisons of performance of firms: 
some conclusions
Much of this chapter has been concerned with how fi rms 
operate in terms of:
■
their production, costs and revenue
■
their behaviour in diff erent market structures
■
their objectives and how they price their products in 
the market.
In terms of effi
ciency, perfect competition is the only 
market structure where fi rms are productively and 
allocatively effi
cient in the long run. It is for this reason 
that this model acts as a benchmark for assessing the 
effi
ciency of other market structures. In monopolistic 
competition, the average cost of production is not at 
the minimum point; price is greater than marginal cost 
and there is excess capacity. Th
e standard criticism of 
monopoly is that price is higher and output is lower 
when compared with an industry in perfect competition. 
Moreover, the lack of competition can lead to what is 
known as x-ineffi
ciency, since the fi rm is oft en producing 
at a higher level of average cost than might be necessary. 
Th
e causes tend to be internal to the fi rm, involving 
poor management, an unmotivated workforce and a lack 
of innovation in the production process. Oligopolies 
are subjected to the same criticisms since they apply 
practices that give them the opportunity to gain 
monopoly power.
An interesting competition policy issue arises from 
the eff ects of a merger between fi rms. On the one hand, 
the merger is likely to provide an opportunity for 
economies of scale, resulting in improved productive 
effi
ciency. On the other hand, the greater market 
power of the merged fi rm may result in increased 
prices, so widening the diff erence between price and 
marginal costs. Th
e fi rm is now even less allocatively 
effi
cient.
Diff erences in barriers to entry have a bearing on 
the level of profi ts in imperfectly competitive markets. 
Th
ey also may prevent a market from becoming 
contestable or, depending on their strength, allow a 
market to actually remain contestable. In monopolistic 
competition, there is relatively free entry and exit. Th
is 
is very similar to perfect competition where there are no 
barriers to entry or exit. With oligopoly and monopoly, 
in contrast, barriers to entry determine market power; 
there are also sunk costs of exit.
In perfect competition firms are price takers. Any 
firm that moves away from a policy of charging more 
or less than the prevailing market price will have to 
leave the industry in the long run. In monopolistic 
competition and oligopoly, firms are price makers, 
although there may be some price competition. 
Consequently, non-price competition, where firms 
compete in terms of product promotion through 
branding, packaging or advertising, is particularly 
relevant in monopolistic competition and oligopoly. 
A monopolist, however, has complete control over the 
prices that are charged.
Other aspects of pricing were discussed in the cases 
of oligopoly and monopoly. Price leadership was stated as 
being prevalent in oligopoly. Here, a market leader may 
be the price leader. Th
is fi rm sets prices and others follow. 
Th
e rigidity of prices in this market was shown by the 
Figure 7.27
 
Price leadership under oligopoly
P
B
MC
B
MC
A
P
A
0
Price/Cost
Quantity
O
A
O
B
A
B
D
D
MR