3.9 What determines the behaviour of firms?

What students need to learn:

Content	Students should be able to:	Additional Guidance Notes
Perfect competition	Understand the assumptions of perfect competition and be able to explain the behaviour of firms in this market structure.	Diagrammatic analysis of the market structure is required in both the short and long run. Students will be expected to understand the significance of firms as price-takers in perfectly competitive markets. An understanding of the meaning of shut-down point is required. The impact of entry into and exit from the industry should be considered.
Monopoly	Understand the characteristics of this model and be able to use them to explain the behaviour of firms in this market structure. Explain and evaluate the differences in efficiency between perfect competition and monopoly. Explain and evaluate the potential costs and benefits of monopoly to both firms and consumers, including the conditions necessary for price discrimination to take place.	Diagrammatic analysis of the market structure is required. Students must be able to explain the sources of monopoly power such as the degree of product differentiation and entry barriers. A diagrammatic explanation to compare the two market structures is expected. Diagrams should also be used to support the understanding of price discrimination.
Monopsony	Explain and evaluate the characteristics and necessary conditions for a monopsony to operate. Evaluate the potential costs and benefits of a monopsony to both firms and consumers.	Students should be aware of the significance of monopsony power for businesses operating in a particular market for example, the impact of supermarket monopsony power on suppliers. Students are not expected to use diagrams to explain monopsony.
Oligopoly	Understand the characteristics of this market structure with particular reference to the interdependence of firms. Be able to explain the behaviour of firms in this market structure. Explain the reasons for collusive and non-collusive behaviour. Evaluate the reasons why firms may wish to pursue both overt and tacit collusion. Use simple game theory to illustrate the interdependence that exists in oligopolistic markets.	Students should be able to explain that oligopolistic markets have high concentration ratios, in which a firm’s decisions on price, output and other competitive activities may have immediate effects upon other competitors. Students should understand the reasons for cartels, non-price competition, price wars, predatory pricing and price leadership. Diagrammatic analysis of this area is not required. Students will be expected to have an understanding of prisoners’ dilemma and a simple two firm/two outcome model. Students should analyse the advantages/disadvantages of being a first mover. Students will not be expected to have an understanding of the Nash Equilibrium. The Kinked Demand curve is not required but may still be used to support an explanation of interdependence — as part of game theory.
Monopolistic competition	Understand the characteristics of a monopolistically competitive market and be able to use these to explain the behaviour of firms in this market structure.	Students should be able to carry out diagrammatic analysis of the market structure in both the short and long run. Students should understand the importance of advertising and differentiation for the model of monopolistic competition and be able to contrast this with other market structures. Students should be able to explain and evaluate the efficiency of monopolistic competition.