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Market Structures

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Market Structures

Type of market structure influences how a firm behaves:

Pricing
Supply
Barriers to Entry
Efficiency
Competition

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Market Structures

Degree of competition in the industry
High levels of competition – Perfect competition
Limited competition – Monopoly
Degrees of competition in between

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Market Structure

Determinants of market structure

Freedom of entry and exit
Nature of the product – homogenous (identical), differentiated?
Control over supply/output
Control over price
Barriers to entry

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Market Structure

Perfect Competition:

Free entry and exit to industry
Homogenous product – identical so no consumer preference
Large number of buyers and sellers – no individual seller can influence price
Sellers are price takers – have to accept the market price
Perfect information available to buyers and sellers

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Market Structure

Examples of perfect competition:

Financial markets – stock exchange, currency markets, bond markets?
Agriculture?

To what extent?

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Market Structure

Advantages of Perfect Competition:
High degree of competition helps allocate resources to most efficient use
Price = marginal costs
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit

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Market Structure

What happens in a competitive environment?

New idea? – firm makes short term abnormal profit
Other firms enter the industry to take advantage of abnormal profit
Supply increases – price falls
Long run – normal profit made
Choice for consumer
Price sufficient for normal profit to be made but no more!

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Market Structure

Imperfect or Monopolistic Competition

Many buyers and sellers
Products differentiated
Relatively free entry and exit
Each firm may have a tiny ‘monopoly’ because of the differentiation of their product
Firm has some control over price
Examples – restaurants, professions – solicitors, etc., building firms – plasterers, plumbers, etc.

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Market Structure

Oligopoly – Competition amongst the few

Industry dominated by small number of large firms
Many firms may make up the industry
High barriers to entry
Products could be highly differentiated – branding or homogenous
Non–price competition
Price stability within the market - kinked demand curve?
Potential for collusion?
Abnormal profits
High degree of interdependence between firms

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Market Structure

Examples of oligopolistic structures:

Supermarkets
Banking industry
Chemicals
Oil
Medicinal drugs
Broadcasting

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Market Structure

Measuring Oligopoly:
Concentration ratio – the proportion of market share accounted for by top X number of firms:

E.g. 5 firm concentration ratio of 80% - means top 5 five firms account for 80% of market share
3 firm CR of 72% - top 3 firms account for 72% of market share

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Market Structure

Duopoly:
Industry dominated by two large firms
Possibility of price leader emerging – rival will follow price leaders pricing decisions
High barriers to entry
Abnormal profits likely

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Market Structure

Monopoly:
Pure monopoly – industry is the firm!
Actual monopoly – where firm has >25% market share
Natural Monopoly – high fixed costs – gas, electricity, water, telecommunications, rail

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Market Structure

Monopoly:

High barriers to entry
Firm controls price OR output/supply
Abnormal profits in long run
Possibility of price discrimination
Consumer choice limited
Prices in excess of MC

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Market Structure

Advantages and disadvantages of monopoly:
Advantages:

May be appropriate if natural monopoly
Encourages R&D
Encourages innovation
Development of some products not likely without some guarantee of monopoly in production
Economies of scale can be gained – consumer may benefit

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Market Structure

Disadvantages:

Exploitation of consumer – higher prices
Potential for supply to be limited - less choice
Potential for inefficiency –

X-inefficiency – complacency over controls on costs

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Market Structure

Kinked Demand Curve

Price

Quantity

D = elastic

D = Inelastic

£5

100

Kinked D Curve

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The intention of this slide is to demonstrate the principle of the kinked demand curve. The slide starts with the vertical and horizontal axes. A demand curve appears – relatively elastic and a price of £5 and q 100 appear. The explanation at this point would imply asking students what would happen if the producer increased price but nobody else in the industry followed? Hopefully students will see that the demand would fall significantly. By this stage students should be aware of the impact on total revenue as a result of this action. The next assumption rests on the firm facing an inelastic demand curve; in this case the firm believes that firms will follow suit in reducing price – the effect is to lead to only a small gain in sales – total revenue would again fall. Assuming the two characteristics would suggest a kinked demand curve and price stability existing in the industry with the likely outcome being non-price comptition.