Introduction to Market Structures

Alternative market structures

▪ Classifying markets by ▪ The four market

degree of competition structures
• number of firms • perfect competition
• freedom of entry to • monopoly
industry • monopolistic competition
• nature of product • oligopoly
• nature of demand curve
The Degree of Competition

▪ Structure → conduct → performance

 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
foreign exchange
(approximately)
Plumbers,
hairdressers,
restaurants
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Prescription
Restricted or drugs produced
completely under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect
foreign exchange
competition
(approximately)
Plumbers,
Monopolistic
hairdressers,
competition
restaurants
Downward sloping.
Relatively inelastic
Oligopoly
(shape depends on
reactions of rivals)
Prescription
Restricted or drugs produced
Monopoly completely under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect Very
foreign exchange
competition many
(approximately)
Plumbers,
Monopolistic Many /
hairdressers,
competition several
restaurants
Downward sloping.
Relatively inelastic
Oligopoly Few
(shape depends on
reactions of rivals)
Prescription
Restricted or drugs produced
Monopoly One completely under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect Very
Unrestricted foreign exchange
competition many
(approximately)
Plumbers,
Monopolistic Many /
Unrestricted hairdressers,
competition several
restaurants
Downward sloping.
Relatively inelastic
Oligopoly Few Restricted
(shape depends on
reactions of rivals)
Prescription
Restricted or drugs produced
Monopoly One completely under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect Very Homogeneous
Unrestricted foreign exchange
competition many (undifferentiated)
(approximately)
Plumbers,
Monopolistic Many /
Unrestricted Differentiated hairdressers,
competition several
restaurants
Downward sloping.
Undifferentiated Relatively inelastic
Oligopoly Few Restricted
or differentiated (shape depends on
reactions of rivals)
Prescription
Restricted or drugs produced
Monopoly One completely Unique under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect Very Homogeneous
Unrestricted foreign exchange
competition many (undifferentiated)
(approximately)
Plumbers,
Monopolistic Many /
Unrestricted Differentiated hairdressers,
competition several
restaurants
Downward sloping.
Petrol, cars,
Undifferentiated Relatively inelastic
Oligopoly Few Restricted electrical
or differentiated (shape depends on
appliances
reactions of rivals)
Prescription
Restricted or drugs produced
Monopoly One completely Unique under a patent,
blocked local water
company
 Features of the four market structures

Implications for
Number Freedom of
Type of market Nature of product Examples demand curve
of firms entry
faced by firm

Cabbages,
Perfect Very Homogeneous Horizontal:
Unrestricted foreign exchange
competition many (undifferentiated) firm is a price taker
(approximately)
Plumbers,
Monopolistic Many / Downward sloping,
Unrestricted Differentiated hairdressers,
competition several but relatively elastic
restaurants
Downward sloping.
Petrol, cars,
Undifferentiated Relatively inelastic
Oligopoly Few Restricted electrical
or differentiated (shape depends on
appliances
reactions of rivals)
Prescription Downward sloping:
Restricted or drugs produced more inelastic than
Monopoly One completely Unique under a patent, oligopoly. Firm has
blocked local water considerable
company control over price
Q
Under which of the following market structures
does Keells Super operate?

A. Perfect competition

B. Monopolistic competition

C. Oligopoly

D. Monopoly
Perfect competition

▪ Assumptions
• large number of buyers and sellers who are all small relative
to the size of the market
• identical/homogenous goods
▪ buyers only care about price
• no barriers to entry or exit
• perfect knowledge
▪ These assumptions mean that firms are price takers
• Infinetly elastic demand curve
 Short-run equilibrium of industry and firm
under perfect competition
Firm is a price taker. Price
is given by the market.
P £
S MC AC

Pe D = AR
AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

Q
Under perfect competition a profit-maximising
firm will increase output if:

A. marginal cost is less than price.

B. price exceeds marginal revenue.

C. marginal revenue equals average revenue.

D. marginal cost exceeds marginal revenue.

E. marginal cost equals marginal revenue.

Q
The table shows the total costs of a perfectly
competitive firm at different levels of output. When
average revenue is £4, what is the most profitable
output?

A. 10
Output TC(£)
B. 11 10 30
11 32
C. 12
12 34
D. 13 13 37
14 42
E. 14
15 50
F. 15
 Loss minimising under perfect competition
Loss is minimised
where MC = MR.
P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

QA perfectly competitive firm is producing 1000
units of output per week where TFC = £1000,
TVC = £1200 and MC = £1.00. If the market price is
£1.50, what should the firm do?

A. Raise its price.

B. Decrease output.

C. Increase output.

D. Maintain output at its present level.

E. Cease production altogether.

 Deriving the short-run supply curve

P S £
MC = S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O
Q (millions) Q (thousands)

(a) Industry (b) Firm

Perfect competition

▪ Long-run equilibrium of the firm

• all supernormal profits competed away
 Long-run equilibrium under perfect competition
Profits return
to normalprofits
New firms enterSupernormal

P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Perfect Competition

▪ Incompatibility of economies of scale with perfect

competition
▪ Benefits of perfect competition
• price equals marginal cost
• prices kept low
• firms must be efficient to survive
Monopoly

▪ Reasons for barriers to entry

• economies of scale
• natural monopoly
• absolute cost advantages
• switching costs
• network externalities
• product differentiation and brand loyalty
• legal restrictions
• mergers and takeovers
• aggressive tactics
Q
Which one of the following would not be a barrier
to firms entering an industry?

A. An upward-sloping long-run average cost curve

B. Patents on key processes

C. Substantial economies of scale

D. Large initial capital costs

E. The threat of takeover by the existing firm(s)

Monopoly

▪ The monopolist’s demand curve

• downward sloping
• MR below AR
 Average and marginal revenue under monopoly
£

AR
MR
O Q
Monopoly

▪ Equilibrium price and output

• output where MC = MR
 Profit maximising under monopoly
£ MC
Profit maximised
at output of Qm
(where MC = MR)

MR
O Qm Q
Monopoly

▪ Equilibrium price and output

• price given by demand (AR) curve
• Supernormal profit can persist in long run
 Profit maximising under monopoly
£ MC

Total profit AC

AR

AC

AR
MR
O Qm Q
Q
The diagram shows a monopoly. Which letter
gives the profit-maximising price?
£
A. MC
AC
B.
A
C. B
C
D
D.
E AR
E.

O MR Q
Monopoly

▪ Disadvantages of monopoly
• high prices/low output: short run
• high prices/low output: long run
• lack of incentive to innovate
• X-inefficiency
▪ Advantages of monopoly
• economies of scale
• profits can be used for R&D and investment
• potential for high profits encourages innovation
• competition for corporate control
Monopolistic competition

▪ Assumptions of monopolistic competition

• many or several firms
• free entry
• differentiated product
▪ Equilibrium of the firm
• short run : possibility for supernormal profits
▪ MR = MC
Monopolistic Competition

▪ Assumptions of monopolistic competition

▪ Equilibrium of the firm
• short run
• Long run (underutilisation of capacity in the long run)
Monopolistic competition

▪ Limitations of the model

• imperfect information
• difficulty in identifying industry demand curve
• entry may not be totally free
• indivisibilities
• importance of non-price competition
▪ The public interest
• comparison with perfect competition
Oligopoly

▪ Key features of oligopoly

• barriers to entry
• interdependence of firms
• incentives to compete or to collude?
▪ Factors favouring collusion
• few firms, open with each other
• similar production methods; similar products
• significant entry barriers
• stable market
Oligopoly

▪ Collusive oligopoly: cartels

• equilibrium of the industry

• allocating and enforcing quotas

Q
In which of the following circumstances would a
cartel be most likely to work?

A. The coffee market, where the product is standardised

and there are many coffee growers.
B. The market for copper, where there are very few
producers and the product is standardised.
C. The car industry, where there are few producers but
there is great product differentiation.
D. The fast-food market, where there are many producers
but the demand for fast food is inelastic.
$ per barrel Oil prices (Brent crude)
130
Recovery falters
120 Banking turmoil and
Actual price onset of recession
110 Cost in 1973 prices
Continuing worries about
100 supply and rapid growth
in demand from China
90 and India

80
Invasion
Revolution
OPEC’s first New OPEC of Iraq Increase
70 in Iran quotas
quotas in output
Worldwide of shale oil
60 Iraq invades Iraq invades slowdown
Iran Kuwait
50 Yom Kippur Recession
War: Arab in Far East
oil embargo Cease-fire in
40 Iran-Iraq war OPEC refuses
Worldwide Start of
recovery to cut output
30 global
First oil from
recovery OPEC/
North Sea
20 non-OPEC
agreement
10

0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Sources: Nominal oil price data from Global Economic Monitor (GEM), Commodities (World Bank); Price Index from Data Extracts (OECD).
Q&A