Market Structure

Market Structure
• Market structure – identifies how a market
is made up in terms of:
– The number of firms in the industry
– The nature of the product produced
– The degree of monopoly power each firm has
– The degree to which the firm can influence price
– Profit levels
– Firms’ behaviour – pricing strategies, non-price competition,
output levels
– The extent of barriers to entry
– The impact on efficiency
 Market Structure
Perfect Pure
Competition Monopoly

More competitive (fewer imperfections)

 Market Structure
Perfect Pure
Competition Monopoly

Less competitive (greater degree

of imperfection)
 Market Structure
Pure
Perfect
Monopoly
Competition

Monopolistic Competition Oligopoly Duopoly Monopoly

The further right on the scale, the greater the degree

of monopoly power exercised by the firm.
 Market Structure
Characteristics: Look at these everyday products – what type of
market structure are the producers of these products operating
in?

Electric Remember to
think about the
Guitar – nature of the
Jazz
VodkaBody product, entry and
exit, behaviour of
the firms, number
and size of the
firms in the
Mercedes CLK Coupe industry.
You might even
have to ask what
Canon SLR Camera
Bananas the industry is??
 Perfect Competition
• One extreme of the market structure spectrum
• Characteristics:
– Large number of firms
– Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
– Freedom of entry and exit into and out
of the industry
– Firms are price takers – have no control
over the price they charge for their product
– Each producer supplies a very small proportion
of total industry output
– Consumers and producers have perfect knowledge
about the market
 Perfect Competition
Diagrammatic representation Given
AtThe
The The
the
MC
average
this industry
assumption
is the
output costcost
price
theof
curveofisprofit
is the
firm
maximisation,
producing
determined
standard ‘U’ –additional
the by
firm
shaped theproduces
demand
curve.
Cost/Revenue atis
MCanmaking
(marginal)
and
output
cuts supply
the ACnormal
where
units of MC
of atprofit.
theoutput.
curve =
industry
MR
its It
MC This
(Q1).falls
lowestas is
Thisat a
a whole.long
first
output
point (due run
level
The
because to firm
the
is
of athe
law
is a of
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equilibrium position. rises
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veryof
mathematical small
the total
returns)
supplier
industry
relationshipthen
within
supply.
asthe
betweenoutput
industry
rises.and
marginal andhas no
average
AC control over price. They will
values.
sell each extra unit for the
same price. Price therefore
= MR and AR

P = MR = AR

Q1 Output/Sales
 Perfect Competition
Diagrammatic representation Because the model assumes
perfect
Average
Nowlower
The knowledge,
assumeand
ACMarginal
aand
firmMC the firm
makes
costs
would
Cost/Revenue gains the advantage for
be only
to a
MC could
some that
imply
short
lower
be
form
time
its product
earning
expected
of modification
the
before
butabnormal
price,
firm istonow
or gainsinothers
the
some copy
short
profit
MC1 the
run, idea
formremains
(AR>AC) or
of cost are attracted
advantage
the same.by
represented to
(say the
the a
industry by
new production
grey area. the existence
method). of
AC abnormal
What would profit.
happen?If new firms
enter the industry, supply will
increase, price will fall and the
AC1 firm will be left making normal
profit once again.

P = MR = AR
Abnormal profit
AC1
P1 = MR1 = AR1

Q1 Q2 Output/Sales
 Monopolistic or Imperfect
Competition
• Where the conditions of perfect competition
do not hold, ‘imperfect competition’ will exist
• Varying degrees of imperfection give rise to
varying market structures
• Monopolistic competition is one of these –
not to be confused with monopoly!
 Monopolistic or Imperfect
Competition
• Characteristics:
– Large number of firms in the industry
– May have some element of control over price due to
the fact that they are able to differentiate their product
in some way from their rivals – products are therefore
close, but not perfect, substitutes
– Entry and exit from the industry is relatively easy –
few barriers to entry and exit
– Consumer and producer knowledge imperfect
 Monopolistic or Imperfect
Competition
Implications for the diagram:
MC WeMarginal
assumeCost that and
the firm
Cost/Revenue This
IfThe
the
is demand
Since firm
a the
short
produces
run
curve
additional equilibrium
Q1
facing
and
produces
Averagewhere Cost willMR be = MCthe
position
sells
the firm
each
revenue forwill
a
unit
firm
befor
received downward
in£1.00
a
from on
(profit
same maximising
shape. However, output). At
monopolistic
average
sloping
each with
and
unit market
soldrepresents
thefalls,
costthe(on
thisbecause
output level,
the products
AR>AC and
structure.
average)
the AR
MR curve earned
forlies
each from
under unitsales.
being
the
AC theare
60p,
firmdifferentiated
makes abnormal
the firm will make 40p x
AR curve.
in
£1.00 profit
some(theway,
greythe shaded
firm willarea).
Q1 in abnormal profit.
only be able to sell
extra output by lowering
Abnormal Profit price.

£0.60

MR D (AR)
Q1
Output / Sales
 Monopolistic or Imperfect
•
Competition
Some important points about monopolistic
competition:
– May reflect a wide range of markets
– Not just one point on a scale – reflects many
degrees
of ‘imperfection’
– Examples?
 Monopolistic or Imperfect
• Restaurants Competition
• Plumbers/electricians/local builders
• Solicitors
• Private schools
• Plant hire firms
• Insurance brokers
• Health clubs
• Hairdressers
• Estate agents
 Oligopoly
• Competition between the few
– May be a large number of firms in the industry but the
industry is dominated by a small number of very large
producers
• Concentration Ratio – the proportion of total
market sales (share) held by the top 3,4,5, etc firms:
– A 4 firm concentration ratio of 75% means the top 4
firms account for 75% of all the sales in the industry
 Oligopoly
• Example:
The music industry has
• Music sales – a 5-firm concentration
ratio of 75%.
Independents make up
25% of the market but
there could be many
thousands of firms that
make up this
‘independents’ group.
An oligopolistic market
structure therefore
may have many firms
in the industry but it is
dominated by a few
large sellers.
Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html
 Oligopoly

• Features of an oligopolistic market

structure:
– Price may be relatively stable across the industry

– Potential for collusion (secret understanding esp. for a

fraudulent purpose)
– Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
– Goods could be homogenous or highly differentiated
– Branding and brand loyalty may be a potent (powerful)
source of competitive advantage
– Non-price competition may be prevalent
– High barriers to entry
 Oligopoly
Price The kinked demand curve - an explanation for price stability?

The
If thefirm
Assume
The firmthe
therefore,
seeks
principle firmofto
is
thelower
effectively
chargingits price
kinked a faces
demand
priceto of
gain
a
£5‘kinked
acurve
and competitive
demand
producing
rests on curve’
advantage,
an the forcing
output of its
principle itrivals
100. to
will follow
maintain asuit.
that: stableAnyorgains
rigid pricing
it makes will
If it chose to raise price above £5, its
quickly beOligopolistic
structure. lost and the firms % changemay in
rivals
a. would
If a firmnotraises
followitssuit
price,
anditsthe firm
demand will
overcome this
beby smaller
engagingthaninthenon-%
effectively
rivalsfaces
will not
an follow
elasticsuit
demand
reduction
price competition.
in price – total revenue
curve for its product (consumers would
would
b. Ifagaina firmfall as theitsfirm
lowers nowitsfaces
price,
buy from the cheaper rivals). The %
£5 a relatively
rivalsinelastic
will all dodemand
change in demand would be greater
the same curve.
than the % change in price and TR
Total would fall.

Revenue B
Total Revenue A
D = elastic
Total Revenue B Kinked D Curve
D = Inelastic

100 Quantity
 Duopoly

• Market structure where the industry is

dominated by two large producers
– Collusion may be a possible feature
– Price leadership by the larger of the two firms may
exist – the smaller firm follows the price lead of the
larger one
– Highly interdependent
– High barriers to entry
– In reality, local duopolies may exist
 Monopoly
• Pure monopoly – where only one producer
exists in the industry
• In reality, rarely exists – always some form of
substitute available!
• Monopoly exists, therefore, where one firm
dominates the market
• Firms may be investigated for examples of
monopoly power when market share exceeds
25%
 Monopoly
• Monopoly power – refers to cases where
firms influence the market in some way
through their behaviour – determined by the
degree of concentration in the industry

– Influencing prices
– Influencing output
– Erecting barriers to entry
– Pricing strategies to prevent or stifle competition
– May not pursue profit maximisation
 Monopoly
• Origins of monopoly:
– Through growth of the firm
– Through amalgamation, merger or takeover
– Through acquiring patent or license
– Through legal means – Nationalisation etc..
 Monopoly
• Summary of characteristics of firms exercising
monopoly power:
– Price – could be deemed too high, may be set to
destroy competition, price discrimination possible.
– Efficiency – could be inefficient due to lack of
competition or…
• could be higher due to availability of high profits
 Monopoly
• Problems with models – a reminder:
– Often difficult to distinguish between a monopoly
and an oligopoly – both may exhibit behaviour
that reflects monopoly power
– Monopolies and oligopolies do not necessarily aim
for traditional assumption of profit maximisation
– Degree of contestability of the market may influence
behaviour
– Monopolies not always ‘bad’ – may be desirable
in some cases but may need strong regulation
– Monopolies do not have to be big – could exist locally
 Monopoly
Costs / Revenue
This(D)
AR
Given isthe
both
curve
barriers
the
forshort
a to
monopolist
entry,
run and
MC likely
the
long monopolist
run
to be
equilibrium
relatively
will be
position
price
able to
inelastic.
exploit
for a monopoly
abnormal
Output assumed
profits in the
to
£7.00
be atrun
long profit
as maximising
entry to the output
(note caution
market is restricted.
here – not all
AC monopolists may aim
Monopoly for profit maximisation!)

Profit
£3.00

MR AR
Output / Sales
Q1