Market Structures

An industry consists of all firms making similar or

identical products.
An industrys market structure depends on the number
of firms in the industry and how they compete.
Here are the four basic market structures:
1. Perfect competition
2. Monopoly
3. Oligopoly
4. Monopolistic competition

Perfect competition
Perfect competition happens when numerous small
firms compete against each other.
Firms in a competitive industry produce the socially
optimal output level at the minimum possible cost per
unit.

Key characteristics
Perfectly competitive markets exhibit the following
characteristics:
There is perfect knowledge/Information
There are no barriers to entry into or exit out of the
market.
Firms produce homogeneous, identical, units of output
that are not branded.
Each unit of input, such as units of labour, are also
homogeneous.
No single firm can influence the market price, or
market conditions.
There are a very large numbers of firms in the market.
There is no need for government regulation, except to
make markets more competitive.

The firm as price taker

The single firm takes its price from the industry, and is,
consequently, referred to as a price taker.
The industry is composed of all firms in the industry
and the market price is where market demand is equal
to market supply.
Each single firm must charge this price and cannot
diverge from it.

Monopoly
A monopoly is a firm that has no competitors in its
industry.
It reduces output to drive up prices and increase
profits.
By doing so, it produces less than the socially optimal
output level and produces at higher costs than
competitive firms.
A pure monopoly is a single supplier in a market.
For the purposes of regulation, monopoly power exists
when a single firm controls 25% or more of a particular
market.

Formation of monopolies
Monopolies can form for a variety of reasons, including
the following:
1. If a firm has exclusive ownership of a scarce resource
2. Governments may grant a firm monopoly status
3. Producers may have patents over designs, or copyright
over ideas, characters, images, sounds or names

A monopoly could be created following the merger of

two or more firms.
Given that this will reduce competition, such mergers
are subject to close regulation and may be prevented if
the two firms gain a combined market share of 25% or
more.

Advantages of monopolies
They can benefit from economies of scale, and may be
natural monopolies
Domestic monopolies can become dominant in their
own territory and then penetrate overseas markets,
earning a country valuable export revenues. This is
certainly the case with Microsoft

Disadvantages of monopoly
Restrict output onto the market.
Charge a higher price than in a more competitive
market.
Reduce consumer surplus and economic welfare.
Restrict choice for consumers.
Reduce consumer sovereignty.

Oligopoly
An oligopoly is an industry with only a few firms.
If they collude, they reduce output and drive up profits
the way a monopoly does.
However, because of strong incentives to cheat on
collusive agreements, oligopoly firms often end up
competing against each other.
Although only a few firms dominate, it is possible that
many small firms may also operate in the market.
For example, major airlines like British Airways (BA)
and Air France operate their routes with only a few
close competitors, but there are also many small
airlines catering for the holidaymaker or offering
specialist services.

Concentration ratios
Oligopolies may be identified using concentration
ratios, which measure the proportion of total market
share controlled by a given number of firms.
When there is a high concentration ratio in an industry,
economists tend to identify the industry as an
oligopoly.

Example of a hypothetical concentration ratio

The following are the annual sales, in m, of the six firms
in a hypothetical market:
A = 56
B = 43
C = 22
D = 12
E=3
F=1
In this hypothetical case, the 3-firm concentration ratio is
88.3%, that is 121/137 x 100.

Key characteristics
Interdependence
Strategy
Barriers to entry
Economies of large scale production
Ownership or control of a key scarce resource
High set-up costs
High R&D costs

The disadvantages of oligopolies

High concentration reduces consumer choice.
Cartel-like behaviour reduces competition and can
lead to higher prices and reduced output.
Firms can be prevented from entering a market
because of deliberate barriers to entry.
There is a potential loss of economic welfare.
Oligopolists may be allocatively and productively
inefficient

The advantages of oligopolies

Oligopolies may adopt a highly competitive strategy, in
which case they can generate similar benefits to more
competitive market structures, such as lower prices
Oligopolists may be dynamically efficient in terms of
innovation and new product and process development
Price stability may bring advantages to consumers and
the macro-economy because it helps consumers plan
ahead and stabilises their expenditure, which may help
stabilise the trade cycle.

Monopolistic competition
In monopolistic competition, an industry contains
many competing firms, each of which has a similar but
at least slightly different product.
Restaurants, for example, all serve food but of
different types and in different locations.
Production costs are above what could be achieved if
all the firms sold identical products, but consumers
benefit from the variety.

Characteristics
Each firm makes independent decisions about price
and output, based on its product, its market, and its
costs of production
Knowledge is widely spread between participants, but
it is unlikely to be perfect.
The entrepreneur has a more significant role than in
firms that are perfectly competitive because of the
increased risks associated with decision making
There is freedom to enter or leave the market, as there
are no major barriers to entry or exit.
Firms are price makers and are faced with a downward
sloping demand curve

Examples of monopolistic competition

The restaurant business
Hotels and pubs
General specialist retailing
Consumer services, such as hairdressing

The advantages of monopolistic competition

There are no significant barriers to entry; therefore
markets are relatively contestable.
Differentiation creates diversity, choice and utility.
The market is more efficient than monopoly but less
efficient than perfect competition

The disadvantages of monopolistic competition

Some differentiation does not create utility but
generates unnecessary waste, such as excess
packaging. Advertising may also be considered
wasteful, though most is informative rather than
persuasive.
There is allocative inefficiency in both the long and
short run.