Market Structures

Dr. Md. Shamsul Arefin

 Market Structures
• Type of market structure influences how a
firm behaves:
– Pricing
– Supply
– Barriers to Entry
– Efficiency
– Competition
 Market Structures
• Degree of competition in the industry
• High levels of competition – Perfect
competition
• Limited competition – Monopoly
• Degrees of competition
 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
 Market Structures & Competition
• There are several possibilities for free
market competition:
• Perfect Competition
• Monopolistic Competition
• Monopoly
• Oligopoly
 Perfect Competition

• A large # of buyers and sellers exchange identical

products under 5 conditions:
• 1. Large # of buyers and sellers
• 2. Products are identical between suppliers
• 3. Buyers and sellers act independently
• 4. Buyers and sellers are well-informed
• 5. Buyers and seller are free to enter, conduct, or
get out of business.
• No Barriers to entry other than start-up costs or
technology
 Perfect Competition
• 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
 Examples of perfect competition
• Examples of perfect competition:
– Financial markets – stock exchange,
currency markets, bond markets?
– Agriculture?
• To what extent?
 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
 What happens in a competitive
environment?

• 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!
 Price and Output
One of the primary characteristics of perfectly competitive markets is that they are efficient.

Market Equilibrium in Perfect Competition

Supply
Price

Equilibrium
Price
Equilibrium
Quantity

Demand

Quantity
 Oligopoly

• Oligopoly describes a market dominated by a few large, profitable

firms through collusion or cartel. It is further away from perfect
competition than monopolistic competition is. Final prices are
higher for consumers.
• Collusion--an agreement among members of an oligopoly to set
prices and production levels.
• 2 forms of collusion: Price- fixing is an agreement among firms to
sell at the same or similar prices. Dividing up the market is
another. Collusion is illegal in the U.S.
• Cartel--an association by producers established to coordinate
prices and production.
• Oligopolists act independently by lowering prices soon after the
first seller announces the cut, but they typically prefer non-price
competition.
Oligopoly – Competition amongst the few

• 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
 Examples of oligopolistic structures
• Examples of oligopolistic structures:
– Supermarkets
– Banking industry
– Chemicals
– Oil
– Medicinal drugs
– Broadcasting
 Duopoly:
• 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
 Monopoly

• Only 1 seller of a particular product.

• It’s VERY DIFFICULT to define a true
monopoly
• Americans prefer competitive trade; few
monopolies in U.S.
• The monopolist is larger than a perfect
competitor, allowing it to be a price MAKER.
• nowadays the trend is to analyze Barriers to
Entry
 Monopoly:
• 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
 Monopoly
• 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
 Types of Monopolies
• Economies of Scale--If a firm's start-up costs are high, and its
average costs fall for each additional unit it produces, then it enjoys
what economists call economies of scale. An industry that enjoys
economies of scale can easily become a natural monopoly. Good
example: Broadband and Cable TV industries

• Natural Monopolies--a market that runs most efficiently when one

large firm provides all of the output. Sometimes the development of a
new technology can destroy a natural monopoly.

• Geographic Monopoly—occurs when a location cannot support two or

more businesses EX: Small-town drugstore or barbershop
• Government Monopoly—see next slide
 Types of Gov’t Monopolies
• Technological Monopolies
The government grants patents, licenses that give the
inventor of a new product the exclusive right to sell it
for a certain period of time, and copyrights, the
exclusive right to protect written or performed work.
EX: Artists get lifetime + 50 yrs.

• Franchises and Licenses

A franchise is a contract that gives a single firm the right
to sell its goods within an exclusive market. A license is
a government-issued right to operate a business. Local
cable companies are frequently franchised.

• Industrial Organizations
In rare cases, such as sports leagues, the government
allows companies in an industry to restrict the number
of firms in the market.
 Advantages and disadvantages of monopoly

• 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
 Advantages and disadvantages of monopoly

• Disadvantages:
– Exploitation of consumer – higher prices
– Potential for supply to be limited - less choice
– Potential for inefficiency –
 Imperfect or Monopolistic
Competition

• 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.
 Monopolistic Competition

In monopolistic competition, many companies compete in an open market to sell

products which are similar, but not identical. Best example:
OTC pain relievers

• 1. Many Firms--As a rule, monopolistically competitive markets are not marked

by economies of scale or high start-up costs, allowing more firms.

• 2. Few Artificial Barriers to Entry--Firms in a monopolistically competitive

market do not face high barriers to entry.

• 3. Slight Control over Price--Firms in a monopolistically competitive market have

some freedom to raise prices because each firm's goods are a little different
from everyone else's. EX: Tylenol, Aleve, and Bayer

• 4. Differentiated Products--Firms have some control over their selling price

because they can differentiate, or distinguish, their goods from other products
in the market. EX: Excedrin better for headache than Tylenol
•
 Monopolistic Competition
Monopolistic competition refers to a market situation with a relatively large number
of sellers offering similar but not identical products. Examples are fast food
restaurants and clothing stores.

Characteristics
1. A lot of firms: each has a small percentage of the total market.
2. Differentiated products: variety of the product makes this model different from
pure competition model. Product differentiated in style, brand name, location,
advertisement, packaging, pricing strategies, etc.
3. Easy entry or exit.

Demand Curve
The firm’s demand curve is highly elastic, but not perfectly elastic. It is more elastic
than the monopoly’s demand curve because the seller has many rivals producing
close substitutes; it is less elastic than pure competition, because the seller’s product
is differentiated from its rivals.
 Price Discrimination

Price discrimination is selling a good or service at a number of different

prices, and the price differences is not justified by the cost differences. In
order to price discriminate, a monopoly must be able to
1. be able to segregate the market
2. make sure that buyers cannot resell the original product or services.

Perfect price discrimination is a price discrimination that extracts the

entire consumer surplus by charging the highest price that consumer are
willing to pay for each unit.

As a result, the demand curve becomes the MR curve for a perfect price
discriminator. Firms capture the entire consumer surplus and maximize
economic profit.
 Non-Price Competition

• Non-price competition is a way to attract customers through style,

service, or location, but not a lower price

• 1. Characteristics of Goods--The simplest way for a firm to

distinguish its products is to offer a new size, color, shape, texture,
or taste.

• 2. Location of Sale--A convenience store in the middle of the desert

differentiates its product simply by selling it hundreds of miles away
from the nearest competitor.

• 3. Service Level--Some sellers can charge higher prices because

they offer customers a higher level of service. EX: Insurance
companies

• 4. Advertising Image--Firms also use advertising to create apparent

differences between their own offerings and other products in the
marketplace.
 Predatory Pricing
• The concept: Drive your competitors out of business
by charging less than cost for a good or service. Once
your opponents are gone, raise prices and screw
consumers.

• How do you define it? Grocery stores often sell some

items under cost to entice consumers. Is that wrong?
• Predatory pricing cannot work in the long-term.
 Inadequacies in the Market
• Inadequate competition—decreases in competition due
to mergers/acquisitions can create market failure
• Resource problems: Inefficient resource allocation
occurs when there’s no incentives to use resources
wisely
• Monopolies can reduce supply, raise prices
• A large business can exert political power
• Consumers, businesspeople, and government officials
must be able to obtain market conditions quickly and
easily.
 Price Discrimination

Price discrimination is the division of customers into groups

based on how much they will pay for a good.

• Although price discrimination is a feature of monopoly, it can be

practiced by any company with market power.

• Market power is the ability to control prices and total market

output.

• Targeted discounts, like student discounts and manufacturers’

rebate offers, are one form of price discrimination.

• Price discrimination requires some market power, distinct

customer groups, and difficult resale.
 Review
The differences between perfect competition and monopolistic competition
arise because
– (a) in perfect competition the prices are set by the government.
– (b) in perfect competition the buyer is free to buy from any seller he or
she chooses.
– (c) in monopolistic competition there are fewer sellers and more
buyers.
– (d) in monopolistic competition competitive firms sell goods that are
similar enough to be substituted for one another.

An oligopoly is
– (a) an agreement among firms to charge one price for the same good.
– (b) a formal organization of producers that agree to coordinate price
and output.
– (c) a way to attract customers without lowering price.
– (d) a market structure in which a few large firms dominate a market.
 Comparison of Market Structures
Markets can be grouped into four basic structures: perfect competition, monopolistic competition,
oligopoly, and monopoly.

Comparison of Market
Structures Perfect Monopolistic Oligopoly Monopoly
Competition Competition

Number of firms Many Many Two to four One

dominate
Variety of goods None Some Some None

Control over prices None Little Some Complete

Barriers to entry and None Low High Complete

exit
Examples Wheat, Jeans, Cars, Public water
shares of books movie
stock studios
 Deregulation
• Deregulation is the removal of some government
controls over a market
• Deregulation is used to promote competition.
• Many new competitors enter a market that has been
deregulated. This is followed by an economically
healthy weeding out of some firms from that market,
which can be hard on workers in the short term.
• EX: Telecommunications sector in U.S. Effects have
been mixed.
 Government and Competition
• Government policies keep firms from controlling the prices
and supply of important goods. Antitrust laws are laws that
encourage competition.
• Sherman Antitrust Act (1890) was the 1 st U.S. law against
monopolies
• Clayton Antitrust Act (1914) outlawed price discrimination
• Federal Trade Commission (1914) was empowered to issue
cease and desist orders to companies practicing unfair
business practices
• Robinson-Patman Act (1936) outlawed special discounts to
some consumers
• Government also taxes to regulate businesses with negative
externalities (Chemical manufacturers)
• Government also requires public disclosure
 Review—Role of Gov’t
Antitrust laws allow the U.S. government to do all of the
following EXCEPT
– (a) regulate business practices.
– (b) stop firms from forming monopolies.
– (c) prevent firms from selling new experimental
products.
– (d) break up existing monopolies.

The purpose of both deregulation and antitrust laws is

to
– (a) promote competition.
– (b) promote government control.
– (c) promote efficient commerce/trade.
– (d) prevent monopolies.
 Ref
1. Economics: Paul A Samuelson & William D Nordhaus
2. Macroeconomics: M. Parkin
3. Microeconomics: N. Gregory Mankiw
4.. Economics: Roger A Arnold
5. Managerial Economics: William F. Samuelson and Stephen G. Marks
6. Managerial Economics in a Global Economy: Dominick Salvatore

7. Krugman, Paul; Obstfeld, Maurice (2008). International Economics: Theory

and Policy. Addison-Wesley. ISBN 0-321-55398-5.

8. Poiesz, Theo B. C. (2004). "The Free Market Illusion Psychological

Limitations of Consumer Choice". Tijdschrift voor Economie en
Management. 49 (2): 309–338.

9. Pindyck, R.; Rubinfeld, D. (2001). Microeconomics (5th ed.). London:

Prentice-Hall. p. 427-435. ISBN 0-13-030472-7.
24 December 2019 Dr. Md. Shamsul Arefin