Krugman/Wells Microeconomics in Modules and Economics in Modules Third Edition Module 24 Introduction to Market Structure

What You Will Learn The meaning and dimensions of market structure The four principal types of market structure—perfect competition, monopoly, oligopoly, and monopolistic competition 2 of

Type of Market Structure Economists have developed four primary models of market structure: perfect competition, monopoly, oligopoly, and monopolistic competition. 3 of 18

Type of Market Structure This system of market structure is based on two dimensions: – The number of firms in the market (one, few, or many) – Whether the products are identical or differentiated 4 of 18

Types of Market Structure 5 of 18 Are Products Differentiated? How many firms are there? Oligopoly Perfect competition No One Few Many Yes Monopolistic competition Not applicable Monopoly This system of market structures is based on two dimensions:  The number of producers in the market (one, few, or many)  Whether the goods offered are identical or differentiated Differentiated goods are different but considered somewhat substitutable by consumers (think Coke versus Pepsi). This system of market structures is based on two dimensions:  The number of producers in the market (one, few, or many)  Whether the goods offered are identical or differentiated Differentiated goods are different but considered somewhat substitutable by consumers (think Coke versus Pepsi).

Perfect Competition A price-taking producer is one whose actions have no effect on the market price of the good it sells. A price-taking consumer is one whose actions have no effect on the market price of the good he or she buys. 6 of 18

Perfect Competition In a perfectly competitive market, all participants are price takers. In a perfectly competitive industry producers are price takers. 7 of 18

Two Necessary Conditions for Perfect Competition 1)For an industry to be perfectly competitive, it must contain many producers, none of whom has a large market share. – A producer’s market share is the fraction of the total industry output accounted for by that producer’s output. 8 of 18

Two Necessary Conditions for Perfect Competition 2)An industry can be perfectly competitive only if consumers regard the products of all producers as equivalent. – A good is a standardized product, also known as a commodity, when consumers regard the products of different producers as the same good. 9 of 18

Economics in Action What’s a Standardized Product? A perfectly competitive industry has a standardized product. People think the products are the same. Producers may try to convince consumers that their product is distinctive—even if it isn’t. So is an industry perfectly competitive if its products are indistinguishable but consumers perceive a difference? No. When it comes to defining the nature of competition, the consumer is always right. 10 of 18

Free Entry and Exit There is free entry and exit into and from an industry when new producers can easily enter into or leave that industry. Free entry and exit ensure that: – the number of producers in an industry can adjust to changing market conditions. – producers in an industry cannot artificially keep other firms out. 11 of 18

Monopoly A monopolist is the only producer of a good that has no close substitutes. An industry controlled by a monopolist is known as a monopoly, such as De Beers. 12 of 18

Monopoly The ability of a monopolist to raise its price above the competitive level by reducing output is known as market power. What do monopolists do with this market power? 13 of 18

Why Do Monopolies Exist? A monopolist has market power and as a result will charge higher prices and produce less output than a competitive industry. This generates profit for the monopolist in the short run and long run. 14 of 18

Why Do Monopolies Exist? Profits will not persist in the long run unless there is a barrier to entry. This can take the form of: – control of natural resources or inputs. – increasing returns to scale. – technological superiority. – government-imposed barriers, including patents and copyrights. 15 of 18

Oligopoly Oligopoly, a common market structure, arises from the same forces that lead to monopoly, except in weaker form. It is an industry with only a small number of producers. A producer in such an industry is known as an oligopolist. 16 of 18

Oligopoly When no one firm has a monopoly but producers nonetheless realize that they can affect market prices, an industry is characterized by imperfect competition. 17 of 18

Is It an Oligopoly—or Not? To get a better picture of market structure, economists often use a measure called the Herfindahl–Hirschman Index, or HHI. The HHI for an industry is the square of each firm’s share of market sales summed over the firms in the industry. For example, if an industry contains only three firms and their market shares are 60%, 25%, and 15%: 18 of 18 HHI = = 4,450

Is It An Oligopoly or Not? According to Justice Department guidelines, an HHI below 1,000 indicates a strongly competitive market; 1,000 to 1,800 indicates a somewhat competitive market; and over 1,800 indicates an oligopoly. In an industry with an HHI over 1,000, a merger that results in a significant increase in the HHI will receive special scrutiny and is likely to be disallowed. 19 of 18

Some Oligopolistic Industries 20 of 18

Monopolistic Competition In monopolistic competition: there are many competing producers. each producer sells a differentiated product. there is free entry and exit into and from the industry in the long run. 21 of 18

Summary 1.The four main types of market structure, based on the number of firms in the industry and product differentiation, are perfect competition, monopoly, oligopoly, and monopolistic competition. 2.In a perfectly competitive market all producers and all consumers are price takers—no one’s actions can influence the market price. 3.Two conditions are necessary for a perfectly competitive industry: many producers, none of whom has a large market share, and a standardized product or commodity. A third condition is often satisfied as well: free entry and exit into and from the industry. 22 of 18

Summary 4.A monopolist is the sole supplier of a good without close substitutes. An industry controlled by a monopolist is a monopoly. 5.Many industries are oligopolies, with only a few sellers. A duopoly has only two sellers. Oligopolies exist for more or less the same reasons as monopolies, but in weaker form. They are characterized by imperfect competition: firms compete but possess market power. 6.Monopolistic competition is a market structure in which there are many competing producers, each producing a differentiated product, and there is free entry and exit in the long run. 23 of 18