Introduction to Market Structure

Types of Market Structures 4 Primary Models Perfect Competition Monopoly Oligopoly Monopolistic Competition

Market structure is based on two dimensions The number of firms in the market (one, few or many) Whether the goods offered are identical or differentiated Differentiated goods are goods that are different but considered at least somewhat substitutable by consumers. (ex: Coke vs. Pepsi)

Perfect Competition Roles within competition Price taking firms A firm whose actions have no effect on the market price of the good or service it sells Price taking consumers A consumer whose actions have no effect on the market price of a good or service

Defining Perfect Competition Perfectly competitive markets A market in which all participants are price-takers This means that neither the consumption decisions by individual consumers nor production decisions by individual producers affect the market price. Supply and demand model is a model of a perfectly competitive market. Supply and demand is appropriate for some markets but not all.

Two necessary conditions for perfect competition It must contain many firms, none of whom have a large market share. In other words their share is a fraction of the total industry output accounted for by that firm’s output. Consumers regard the products of all firms as equivalent. Standardize product or commodity A product that consumers regard as the same good even when it comes from different firms.

Free Entry and Exit Most perfectly competitive industries have one more feature: it is easy for new firms to enter and old firms to leave. When there are no obstacles to entry or exit, we would say that the industry has free entry and exit.

Monopoly Defining Monopoly Monopolist A firm that is the only producer of a good that has no close substitutes An industry controlled by a monopolist is known as a monopoly

Why do monopolies exist? For a profitable monopoly to persist, something must keep others from going into the same business The “something” is known as barrier to entry

Four Principle Types of Barriers to Entry Control of a scarce resource or input Economies of Scale A monopoly created and sustained by economies of scale is called a natural monopoly. (ex: Utilities)

Technological Superiority Government-created barriers Patents Gives the inventor a temporary monopoly in the use or sale of an invention Copyrights Gives the creator of a literary or artistic work sole right to profit from that work.

Oligopoly An industry with only a few firms

Oligopolist A producer in an oligopoly industry. Compete with each other for sales Know their decisions about how much to produce will affect market price They have some market power

When firms compete and have market power, which enables them to affect market prices, economists call this situation- imperfect competition

Two types of imperfect competition Oligopoly Monopolistic Competition

Oligopolies are not necessarily made up of large firms The question to determine whether an industry is an oligopoly is how many competitors there are.

Two measures of market power Concentrated Ratios They measure the percentage of industry sales accounted for by the “x” largest firms Uses either 4-firm concentration ratio or the 8- firm concentration ratio A higher concentration ratio signals a market is more concentrated and thus is more likely to be an oligopoly

Herfindahl-Hirschman Index (HHI) It is the square of each firm’s share of market sales summed over the industry. It gives a picture of the industry’s market structure

Monopolist Competition It is a market structure in which there are many competing firms in an industry, each firms sells a differentiated product, and there is free entry into and exit from the industry in the long run. Each producer has some ability to set the price of her differentiated product, but how high the price can be set is limited because of other competing firms.

Defining Monopolistic Competition Large Numbers Has many firms and many competitors

Differentiated Product Each firm has a product that consumers view as somewhat distinct from the products of competing firms. But consumers also see these products as close substitutes.

Free Entry and Exit in the Long Run New firms, with their own distinctive products can enter the industry freely in the long run Firms will exit the industry if they find they are not covering their costs in the long run.

Monopolistic Competition Differences Not the same as Perfect Competition Firms have some power to set prices It is not pure Monopoly Firms face some competition Not an Oligopoly Many firms and free entry.