Market structures
Economists identify several market structures, including perfect competition, monopolistic competition, duopoly, oligopoly and monopoly.
We can identify the key differences in each market form, which revolve around:
- Knowledge
- Barriers to entry
- Number of firms
- Product differentiation
- Level of competition
- Price
- Level of profits
- Efficiency levels, and:
- Welfare
We can now apply these to different market structures:
- Knowledge is ‘complete’
- There are no barriers to entry or exit
- There are infinite numbers of competitive firms
- Products are identical
- Firms are price takers
- Super-normal profits are available in the short run, but not long run
- Firms are allocatively efficient in both the short and long run, but only productively efficient in the long run, and:
- Welfare is maximised
In the diagram we can see that, in the short run, the single firm can
gain super-normal profits. However, this acts as an incentive for new firms
to enter the market in anticipation of also making super-normal profits.
Given that there are no barriers to entry, and with perfect knowledge, firms
can enter. As they enter, the industry supply curve shifts to the
right, pushing down the industry price. The effect of this is to reduce the
super-normal profits available for each firm. Entry comes to an end when
only normal profits are available to the 'marginal' firm.
- Knowledge is only partial and asymmetric
- Minor barriers to entry exist
- There are large numbers of independent firms
- Products are differentiated
- Firms are price makers and can vary prices
- Super-normal profits are available in the short run, but not long run
- Firms are not allocatively or productively efficient in the short and long run, and:
- There is a welfare loss as price is greater than marginal cost
In a process similar to perfect competition, the firm operating under
monopolistic competition can gain super-normal profits in the short run.
This acts as an incentive for new firms to enter the market in anticipation
of also making super-normal profits. They can enter either by offering a
different product, or by making an 'existing' product more cheaply or more
effectively. As firms enter, the industry supply curve shifts to the
right, pushing down the industry price. As with perfect competition, the
effect of this is to reduce the super-normal profits available for each
firm, and entry comes to an end when only normal profits are available to
the 'marginal' firm.
- Knowledge is only partial and not symmetrical, with firms able to control information
- There are just a few interdependent firms
- Firms may engage in collusion, including overt, covert and tacit
collusion (see Game Theory)
- Products may be differentiated
- Price tends to remain ‘sticky ’- see the video for an explanation
- Knowledge is asymmetric, with the monopolist able to control information
- The monopolist is a 'price maker' and can set a price without taking
competitors into account - however, monopolists may not have absolute
power given that consumers may simply not purchase products if the price
set is outside of their budget limit. This is, of course, problematic if
the good or service is 'essential'
- The diagram below shows the main pricing options for a monopolist,
including profit maximisation at output Q, revenue maximisation at
output Q1 (whe MR=zero), and sales maximisation at output Q2 (where the monopolist sells as much as it can without making a loss)
- Major barriers to entry exist, including ‘limit’ pricing, vertical integration along the supply chain, and control of key resources, including infrastructure
- Super-normal profits are likely, (and are maximised at Q in the diagram, where MC = MR) though monopolists may make losses (as shown, especially when average cost is excessive)
- Given the likelihood that monopolists may act against the interests of consumers and the national economy, they may be nationalised,
or tightly regulated through price controls, profit controls and special taxes, setting standards, fining anti-competitive practices,
and establishing competition regulators, such as the
Federal Trade Commission in the US, and the
Competition and Markets Authority in the UK.
Oligopoly
What are the disadvantages of oligopoly?
Oligopoly
Game theory
How does game theory explain oligopoly?
Game theory