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:

  1. Knowledge
  2. Barriers to entry
  3. Number of firms
  4. Product differentiation
  5. Level of competition
  6. Price
  7. Level of profits
  8. Efficiency levels, and:
  9. Welfare

We can now apply these to different market structures:

For perfect competition;

  1. Knowledge is ‘complete’
  2. There are no barriers to entry or exit
  3. There are infinite numbers of competitive firms
  4. Products are identical
  5. Firms are price takers
  6. Super-normal profits are available in the short run, but not long run
  7. Firms are allocatively efficient in both the short and long run, but only productively efficient in the long run, and:
  8. Welfare is maximised

Video on market structures

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.

Perfect competition

For monopolistic competition

  1. Knowledge is only partial and asymmetric
  2. Minor barriers to entry exist
  3. There are large numbers of independent firms
  4. Products are differentiated
  5. Firms are price makers and can vary prices
  6. Super-normal profits are available in the short run, but not long run
  7. Firms are not allocatively or productively efficient in the short and long run, and:
  8. 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.

Monopolistic competition

For oligopoly

  1. Knowledge is only partial and not symmetrical, with firms able to control information
  2. There are just a few interdependent firms
  3. Firms may engage in collusion, including overt, covert and tacit collusion (see Game Theory)
  4. Products may be differentiated
  5. Price tends to remain ‘sticky ’- see the video for an explanation
Oligopoly

For monopoly

  1. Knowledge is asymmetric, with the monopolist able to control information
  2. 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'
  3. 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)
  4. Major barriers to entry exist, including ‘limit’ pricing, vertical integration along the supply chain, and control of key resources, including infrastructure
  5. 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)
  6. 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.
Monopoly

Check your knowledge
Market structures

Try a Quiz on Market structures.

Go market structures quiz

facebook link logo twitter link logo email link logo whatsapp link logo gmail link logo google classroom link logo