Market Structures

Market structure – identifies how a market is made up in

terms of:
– The number of firms in the industry
– The nature of the product produced
– The degree of monopoly power each firm has
– The degree to which the firm can influence price
– Profit levels
– Firms’ behaviour – pricing strategies, non-price
competition, output levels
– The extent of barriers to entry
– The impact on efficiency
 Market Structure

Perfect Imperfect
Competition Competition

More Competitive to fewer Competition

Less competitive greater degree of imperfection

More competitive lesser degree of imperfection
 Market Structure

Perfect Pure
Competition Monopoly
Monopolistic Competition Oligopoly Duopoly Monopoly
 Perfect Competition
Characteristics:
– Large number of firms
– Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
– Freedom of entry and exit into and out of the industry
– Firms are price takers – have no control over the price they charge
for their product
– Each producer supplies a very small proportion of total industry
output
– Consumers and producers have perfect knowledge about the market
– buyers are small and quantity supplied is insignificant, sellers are
small and quantity bought is also insignificant
– Market is well organised and trading is a continuous process
– There are many competitors (both sellers and buyers) each acting
independently
– The market price must be flexible over a period of time constantly
rising and falling in response to changing conditions of supply and
demand
Distinction between Pure and Perfect competition:

Pure and perfect competition is used synonymously many times.

Pure competition is said to exist where only two conditions are
Fulfilled:
1) There must be large number of firms in the industry
2) The products of the firm must be homogenous

Perfect competition is otherwise called as free competition.

Determination of Price under perfect competition:

Price under perfect competition are determined by the forces of

supply and demand.
Price will be fixed at a point where the supply and demand are at
Equilibrium.
The equilibrium will change by changes in the forces of demand
and supply.
If demand rises, Price goes up
If supply rises , Price goes down.
 At this output the firm is making normal profit. This
Perfect Competition is a long run equilibrium position.

Diagrammatic Given the assumption of profit maximisation, the firm produces at an output where MC
= MR (Q1). This output level is a fraction of the total industry supply.
representation The average cost curve is the standard ‘U’ – shaped curve. MC cuts the AC curve at its
lowest point because of the mathematical relationship between marginal and average
values.

Cost/Revenue
MC The MC is the cost of producing
additional (marginal) units of
output. It falls at first (due to the
law of diminishing returns) then
AC rises as output rises.

P = MR = AR
The industry price is
determined by the demand
and supply of the industry as
a whole. The firm is a very
small supplier within the
industry and has no control
over price. They will sell
Q1 Output/Sales each extra unit for the same
price. Price therefore = MR
and AR
 Monopolistic or Imperfect Competition

• Where the conditions of perfect competition do

not hold, ‘imperfect competition’ will exist
• Varying degrees of imperfection give rise to
varying market structures
• Monopolistic competition is one of these – not to
be confused with monopoly!
 Monopolistic or Imperfect Competition
Characteristics:
1. 25-75 buyers and sellers must exist. Firms act independently but no single firm
is large enough to change the supply or price of a good.
2. The products are similar but they emphasize product differentiation
(differences among products). This is the one thing that separates
monopolistic competition from perfect competition. The differences may be
real or imaginary (a refrigerator with plastic or metal trays). Revlon offers 157
shades of lipstick – 41 are pink)
3. Buyers must be well informed about differences in products. Monopolistic
competitors rely on informative and competitive advertising.
4. Easy to enter or exit the industry. Few restrictions exist.
5. Large number of firms in the industry
6. May have some element of control over price due to the fact that they are able
to differentiate their product in some way from their rivals – products are
therefore close, but not perfect, substitutes.
7. Entry and exit from the industry is relatively easy – few barriers to entry and
exit
8. Consumer and producer knowledge imperfect
 Monopolistic Competition – fairly large number (25-75) of sellers
competing to sell slightly differentiated products. Product differentiation
(real or imaginary) is vital. This is the most common market structure.
Sellers try to decrease competition by making their products
different from the others. Since each firm attempts to make its product
unique, unique, there is an “element of monopoly”, thus monopolistic
competition. Product differentiation, when it is successful, enables a firm
to “establish a kind of monopoly” so that loyal customers will prefer it rather
than buy from the competition. [They try to monopolize a small portion of
the market.]
Even virtually identical products may be differentiated by
brand name, packaging, or design but they are still similar. They have all
the conditions of perfect competition except for product “differentiation.

They use “nonprice” methods of competition such as

advertising and improved service to increase sales. Reputation
is important [builds loyalty]. Most manufactured goods are made by only
a few producers
 Monopolistic or Imperfect Competition
• Restaurants
• Plumbers/electricians/local builders
• Solicitors
• Private schools
• Plant hire firms
• Insurance brokers
• Health clubs
• Hairdressers
• Funeral directors
• Estate agents
• Damp proofing control firms
Branding and Pricing under Monopolistic Competition:
A brand distinguishes a product or service from similar offerings on the
basis of unique features perceived by the consumer. Buyers feel that well
known firm have a reputation to maintain and the resources to do so. In
course of time, consumers tend to become more or less attached to
particular brand names.

Firms with reputed brands are in a position to change higher price for
their products. It has been found that an unknown brand must be offered
at a price somewhat lower than that of the leading brand in order to sell a
substantial quantity.
 This is a short run equilibrium position for a firm in a

Monopolistic or monopolistic market structure.

If the firm produces Q1 and sells each unit for

Imperfect Competition £1.00 on average with the cost (on average) for
each unit being 60p, the firm will make 40p x Q1 in
abnormal profit.

We assume that the firm produces where MR =

MC (profit maximising output). At this output
Implications for the diagram: level, AR>AC and the firm makes abnormal
MC profit (the grey shaded area).
Cost/Revenue
The demand curve facing the
firm will be downward
sloping and represents the
AC AR earned from sales.
£1.00
Since the additional revenue received from
each unit sold falls, the MR curve lies under
Abnormal Profit the AR curve.

£0.60
Marginal Cost and Average
Cost will be the same shape.
However, because the products
are differentiated in some way,
the firm will only be able to sell

MR D (AR) extra output by lowering price.

Q1
Output / Sales
Pricing under Monopolistic Competition:
There is some control over price because differentiation creates buyer
loyalty [jeans]. Non-price competition is used to control price.
Developing brand name loyalty will enable a firm to marginally
increase price without losing customers. If the increase is too much,
buyers will switch to a competitor’s product

Difference between Perfect competition and Monopolistic Competition

1. Perfect competition is a myth, Monopolistic is fact of life.

2. Under perfect competition, the products are homogenous; under
monopolistic competition, products are differentiated
3. Under perfect competition, the price prevailing in the market is the
same for all producers; under monopolistic competition, there are
different prices for differentiated products.
4. Advertisement does not help in perfect competition; it is rather
necessary to sustain monopolistic competition.
 Oligopoly
• Competition between the few - . “Oligo” – few in an industry.
• May be a large number of firms in the industry but the industry is dominated
by a small number of very large producers
• Concentration Ratio – the proportion of total market sales (share) held by the
top 3,4,5, etc firms:
4 firm concentration ratio of 75% means the top 4 firms account for 75% of all
the sales in the industry.
• Two Types of Oligopolies Pure (Undifferentiated) Oligopoly – 3 or 4
producers dominate the production of an identical product (steel, zinc,
copper, aluminum, lead, cement, industrial alcohol)
• Differentiated Oligopoly – 3 or 4 producers dominate the production of
differentiated (similar) products. [typewriters, tires, soap, cigarettes,
refrigerators, cereals, TVs & autos]
 Oligopoly
• Features of an oligopolistic market structure:
– Price may be relatively stable across the industry –
kinked demand curve?
– Potential for collusion
– Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
– Goods could be homogenous or highly differentiated
– Branding and brand loyalty may be a potent source of competitive
advantage
– Non-price competition may be prevalent
– Game theory can be used to explain some behaviour
– High barriers to entry
Market Conditions For Oligopolies
1. A few sellers control over 70% of market.
2. Firms offer identical or differentiated products (real or
imaginary). Advertising important.
3. Product
. information must be easily available. They use
informative advertisement (price, quality, and special features)
to introduce new products.
4. There are huge barriers to entry into the industry. The three
major barriers are technological knowledge, money, &
brand name loyalty.
5. Entry is difficult because many have patents or own
essential raw materials. This makes it difficult for new firms to try
to compete.
Oligopoly and Price : Oligopolies control price to some degree by creating brand name
loyalty and using non-price competition.
Price Leadership – when one firm, usually the largest and most powerful in the industry,
offers a new product at a certain price. The others then follow because they fear a
price war or because they would be better off financially by doing so. In other words,
oligopolists play the game, “follow the leader”.
Price leadership is legal because it does not involve any agreement among
competitors. If the competition does not follow the leader’s price, the leading firm may
be forced to change its price and fall in line with the prices of the competition. The firm
therefore, effectively faces a ‘kinked demand curve’ forcing it to maintain a stable or rigid
pricing structure.
Oligopolistic firms may overcome this by engaging in non-price competition. The principle of
the kinked demand curve rests on the principle that: If a firm raises its price, its rivals will not
follow suit If a firm lowers its price, its rivals will all do the same. If the firm seeks to lower its
price to gain a competitive advantage, its rivals will follow suit. Any gains it makes will quickly
be lost and the % change in demand will be smaller than the % reduction in price – total
revenue would again fall as the firm now faces a relatively inelastic demand curve.
 The kinked demand curve - an explanation for price stability?

Oligopoly

Price If the firm seeks to lower its price to gain a competitive advantage, its
rivals will follow suit. Any gains it makes will quickly be lost and the %
change in demand will be smaller than the % reduction in price – total
revenue would again fall as the firm now faces a relatively inelastic
demand curve.

£5

Total
Revenue B
Total Revenue A
D = elastic
Total Revenue B Kinked D Curve
D = Inelastic

100 Quantity
 Duopoly
• Market structure where the industry is dominated by
two large producers
– Price leadership by the larger of the two firms may exist – the smaller firm
follows the price lead
of the larger one
– Highly interdependent
– High barriers to entry
– Duopoly – when 2 firms dominate an industry. Coke products have 43%
of the market and Pepsi products have 32%.
 Monopoly
• Pure monopoly – where only one producer exists in the industry
• In reality, rarely exists – always some form of substitute available!
• Monopoly exists, therefore, where one firm dominates the market
• Firms may be investigated for examples of monopoly power when market
share exceeds 25%
• Monopoly power – refers to cases where firms influence the market in some
way through their behaviour – determined by the degree
of concentration in the industry
– Influencing prices
– Influencing output
– Erecting barriers to entry
– Pricing strategies to prevent or stifle competition
– May not pursue profit maximisation – encourages unwanted entrants to
the market
– Sometimes seen as a case of market failure
 Monopoly
• Origins of monopoly:
– Through growth of the firm , Through amalgamation, merger
or takeover, Through acquiring patent or license
– Through legal means – Royal charter, nationalisation, wholly owned place
• characteristics of firms exercising monopoly power:
• Price – could be deemed too high, may be set to destroy competition
(destroyer or predatory pricing), price discrimination possible.
• Efficiency – could be inefficient due to lack of competition or… could be
higher due to availability of high profits.
• Innovation - could be high because of the promise of high profits, Possibly
encourages high investment in research and development (R&D)
• High levels of branding, advertising and non-price competition
• Monopolies not always ‘bad’ – may be desirable in some cases but may need
strong regulation.
• Monopolies do not have to be big – could exist locally
Features of Monopoly:
• There is single producer or seller of a product
• There is a complete absence of competition
• There is no close substitute for the product
• There is complete control over the market supply on the part of
the monopolist.
• There is no distinction between firm and industry
• There is prevention of entry of new firm in the long run.
• Monopolist is a price-maker and not a price taker. He is
independent of making his price decisions.
• He can fix both price and output to be sold in the market.
• The aim of the monopolist is to maximize his total money profits.
• He will be in equilibrium at the price-output level at which his
profits are maximum.
 Natural Monopoly
Government Monopoly
Competition would be
Owned & operated by G
chaotic. It is natural
Ex: State Highways,
to give it to one co.
Postal, Rail services
Ex: Utilities
“Price Makers” Cable TV

Monopoly
[mono(1) poly (seller)]
Control over price: Total
Product: unique

Technological Monopoly
Geographic Monopoly
“Patent”
Only seller in a specific area
Ex: Process and product
Example: Remote Store

Monopoly – the “power of one”

Pure Monopoly – one firm industry [“monopolist”] Market Condition.
1. One firm is the only seller. Advertising promotes image.
2. No close substitute goods are available.
3. Prohibitive barriers to entry in the industry. High investment costs and
technological expertise prevent others from entering the market. Legal
restrictions make entry in government-supported monopolies nearly
impossible.
4. Almost complete control of market price.
5. Monopolist have much control over price because they are the only seller. A
higher price would hurt demand. The state may control the price on some
legal monopolies. These single suppliers are “price makers.”
Four Types of Legal Monopolies:
• Natural Monopoly – where competition would be chaotic, it is natural to give
the business to one firm. Examples: Public Utilities (electric & gas) – privately
owned companies (buses-Continental Trailways) but regulated by the
government. Market where average costs are lowest when all output is
produced by a single firm.
Government Monopoly – monopoly owned and operated by the government.
The difference between natural [privately owned] & government monopolies
[government owned] is that these monopolies are owned operated by any level of
government. Examples would be interstate highway system, public libraries,
public schools, Postal Service. In most cases, government monopolies deal with

economic products needed for the public welfare . Most tend to provide goods that
enhance the general welfare rather than seek profits.
Geographic Monopoly – when a firm is the only seller of a good in a
specific location.
Technological Monopoly – results from the invention of a new product
(patent) or when technology changes the way a good is produced. Production
submarines, Super computers, medicine to cure cancer.
Voluntary, Legal and Social otherwise called as Government Monopoly also
exist.
Reasons for Monopoly:
1.Restriction by Law: when government makes it a law no to allow
any competition in the production and distribution of a particular
product. (EB, Army, Water Service, Tourist Places)
2. Control over Key raw materials: when the strategic raw material
To produce a particular commodity is scarce and is fully controlled
by a single firm, that firm may not allow the use of this important
Raw material by other firm and may thus acquire monopoly status.
Eg. Nuclear weapons.
3. Specialized Technology – technique of production
4. Economies of Scale – a single firm being large can eliminate
competition by reduces its cost to low level without affecting the
quality of product, so as make other firms unable to survive.
5. Small market size – only one player not possible for multiple player.
Discriminating Monopoly: Price discrimination exists when the same
product is sold at different prices to different buyers. Eg. Different
locations of seats with limited features as in train, theatre, aircraft.
Is monopoly an unmixed evil?
1. A monopoly firm generally possess large financial resources. It
can thus sufficiently on innovation and technological progress so
as to introduce new inventions and better techniques.
2. Monopoly also enables savings in expenditure on advertisement.
3. Large capital investment and confidentiality and service to public
and no profit is needed for few services, eg. Electricity, water,
transport, army in such cases monopoly is exercised.
4. Monopoly can face foreign competition and many countries will
encourage monopoly in the name of cartels and syndicates.
Competition and the Market Structure
Price Control and the Market Structure
Least control over price

Most control over price

Very Agric. products
Many Fishery

Some Extensive

Fair amount
Fair with
differentiated Extensive
Amount
oligopolies

Cable TV
Water