Market structure describes characteristics of a market in terms of:
1. The number of buyers and sellers in the market
2. The nature of the products and whether they are different
3. The ease of entry
4. The extent to which all firms in the market have the same information.
Perfect competition is an ideal market structure where there are:
1. Several firms
2. Freedom of entry into the industry
3. Firms producing identical products
4. Firms are price takers
5. Perfect information for all firms
Imperfect competitions:
1. Monopolistic competition
➢ Firms are price makers
➢ There are many firms and freedom to entry but firms have a certain level of
control over the price and the product.
2. Oligopoly
➢ Few firms
➢ Firms have market power to erect barriers to entry to Prevent competition from
new firms
➢ Firms are price makers
➢ Products are wide ranging
3. Monopoly
➢ Single seller in the market
➢ One firm produces a good or service for entire market
➢ Pure monopoly
➢ One firm because of its large market share,
➢ Barriers to entry are substantial due to patents and other restrictive methods that
prohibit competition.
➢ Price maker.
➢ Limited information about how firm operates.
4. Natural monopoly
➢ LRAC lower when just one firm is in industry.
Ways to identify market structure
1. Count the number of firms. The larger the total, the closer to perfect competition.
2. Use a concentration ratio to see the combined market share of the biggest 3 or 4 or 5
firms as a percentage of total market. Bigger the percentage = oligopoly or monopoly.
3. Market size of 4 firms/ total market size x100%
4. Ease of entry and exit barriers
5. Importance of economies of scale. If important then can be oligopoly.
Barriers to entry and exit:
Barriers to entry are a range of obstacles that deter or prevent new firms from entering a market
to compete with existing firms. Barriers to entry give firms a degree of market power. Decisions
can be made by existing firms without the risk of their market share or price being challenged
from outside. The construction and maintenance of these barriers can become part of the firm’s
behaviour.
Where barriers are strong, market is likely to be dominated by a few large producers.
Legal barriers:
Impossible for new firms to enter because the economic activity is state owned or the good is
produced under a license given by the government. This is a legal monopoly usually created to
achieve social and political objectives. the economic justification lies in the concept of a natural
monopoly, where it is more efficient to have 1 producer producing a certain product for eg. in
cases of railways.
Copy right or patent, intellectual property right
Guarantee exclusivity to entrepreneurs, a barrier to accessing technology or information.
Market barriers:
High capital investment.
Advertising=flooding the market with information
Increases sunk cost=increasing entry barrier cause i have to invest a lot to compete
Brand names with a high degree of consumer loyalty= a big obstacle.
branding=greater market power=consumers don't see rivals' products as a close substitute even
if it does extensive advertisement.
Cost barriers:
High fixed costs, set up costs. Pharmaceutical companies is an example.
Barrier is access to capital. Very large firms able to fund necessary investment. Research and
development. High sales needed to become profitable.
Economies of sale is a barrier. Large firms are enjoying low average costs so they can cut
prices and eliminate high cost producers. Predatory pricing.
Limit pricing. Existing firms may deliberately set low price and temporarily abandon profit
maximization to remove new entrance. Collusion.
Physical barriers:
Monopoly access to raw materials.
Barriers to exit:
Sunk costs. R and d costs irrecoverable. Resources cant be used for other purposes.
Characteristics of perfect information:
1. Large number of buyers and sellers who have perfect knowledge of market conditions
and price.
2. No firm has influence on the market price. Price takers. Consumers decide price by
expressing their demands and the amount they are ready to pay.
3. Homogenous products. Same quality. Identical in eyes.
4. Freedom of entry and exit
5. Perfect information
Firm cannot do anything to influence market price. It can produce whatever quantity it wants but
it will only be able to sell it at the ruling market price. Demand curve perfectly elastic at this
price. Extra unit of output, same price. Marginal revenue equal to price or average revenue.
D=MR=AR
Only decision it can make is how much to supply. Consider relevant costs of production.
Maximise profits, chosen output MC=MR
TC=TR normal profit TR>TC supernormal profits