Chapter 3 - Market Structure, Market Failure and Government Intervention Flashcards
What is the definition of Market Structure?
Market Structure looks at the way different industries are organised. An Industry will generally consist of firms who will be supplying products in a particular market.
Each industry has unique characteristics that influence the level of competition and the way resources are allocated.
What is the general criteria determining the structure of a market?
The level of competitiveness within a market will be influenced by the structure of that market, which is often determined by the following general criteria:
- The Number of Firms - this may look at the total number of firms and also whether any particular firms have a large share of the market.
- The product’s degree of homogeneity - in other words the products can either be virtually identical or highly differentiated.
- The barriers of entry/exit - in some markets there may be natural or artificial barriers to entry which would restrict competition
- The way firms compete - they may compete purely on price or rely heavily on advertising and product differentiation.
What is perfect competition?
The benchmark for determining the degree of competition in a market is perfect competition.
- There are many buyers and sellers in the market. This means that each party involved in a transaction is a price taker because they have no individual ability to influence the market price that is determined through the forces of demand and supply.
- The goods offered by suppliers are homogenous. This means that they are virtually identical and easily substitutable, encouraging competitors to offer the lowest price possible.
- Firms can enter and exit the market freely.
There are very few examples of perfectly competitive markets in a modern economy like Australia. However, some markets fo have characteristics of a perfectly competitive market, such as the share market.
What assumptions are made about perfect competition?
- All buyers and sellers operate with perfect information. They are able to access, and therefore compare all prices and can research the availability of resources. Economic agents, therefore, make fully informed rational decisions based on all available information.
- All resources are mobile and can be moved easily to where they can be used in their most profitable manner.
- Each party to a transaction aims to maximise his/her own wellbeing.
What is monopolistic competition?
Monopolistic Competition occurs in an industry that is also highly competitive, with many similarities to perfect competition, but with one major difference - products are not homogenous.
Has the following attributes:
- There are a large number of buyers and sellers who are well informed about products available.
- Easy for firms to enter and exit the market and few or no restrictions on firms competing
- Sellers engage in product differentiation. They will try to make their product different to their competition in some way, even though their products will be very similar in nature.
What do firms in a monopolistic competitive market do to differentiate products.
- Physical - sizes, colours, tastes, textures, quality.
- Location - firms minimise time & distance needed for the consumer to acquire product
- Services - differentiate product by the degree and range of service offered to customers
- Image - firms try to create and image or lifestyle associated with their product so that customers develop brand loyalty.
What is an oligopoly?
Many of the big businesses that operate in Australia do so in oligopolistic industries.
- A few (very large) firms tend to dominate the industry in terms of market share and volumes sold. Can include a large amount of firms, however, they have little market power compared to the largest firms.
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Product Differentiation:
- Homogenous: large setup costs, tendency for firms to engage in practices that minimise competition.
- High Degree: firms must develop brand loyalty or develop a higher quality product. Complex pricing and marketing strategy
- Firms must achieve economies of scale to be profitable in some oligopolistic markets, thus creating an effective barrier of entry.
What is a monopoly?
A monopoly exists when there is a sole seller of a product and the product does not have a close substitute. The monopoly supplier in the market may face many buyers and may sell a homogenous or differentiated product.
Reasons for a monopoly:
- The monopolist owning the key resource: e.g. infrastructure needed to operate in an industry
- Governments giving the monopolist exclusive right to produce the product: copyright laws, patent laws.
- Natural Monopoly: may arise when a single firm can supply a good or service to a market cheaper than two or more firms could. e.g. Australia Post (letters)
What is a monopsony market?
Is a market situation where there is a single buyer of a product.
e.g. farmers selling to large supermarket chains
Perfect competition: achieving allocative and productive efficiency
The achievement of an efficient allocation of resources, where society’s wellbeing is maximised at the lowest opportunity cost, is considered by many economists to be the primary aim of an economic system.
Perfect Competition is generally regarded as the benchmark market structure because it is more likely to generate the most efficient allocation of resources.
Competitive markets will promote both productive efficiency and dynamic efficiency.
Perfectly Competitive Market Expectations
- businesses will make things in the most efficient way
- businesses will make things that meet the needs and wants of the consumer
- businesses will make the right amount of things that consumers want
- resources will go to those who value them most
Monopoly and its impact on societal welfare
The outcome in a monopoly market will generally be less beneficial to society if the monopolist is in pursuit of profit.
A monopolist may choose to restrict output and, as a result, the market price will tend to increase. The consumers who may have been willing and able to purchase the product at a price above what it would cost to produce the additional unit are now excluded from the market even though production and consumption of this product would have added to society’s wellbeing. Thus, there will be an under-allocation of resources to the production of this good or service when compared to perfect competition.
What is the definition of market failure and the four assumptions that if not met cause market failure?
Market failure occurs when an unregulated market is unable to allocate resources efficiently or where resources are allocated in such a way that national living standards or welfare is not maximised.
- Public Goods (free rider problem)
- Externalities
- Market Power
- Asymmetric Information
What are public and private goods?
- Private Goods: are those which are excludable and rival in consumption. Most goods in our market are private. You don’t get the product unless you pay for it, and once consumed, it cannot be consumed by anyone else.
- Public Goods: are both non-excludable and non-rival (non-depletable) in consumption. A person who does not pay for the good cannot be excluded from consuming it and one person’s consumption does not lessen another’s ability to consume the product.
What is the free rider problem?
A person who receives the benefit from a public good but does not pay for it.
