Lecture 1 - Market Structures

Question 1

The 4 market structures

In order of competitiveness

Answer 1

• Perfect competition
• Monopolistic competition
• Oligopoly
• Monopoly

Question 2

How to distinguish the market structures (4 ways)

Answer 2

• Number of firms
• How freely firms enter the industry
• Nature of the product
• Firm’s degree of control over the price (market power)

Question 3

What is market power?

Answer 3

When firms can control the price, they can raise prices and profits above the perfectly competitive level

Question 4

Assumptions of perfect competition

Answer 4

• Large Number of buyers and sellers, therefore no firm or consumer can influence the market price (price takers)
• Homogenous products (identical)
• Freedom of entry and exit of the market (costless)
• There’s Perfect knowledge about prices, technology and demand conditions
• All firms make normal profits only at equilibrium

Question 5

Profit maximisation for perfect competition

Answer 5

P=MC

Question 6

Why are excess profits eradicated in perfect competitive markets

Answer 6

Because of perfect knowledge

• Similarly, if price falls below minimum average costs firms will leave the market so losses are not incurred

Question 7

How much profit is made in perfect competitive markets

Answer 7

The minimum level

Question 8

Examples close to perfect competition

Answer 8

• Foreign exchange markets
• Internet based industry

Question 9

What does mainstream theory suggest about monopolies

Answer 9

There are Inefficiencies with industries dominated by a single firm

Question 10

What other market structure is monopoly contrasted by

Answer 10

Perfect competition

Question 11

Is government intervention justified in monopolies

Answer 11

Yes

Question 12

To maintain a monopoly position, there must be barriers to entry, give examples

Answer 12

Economies of scale (natural monopoly)
Economies of scope
Mergers
Legal protection

Question 13

Profit maximisation for monopoly

Answer 13

MC=MR

Question 14

How does monopoly imply a loss in market output and economy as a whole

Answer 14

Because they produce less and sell at a higher price

Question 15

Disadvantages of monopoly

Answer 15

• Higher price and lower output than perfect competition
• Potential Higher Costs due to lack of competition and deadweight loss

This is why governments try to regulate monopolies market power

Question 16

What’s a natural monopoly

Answer 16

An industry which one firm can supply the entire market at a lower price than two or more firms

• Its Most efficient for production to be permanently concentrated in a single firm rather than contested competitively

Examples: Public utilities like water services and electricity

Question 17

What is monopoly
What is market power

Answer 17

Monopoly = The firms is the industry

Market power = Abnormal profits are being made and the extent of that is measured by the extent of price minus costs (can be exercised in oligopolies)

Question 18

Assumptions of monopolistic competition

Answer 18

• Quite a large number of firms
• Freedom of entry of new firms into the industry

Examples: coffee shops, hairdressers, restaurants

Question 19

Describe oligopoly

Answer 19

• Greek meaning for “few”
• Two or more firms competing with one another, but there are not a sufficient number of firms for a truly competitive market
• Firms In oligopolies May be able to attain abnormal profits, thereby exerting monopoly power

Question 20

Two crucial features distinguish oligopoly from other market structures

Answer 20

• Barriers to entry = In contrast to monopolistic competition, there are various barriers to the entry of new firms. Similar to monopolies
• Interdependence of the firms = Because there are few firms they each have to take account of the others. This means they are mutually dependent: they are interdependent. Each firm is affected by its rivals actions. No firm can afford to ignore the actions and reactions of other firms in the industry

Question 21

4 approaches to industrial economics

Answer 21

• Harvard
• Mainstream economics (Chicago)
• Austrian
• Modern IO strategic approach

Question 22

1) Describe Harvard approach

Answer 22

• Dominated economics before the 70’s
• Structure - Conduct - Performance model developed at Harvard
• Analysis of market structure was central to this approach

Question 23

2) Describe mainstream approaches (Chicago approach)

Answer 23

• Used standard economic - I.e neoclassical or “mainstream” theory
• Emphasis on profit maximisation
• Sceptical of intervention by policy makers - why?
• Because abnormal profits may be due to cost advantages or efficiencies
• Free entry - contestable markets
• Market power
• Competition prevails through free entry

Question 24

3) Describe Austrian economics

Answer 24

• In 20th century, scholars turned away the static view of competition - Schumpeter
• Views competition as a dynamic process that can’t be examined using static models
• Sceptical of Intervention by policymakers
• Abnormal profits don’t constitute evidence of market power abuse by a firm, they play an important role in motivating firms towards R&D and innovation
• Successful innovator will be rewarded with monopoly profits
• Then imitators will follow or a new innovator and monopoly profits will erode
• Thus, Monopoly status is temporary (due to this dynamic view of competition)
• Similar to Chicago school of thought: Industries will tend towards competition - no need for regulation

Question 25

4) Describe the Modern IO strategic approach

Answer 25

• With time came the realisation Conduct and Performance variables affect Structure
• Causality within SCP paradigm runs both ways, rather than undimensionally
• Structure is not the most important determinant of level of competition
• Firms behave strategically (conduct) and affect structure;
• Firms’ strategies are affected by industry performance;
• Firms’ strategies are affected but also affects basic conditions
• So market power is mainly created and maintained by firms’ strategies