Lecture 1 - Market Structures Flashcards
The 4 market structures
In order of competitiveness
- Perfect competition
- Monopolistic competition
- Oligopoly
- Monopoly
How to distinguish the market structures (4 ways)
- Number of firms
- How freely firms enter the industry
- Nature of the product
- Firm’s degree of control over the price (market power)
What is market power?
When firms can control the price, they can raise prices and profits above the perfectly competitive level
Assumptions of perfect competition
- 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
Profit maximisation for perfect competition
P=MC
Why are excess profits eradicated in perfect competitive markets
Because of perfect knowledge
- Similarly, if price falls below minimum average costs firms will leave the market so losses are not incurred
How much profit is made in perfect competitive markets
The minimum level
Examples close to perfect competition
- Foreign exchange markets
- Internet based industry
What does mainstream theory suggest about monopolies
There are Inefficiencies with industries dominated by a single firm
What other market structure is monopoly contrasted by
Perfect competition
Is government intervention justified in monopolies
Yes
To maintain a monopoly position, there must be barriers to entry, give examples
Economies of scale (natural monopoly)
Economies of scope
Mergers
Legal protection
Profit maximisation for monopoly
MC=MR
How does monopoly imply a loss in market output and economy as a whole
Because they produce less and sell at a higher price
Disadvantages of monopoly
- 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
What’s a natural monopoly
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
What is monopoly
What is market power
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)
Assumptions of monopolistic competition
- Quite a large number of firms
- Freedom of entry of new firms into the industry
Examples: coffee shops, hairdressers, restaurants
Describe oligopoly
- 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
Two crucial features distinguish oligopoly from other market structures
- 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
4 approaches to industrial economics
- Harvard
- Mainstream economics (Chicago)
- Austrian
- Modern IO strategic approach
1) Describe Harvard approach
- Dominated economics before the 70’s
- Structure - Conduct - Performance model developed at Harvard
- Analysis of market structure was central to this approach
2) Describe mainstream approaches (Chicago approach)
- 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
3) Describe Austrian economics
- 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
4) Describe the Modern IO strategic approach
- 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
