Market structure

Question 1

Market structure

Answer 1

• Market structures refers to the characteristics of a market which determines the behaviour of firms within it
• There are a number of determinates of a markets structure:
  > Number of firms
  > Barriers to entry
  > Natural (barriers to entry)
  > Network effect
  > Ownership or control of a key or scarce resource
  > High set up costs
  > High R&D costs

Question 2

Number of firms

Answer 2

• These can be laced along a ‘spectrum of competition’

MORE COMPETITON & LESS CONCENTRATION

| > Perfect competition

> Monopolistic competition
| > Oligopoly
| > Monopoly
v
LESS COMPETITION & MORE CONCENTRATION

Question 3

Barriers to entry

Answer 3

• These can be defined as costs which are not borne by incumbent firms
• These can be divided into natural or structural barriers, and artificial or strategic barriers

Question 4

Natural (barriers to entry)

Answer 4

• Economies of large scale production
• If a market has significant economies of scale which have already been exploited by the incumbents, new entrants are deterred. Examples include those industries which currently have a high concentration ratio
• The concentration ratio indicates the size of firm in relation to their industry as a whole
• Low concentration ratio in an industry would indicate greater competition among the firms in that industry
• One with a ration nearing 100 would be evident in an industry characterised by a monopoly
• For example the four firm concentration ratio which consists of the market share of one of the four largest firms in an industry expressed as a percentage is a commonly used concentration ratio

Question 5

Network effect

Answer 5

• A network effect is the effect that multiple users have on the value of a good or service to other users. The greater the number of people using the specific good or service the greater the individuals benefit
• If a strong network already exists it may limit new entrants who fail to gain sufficient numbers of users to create a positive network effect
• E.g. social media, mobile phone

Question 6

Ownership or control of a key o scarce resource

Answer 6

• Owning scarce resources, which other firms could use, creates a considerable barrier to entry, such as an airline controlling access to an airport through its landing slots

Question 7

High setup costs

Answer 7

• High setup costs deter initial market entry. Many of these costs are sunk costs
• Sunk costs are those that cannot be recovered when a firm leaves a market, including marketing and advertising costs and other fixed costs

Question 8

High R&D costs

Answer 8

• When firms spend money on R&D, it is often a signal to potential entrants that they have large financial reveres. In order to compete, new entrants will have to match or exceed this level of spending in order to compete in the future
• This deters entry and is widely found in oligopolistic markets such as pharmaceuticals and chemical industry

Question 9

Barriers to exit

Answer 9

• product homogeneity
• Market knowledge
• Interrelationship between markets