Market structure(Chapter 19) Flashcards
What is market structure
Market structure refers to the features of a market that affect how buyers and sellers this depends on the characteristics of the market:
- Number of firms: This refers to the number of sellers or firms operating in the market. It can range from a single seller (monopoly) to numerous sellers (perfect competition).
- Type of product: This refers to the nature of the goods or services being sold in the market. It can be homogeneous (identical) in perfect competition or differentiated in monopolistic competition, oligopoly, or monopoly.
- Entry and exit barriers: These are the obstacles that determine the ease or difficulty for new firms to enter the market or for existing firms to exit. Barriers can include high startup costs, government regulations, patents, or economies of scale.
- Control over price: The extent to which firms can influence the price of their product in the market. In perfectly competitive markets, firms are price takers, while monopolistic and oligopolistic firms have some degree of control over pricing.
- Market power: This refers to the ability of a firm or a group of firms to influence market conditions, such as price, output, or competition. Monopolies have significant market power, while firms in perfect competition have no market power.
- Non-price competition: The degree to which firms compete on factors other than price, such as advertising, branding, product differentiation, or customer service. Monopolistic competition and oligopoly tend to involve more non-price competition.
Perfect competition
In a competitive market structure, a large number of firms compete to supply the market, with each firm producing a small share of the total market supply. These firms have perfect knowledge and access to the same resources, resulting in equal costs and product quality. They supply identical products, eliminating any product differentiation. As price takers, firms can only maximize profits by selling at the market price. If a firm increases its price, consumers will shift to other firms. In this competitive environment, profits attract new firms into the market, leading to increased competition, lower prices, and reduced profits until firms earn only normal profits necessary to stay in the market.
Monopoly
A monopoly is when a company controls an entire market for a specific good or service. It means that there are no other competitors, giving this company complete control over pricing, distribution and production. Which can then lead to higher prices, less incentive to innovate/invest, productive inefficiency, restricting supply, reduced choice and potential diseconomies of scales.
Competitive pricing strategies
- Setting prices at or below rival products.
- Destruction pricing: Lowering prices below competitor costs to force them out.
- Price wars: Competitors undercutting each other’s prices.
- Follow-the-leader pricing: Matching prices of closest rivals, led by market share leader.
Product differentiation
- Firms differentiate products to attract and retain customers.
- Differentiation can include brand name, features, warranty, after-sales care.
- Examples include various laundry detergents with different branding and claims.
- Despite similarities, differentiation allows firms to charge higher prices.
- Real-world markets have many firms competing on price and features for similar products.
‘Small numbers’ competition
- Some markets are dominated by a small number of large firms.
- Competition between dominant firms can still be fierce.
- Price wars may occur, but collusion to control prices is also possible.
- Competition focuses on non-price factors like product features and brand differentiation.
- Market displays vigorous price and non-price competition, changing product features, and varying strategies in response to competitors.
Disadvantages of monopoly
- Less consumer choice due to limited competition.
- Lower output and higher prices compared to competitive markets.
- Lower product quality as monopolies lack incentive for improvement.
- X-inefficiency and higher production costs.
- Governments need to allocate resources to regulate and control monopolies.
- Competition policies are implemented to address monopolistic behaviors, including fines, breaking up monopolies, and regulating prices and service levels.
- Regulatory bodies monitor and enforce competition laws in various industries.
- Higher taxes may be imposed on monopoly profits.
- Government may nationalize monopolies for direct control.
How monopolies restrict competition
- Monopolies aim to prevent new firms from entering the market to protect their position and profits.
- Barriers to entry make it difficult for new firms to introduce their products.
- Natural barriers to entry arise from differences in size, costs, and scale of production.
- Artificial barriers to entry are intentionally created by dominant firms to restrict competition.
Natural barriers to entry
- Economies of scale make large-scale production more efficient than small-scale production.
- Capital size required for certain industries may limit competition to larger firms.
- Historical reasons, such as being the first entrant with an established customer base, can create a monopoly.
- Legal considerations, like patents and copyrights, can grant exclusive rights to innovative producers.
Artificial barriers to entry
- Destruction or predatory pricing: Large firms cut prices to force smaller competitors out of business.
- Restricting supplies to rival firms: Dominant firms threaten to take their business away from suppliers if they supply new firms.
- Exclusive dealing: Monopolies force retailers to only stock their products, preventing competition from other firms.
Are all monopolies bad
- Some monopolies can be more efficient and offer lower prices to consumers.
- Monopolies may face competition from other firms in related markets or from overseas.
- In contestable markets, monopolies may offer competitive prices and high-quality products to maintain their position.
- Abnormal profits can provide the incentive for monopolies to fund risky investments and develop better products.
- Monopolies can protect jobs and incomes in the economy by withstanding competition from large overseas firms.
