Market Structure - Part of Microeconomics

Question 1

Define “market structure”

Answer 1

The economic environment within which a firm produces and distributes its good or service.

The primary factors that distinguish different market structures are:

1. Number of sellers and buyers in the market
2. Nature of the commodity in the market
3. Difficulty of entry into the market

Question 2

What are the 4 market structures normally considered in economic analysis?

Answer 2

1. Perfect competition
2. Perfect monopoly
3. Monopolistic competition
4. Oligopoly

Question 3

What is central to determining the nature of a market structure in a free market economy?

Answer 3

The extent of competition in the market. It determines how prices are established, operating results at various levels of production, and other performance characteristics.

Perfect competition occupies one end of a conceptual market structure continuum and perfect monopoly - absence of competition - occupies the other end.

Question 4

The economic analysis of different market structures is concerned with:

Answer 4

Both short-term and long-term analysis.

Question 5

List the characteristics of perfect competition:

Answer 5

1. A large number of independent sellers and buyers, each of which is too small to separately affect the price of a commodity.
2. All firms sell homogeneous (same) products or services.
3. Firms can enter and leave the market easily.
4. Resources are completely mobile.
5. Buyers and sellers have perfect information.
6. Government does not set prices.

Question 6

What is a “price taker” firm?

Answer 6

The assumption that a firm in a perfectly competitive market must accept (“take”) the price set by the market and can sell any quantity of its commodity at that price. Thus, the demand curve faced by a single firm in perfect competition is a straight horizontal line at the market price.

Question 7

A perfect competitive market is virtually impossible to identify. Nevertheless, analysis under assumed conditions is useful in understanding:

Answer 7

Pricing, production, profit, and related items.

Question 8

What is the shape of the demand curve for a firm in perfect competition?

Answer 8

The demand curve faced by a single firm in a perfectly competitive market is a straight horizontal line originating at the price set by the market (of all firms).

Question 9

Describe the point of short-run profit maximization for a firm in perfect competition:

Answer 9

Short-run profit is maximized where marginal revenue is equal to rising marginal cost; total revenue will exceed total costs by the greatest amount at this point.

Question 10

How are long-run profits determined for a firm un perfect competition?

Answer 10

There are no long-run profits possible in a perfect competitive market.

If profits are made in the short-run, more firms will enter the market and increase supply, thus decreasing market price until all firms just break even.

If losses are suffered in the short-run, some firms will exit the market, causing market price to increase until all firms break even.

Question 11

In the short-run, a firm will shut down if:

Answer 11

Marginal revenue (price) is less than average variable cost. It would shut down because each unit it produces fails to cover the direct cost of producing the unit.

Question 12

In the long-run, in perfect competition:

Answer 12

All firms will break even.

Question 13

In perfect competition, in the short-run, each and every unit produced can be sold at the market price, therefore:

Answer 13

Price is also demand and marginal revenue.

Question 14

When marginal revenue = marginal cost:

Answer 14

The amount received from the last unit sold (MR) equals the incremental (marginal) cost (MC) of providing that unit. At any quantity below that level, an additional unit would provide more revenue than cost. At any quantity above, an additional unit would cost more than the revenue it would generate.

Question 15

List the characteristics of a perfect monopoly:

Answer 15

1. A single seller.
2. A commodity for which there are no close substitutes.
3. Restricted entry into the market.

Question 16

List examples of reason why monopolies exist:

Answer 16

1. Control of raw materials or processes.
2. Government granted franchise (i.e., exclusive right);
3. Increasing return to scale (i.e., natural monopolies).

Question 17

What’s a natural monopoly?

Answer 17

A natural monopoly is defined as a monopoly that results from the economics associated with providing a good or service. Specifically, it results in industries in which there is increasing returns to scale over a sufficient quantity of output, such that a single firm can satisfy entire market demand at lower cost per unit than two or more firms.

Traditional “public utilities” are examples of natural monopolies.

Question 18

What is the shape of the demand curve for a firm in perfect monopoly?

Answer 18

Downward sloping. A monopolistic firm is the only firm in industry (thus it’s the demand curve for industry as well). In order to sell more, it must reduce its selling price (negatively sloped).

Question 19

Describe the point of short-run profit maximization for a firm in perfect monopoly:

Answer 19

Short-run profit is maximized where marginal revenue is equal to rising marginal cost. (MR=MC). The price charged at that quantity will depend on the level of the demand curve.

Monopoly does not assure a firm a profit. Short-run result depends on a firm’s Average Total Cost (ATC) vs. Market Price.
ATCMP= Loss

Question 20

In the long-run, how may a monopoly firm increase its profits?

Answer 20

A monopoly firm can increase its profit in 2 ways:

1. Reduce cost by changing the size of its operations.
2. Increase demand through advertising, promotion, etc.

Question 21

Compared to a firm in perfect competition, a monopolistic firm,

Answer 21

A monopolistic firm will have a greater ability to influence its buyers.

Question 22

A monopoly in the long-run results in a higher commodity price and less output than a firm in perfect competition. Why?`

Answer 22

For a monopolistic firm, production at MR=MC results in an inefficient use of resources and a higher price than it would result from a firm with the same costs under perfect competition. The reason this happens is because the monopolistic firm faces a downward sloping demand curve vs horizontal (perfect competition where D=MP).

Question 23

In a perfect monopoly, describe the relationship between the marginal revenue curve and the demand curve:

Answer 23

The marginal revenue curve is below the demand curve and the curves diverge as the quantity increases.

The basic reason for this relationship is that, facing a negatively sloped demand curve, firm must continuously lower its selling price in order to sell more units; therefore, marginal revenue must be below demand.

Question 24

True or false: In a pure monopoly, a single firm is the industry:

Answer 24

TRUE

Question 25

List the characteristics of monopolistic competition:

Answer 25

1. Large number of sellers;
2. Firms sell a differentiated product or service (similar but not identical), for which there are close substitutes;
3. Firms can enter and leave the market easily.

Question 26

What is the shape of the demand curve for a firm in monopolistic competition?

Answer 26

Downward sloping and highly elastic (because there are close substitutes for the good or service offered).

Question 27

How are long-run profits determined for a firm in monopolistic competition?

Answer 27

There are no long-run profits possible in a monopolistic competition. If profits are made in short-run, more firms will enter the market and lower the demand for each firm until each just breaks even (like perfect competition).

Question 28

Describe the point of short-run profit maximization for a firm in monopolistic competition.

Answer 28

Short-run profit is maximized where MR=MC (provided price>ATC).

Question 29

Under monopolistic competition, what determines whether or not a firm makes profit? (Short-run)

Answer 29

The relationship between the price ℗ that can be charged and the firm’s ATC.
If ATCMP= Loss

Question 30

List the characteristics of an oligopoly:

Answer 30

1. A few sellers
2. Firms sell either a homogenous product (standardized oligopoly) or a differentiated product (differentiated oligopoly).
3. Restricted entry into market.

Question 31

Because there are few firms in oligopolistic market,

Answer 31

The actions of each firm are know by and affect, other firms in the market. Each firm is large enough to influence market price. Therefore, if one firm lowers its prices to increase its share of the market, other firms are likely to reduce their prices as well.

In the extreme, a “price war” will result. Consequently, oligopolistic firms tend to compete on factors other than price (quality, service, distinction, advertising, packaging)

Question 32

Describe the point of short-run profit maximization for a firm in an oligopolistic industry.

Answer 32

Short-run profit is maximized where MR=MC (provided ATC<MP).

Question 33

How are long-run profits determined for a firm in an oligopoly industry?

Answer 33

A firm in oligopoly industry will make profits in the long-run if ATC<MP, and can continue to do so because entry into the market is restricted.

Question 34

In what ways do firms in oligopoly market compete?

Answer 34

They compete based on quality, service, distinctiveness, etc., but not on price, which might incite a “price war”.

Question 35

Distinguish between overt collusion and tacit collusion:

Answer 35

1. Overt collusion = Firms conspire to set output, price or profit, illegal in the US. Cartels do this.
2. Tacit Collusion = Firms follow price charged by the price leader in the market, not illegal in the US. Example: airlines

Question 36

A firm in an oligopolistic environment that is making a profit in the short-run can continue to make a profit in the long-run because:

Answer 36

New firms are restricted to entering the market.

Question 37

What’s a cartel?

Answer 37

A group of firms that conspire to make price and output decisions for a product or service; it is overt collusion and illegal in the US. Example is OPEC - which meets regularly to set output quotas for oil for oil-exporting countries.

Question 38

In which form of market structure is competition based on price least likely to occur?

Answer 38

Oligopoly, because each firm in the industry is aware of the actions of other firms in the industry.

Question 39

Describe a market structure that includes only a few providers.

Answer 39

Oligopoly market; there are few providers of goods or services. In monopoly there is only one provider; in perfect competition or monopolistic competition there are may providers.

Question 40

Describe the least likely market structure in the US economy:

Answer 40

Perfect Competition; virtually non-existent in US economy. It assumes the product or service is perfectly homogenous, such that there are no differences in size, quality, style, or other features, and therefore, no reason to advertise to compete.

Monopoly, monopolistic competition, and oligopoly markets are common.

Question 41

Describe the justification for natural monopolies.

Answer 41

A monopoly exists where there is a single provider of a commodity for which there are no close substitutes and where entry to market is difficult. Natural monopolies exist where there is increasing return to scale of operations and is justified by a single entity being able to satisfy demand at a lower cost than 2 or more firms. Public utilities have been cited traditionally as exampled of natural monopolies.

Question 42

Describe the nature of the market structure in the US economy.

Answer 42

The US economy is a mix of market structures with different commodities/industries operating in different market structures.

Question 43

Which characteristic is common to the 4 basic market structures?

Answer 43

Firms will seek to produce at the quantity where MR=MC.

Question 44

Is any firm assured of making profit in short-run?

Answer 44

A firm is NOT assured of making profit in any market structure. They will all have either a profit, break-even, or loss.

Question 45

In which market structure is there the greatest incentive and it is more feasible for firms to engage in collusion in the setting of the quantity and price of industry output?

Answer 45

Oligopoly; there are few sellers and the actions of each firm are known by and affect the other firms in the industry. In order to be profitable, the firms must be able to charge a price that is greater than the marginal cost of the commodity.

Thus, the few firms have an incentive to agree (collude) on the quantity to be produced in order to keep supply below demand and to agree on price and an allocation of industry quantity among the few sellers.

Question 46

To review, what’s a Monopoly?

Answer 46

Exists when there is a single provider of a good or service for which there are no close substitutes. Monopolistic firms do exist in the US. Historically, public utilities have been permitted to operate as monopolies with the justification that market demand can be fully satisfied at a lower cost by one firm, rather than by 2 or more firms.
To limit the economic benefits of such monopolies, governments generally impose regulations which affect pricing, output, and/or profits. Monopolies can also exist as a result of exclusive ownership of raw materials or patent rights. In most cases, however, exclusive ownership monopolies are of short duration as a result of the development of close substitutes, the expiration of rights, or government regulation.

Question 47

What is monopolistic competition? REVIEW

Answer 47

Common in the US, especially in general retailing where there are many firms selling similar (but not identical) goods and services. Because there products are similar, monopolistic competitive firms engage in extensive non-price competition, including advertising, promotion, customer service initiatives, all of which are common in contemporary US economy.

Question 48

What is Oligopoly? REVIEW

Answer 48

Exists in markets where there are few providers of goods/services. The markets for many metals (steel, aluminum, copper, etc.) are oligopolistic. So, also, are the markets for diverse products as automobiles, cigarettes, and oil. Firms in oligopolistic markets tend to avoid price competition for fear of creating a price war, but do rely heavily on non-price competition.