Market Structure (Topic 7) Flashcards
Difference between firm and industry
Firm : An organisation that produces goods and services. All producers are called firms, no matter how big they are or what they produce (Toyota)
Industry : A group of firms that sells a well-defined product or closely related set of products (car industry)
Types of barriers (1)
Legal barriers
1) Government licensing
2) Franchise
3) Patents
Types of barriers (2)
Natural barriers
1) Control over essential input needed to produce a particular good
2) Economies of scale: gives rise to a natural monopolist. One big firm can become so efficient that it can supply the entire market (draw)
Profit equation
Total revenue = P x Q
Total cost = ATC x Q
Profits = Total revenue - Total cost
3 types of profits
1) Economic (supernormal) profit [R > C]
2) Zero economic (normal) profit [R = C]
3) Economic loss (subnormal profit) [R < C]
Market structure (1)
Perfect competition
1) Large number of small firms
Each firm has a small share of the market even when it changes its output
2) Homogeneous product
→ Assumption rules out rivalry among firms in advertising
→ Buyers are indifferent as to which seller’s product they buy
3) No barriers to entry
Firms and resources are completely mobile to freely enter or exit a market
→ Ensures that the number of firms in PC remains large
→ Firms can only earn normal profit in the long run
Demand curve of the PC firm (price taker, why can’t firms set a different price from the existing market price)
A price taker is a seller that has no control over the price of the product it sells
PC firm accepts the market price and it can only sell at this one price. The PC firm’s demand curve is horizontal (perfectly elastic)
If the firm sets a higher price than market price, it will sell zero output. Since the firm can sell as much output as it wants at the going market price, a firm will not decreases its price because a lower price would reduce revenue and hence profit
Market structure (2)
Monopolistic Competition
1) A large number of relatively small firms
Each firm has a small market share
2) Sells differentiated products
Products sold are close, but not perfect substitutes for one another → some market power
Non-price competition (e.g. advertising)
→ To increase the demand for its product
→ To make its demand cure more inelastic by developing consumer loyalty
3) Minimal barriers to entry and exit
Monopolistically competitive firms can make only normal profit in the long run
Demand curve of a monopolistically competitive firm
Product differentiation → has some market power
Demand curve is negatively sloped, but relatively more elastic than that of a monopolist, as the monopolist has more market power
When monopolistically competitive firms increase their price, they will lost some customers
if they decrease their price, it can sell more as it is able to draw away some sales from its competitors
Market structure (3)
Oligopoly
1) Small number of relatively large firms
→ Gives each firm a substantial degree of market power
→ generates mutual interdependence (A condition in which an action by one firm may cause a reaction from other firms)
A few large firms supplying most of the output in the market
2) Homogeneous (oil) or differentiated products (cars)
→ Non-price competition
3) Strong barriers to entry
Oligopolies can earn economic profits in the long run
Demand curve of an oligopolist
The kinked demand curve assumes rivals will match a price decrease but ignore a price increase
1) Highly elastic when it increases its price above the current level
Other firms will not raise their price and the firm will lose most of its customers
2) Very inelastic when it decreases its price below the current level
Other firms will match the reduction in price. The firm that decreases its price will therefore not be able to increase its market share
Market structure (4)
Monopoly
1) A single firm
2) Selling a unique product
3) Very strong barriers to entry
→ So effective that only one firm exist in the industry
→ Monopolist can continue to make economic profit even in the long run
Demand curve of a monopoly
Since the monopoly is the only seller, the monopolist’s demand curve is the market demand curve
Since the market demand curve is negatively sloped, the monopolist’s demand curve is also negatively sloped
Monopolist is a price maker, and has market power as it can influence the price or the quantity sold
because of
1) its size
2) the fact that it sells a unique product
More market power, more inelastic the demand curve
