Chp.

35 Different market structures

Explain the characteristics of market structure:
The term market structure describes the way in which
goods and services are supplied by firms in a particular
market. More specifically, it describes the characteristics
of a market in terms of:
• the number of buyers and sellers in the market
• the nature of the products and whether they are
different
• the ease of entry into the market
• the extent to which all firms in the market have the
same information.
Define market structure:
The way in which a market is organized in terms of
certain characteristics which can be used to explain the
behavior of firms in a market.
Explain the difference between perfect and imperfect
competition:
Perfect competition is an ideal market structure where
there are many firms, freedom of entry into the industry
with all firms producing identical products. Firms are price
takers and there is perfect information for all firms in the
market. Imperfect competition refers to a market
structure where the conditions that are necessary for
perfect competitive market i.e: many buyers and sellers,
not fully met. It describes a market environment where
vendors sell differentiated products.

Define perfect competition:

An ideal market structure that has many buyers and
sellers, identical products sold, no barriers to entry;
sometimes referred to as total competition.
Define imperfect competition:
Any market structure except for perfect competition.
Define monopolistic competition:
A market structure where there are many firms,
differentiated products and few barriers to entry.
Define oligopoly:
A market structure with few firms and high barriers to
entry.
Define barriers to entry:
Restrictions that prevent new firms entering an industry.
Explain the difference between pure and natural
monopoly:
Monopoly is where there is a single seller in the market.
When there is just one firm producing a good or service
for the entire market, this is referred to as a pure
monopoly. A natural monopoly is where long-run average
costs are lower when there is just one firm in the industry.
Define pure monopoly:
Where there is just one seller in the market.
Define natural monopoly: Where with falling long-run
average costs, it makes sense to have only one firm
providing goods/services.
Explain the four ways to identify the type of market
structure:
[Link] the number of firms. The larger the total, the
closer to perfect competition.
[Link] a concentration ratio to see the combined market
share of the biggest firms as a percentage of the total
market. The bigger the percentage, the closer the market
will be to the oligopoly and monopoly models.
[Link] considering how easy or difficult it is for new firms to
enter and how easy it is for existing firms to exit the
industry. Barriers to entry are indicative of market
structures on the less competitive side of the spectrum.
[Link] considering the importance of economies of scale to
firms. The more important they are, the closer the
industry will be to an oligopoly.
Define concentration ratio:
A measure of the combined market share of the biggest
three or four firms in a market.
Explain the five types of barriers to entry and exit:
Legal barriers: Government-imposed rules, regulations or
restrictions that make it difficult or costly for new
businesses to enter a market, protecting existing firms,
and influencing competition. These barriers, such as high
licensing fees for doctors, increasing costs for
newcomers, limiting competition and potentially leading
to higher prices or restricted innovation.

Market barriers: Advertising and brand names with a high

degree of consumer loyalty may be a difficult obstacle to
overcome. Existing firms can make entry for new firms
more difficult by saturating the market with lots of
brands, giving its consumers what appears to be a wide
range of choices. Branding gives the firm greater market
power because consumers do not see the rival firm’s
product as a close substitute due to extensive
advertising.
Cost barriers: The high fixed cost or setup cost in
activities such as electricity generation may deter
potential entrants. The barrier here is access to capital.
Only very large firms will be able to fund the necessary
investment as research and development costs will
represent a high proportion of total costs. High sales over
a long period of time are needed before the firm is
profitable.
Physical barriers: Some firms may have monopoly access
to raw materials or retail outlets, which will make it
difficult for new entrants to make an impact. Vertically
integrated manufacturing businesses will only be
protected by the fact that their rivals’ costs will be higher.
Barriers to exit: If a firm shuts down, then some costs
such as research and development costs cannot easily be
transferred to other uses. These are regarded as sunk
costs and act as a barrier to exit from the industry
because the capital investment will be lost. It is therefore
the risk of entering and the high cost of failure that deters
potential entrants and so acts as a barrier to entry.
Define predatory pricing: Where a firm sells its goods
below average variable cost to force competitors out of
the market.

Define limit pricing:

Where firms deliberately lower prices and abandon a
policy of profit maximization to stop new firms from
entering a market.
Define collusion:
An anti-competitive action by producers
Define barrier to exit:
A restriction that prevents a firm from leaving the market.
Explain the characteristics of perfect competition:
Perfect competition has the following characteristics:
[Link] are many buyers and sellers who have perfect
knowledge of market conditions and the price that is
charged.
[Link] individual firm has any influence on the market price
as firms are the price takers. The ruling price is
determined by the forces of market demand and the
output of all the firms.
[Link] products sold are identical. This means that they
are all the same quality and are identical in the eyes of
the consumer.
[Link] is complete freedom of entry into and exit from
the market.
[Link] firms and consumers have complete information
about products, prices and means of production.
Define shut-down price:
A firm will stop production when price falls below average
variable costs.

Explain the characteristics of monopolistic competition:

Monopolistic competition has the following
characteristics:
[Link] are many buyers and sellers.
[Link] are few barriers to entry into the market, and it is
easy for firms to recoup their capital expenditure on exit
from the market.
[Link] face a wide choice of differentiated
products. Each firm has a slight degree of monopoly
power in that it controls its own brand through quality
and physical differences.
[Link] have some influence on the market price and are
therefore price makers.
Define price competition:
Where firms compete on price to attract customers
Define non-price competition:
When firms use methods other than price to attract
customers from rival producers.
Explain the characteristics of oligopoly:
An oligopoly has the following characteristics:
[Link] market is dominated by a few firms.
[Link] decisions taken by firms are interdependent. Firms
must decide their market strategy to compete with close
rivals, but they must also try to anticipate their rivals’
reactions and think what the next step should be in the
light of this response.
[Link] are high or substantial barriers to entry.
[Link] products may be differentiated or undifferentiated.
[Link] uncertainty and risks associated with price
competition may lead to price rigidity
Define kinked demand curve:
A traditional model of a firm’s behavior in oligopoly.
Define price rigidity:
Where prices are unchanged despite a change in costs.
Explain the features of non-price competition:
[Link] and promotions
[Link] innovation. This is the attempt to make the
products more appealing to consumers
[Link] proliferation. Where the firm produces lots of
brands to saturate the market and to leave no gaps for
rivals
[Link] segmentation. Producers may decide that there
are markets where the consumers have different
characteristics and needs; products will be adapted
accordingly to maximize sales.
[Link] innovation. This is usually seen as a way of
reducing average costs, allowing the firm to cut the price
without sacrificing profits.
Define price leadership:
A situation in a market whereby a particular firm has the
power to change prices, the result of which is that
competitors follow this lead.
Define cartel:
A formal agreement between firms to limit competition by
limiting output or fixing prices.
Explain the characteristics of monopoly:
In theory, a monopoly has the following characteristics:
1.A single seller
[Link] close substitutes
[Link] barriers to entry
[Link] monopolist is a price maker.
Define X-inefficiency:
Where the firm’s costs are above those experienced in a
more competitive market.
Define contestable market:
A market where entry is free and exit is costless.
Define contestability:
The extent to which barriers to entry into a market are
free and exit from the market is costless.
Define deregulation:
When barriers to entry into an industry are removed.