Market structures

Define market structure

• The organisation of a market in terms of the number of firms in the market and the ways in which they behave

• E.g. If goods sold are homogenous + If the market causes barriers to entry

Range of market structures from highly competitive

• Perfect competition

• Monopolistic - Similar goods not identical/each firm has a degree of market power/ many sellers

• Oligopoly-Few larger firms dominate the market/ slightly differentiated products

• Monopoly

Define price taker

• A firm which accepts the ruling market price and cannot influence price

Define price maker

• A firm possessing the power to set prices

Characteristics of perfect competition

• Large number of buyers and sellers

• Perfect information regarding what is happening in the market

• Consumers are able to buy and producers are able to sell as much as they wish at the ruling market price

• Market price is determined by the interaction of all the buyers and sellers in the market

• Goods/services are identical

• No barriers to entry/exit

Why is there no barriers to leaving the market in perfect competition?

• Firms wont make financial losses when leaving the market as they don’t invest heavily in advertising

• Minimal market disruption as consumers can simply switch to another firm

• When leaving the market firms can easily sell equipment and start up a different business

Why is perfect competition a theoretical concept?

• Not all conditions for perfect competition can be met simultaneously

Define a concentrated market

• Only contain very few firms

Define a pure monopoly

• A single firm produces the whole of the output of a market

• It is the most extreme example of a concentrated market

A monopoly is a relative rather than….

• An absolute concept

UK legal definition of a monopoly

• When a firm holds over 25% of market share

Explain how British gas was formerly a monopoly

• It was the single producer of piped gas

• But experienced competition from other sources of energy like oil and electricity

• Monopoly power was eventually reduced when other companies were allowed to sell gas via pipelines previously owned by British gas

Why are pure monopolies rare

• Due to competitive pressures arising from substitute products

Define imperfect competition

• Any market structure lying between the extremes of perfect competition and pure monopoly

Characteristics of imperfect competition

• Competitive market with many sellers

• Goods sold are heterogeneous

• (Term covers market structures where there are a large number of highly competitive firms approximating to perfect competition to those that are highly concentrated approximating to pure monopoly)

• Almost all real world markets are imperfectly competitive

What is a firms ultimate objective believed to be?

• Profit maximisatiom

Why may a firm decide to grow/expand?

• Because they believe growth will lead to higher profits

What may a firm do if they believe growth will reduce profit?

• Firm will resist pursuing expansion/growth

Explain the conflict that may arise between short run and long run profit maximisation?

• Long run profits may require substantial investment.

• If a firm is worried about how to finance such investments and the lack of immediate profit rendering it vulnerable to hostile takeover by other firms

• It many decide not to grow despite the possibility of long run profits

Define sales maximisation

• Another objective of firms

• It occurs at the level of output at which the sale of an extra unit of output would yield no extra revenue (Marginal revenue=0)

• Achieved by lowering prices to attract more consumers

• Eventually the price cuts will cancel out the revenue gained

Define marginal revenue

• Revenue a firm earns from selling one more unit

Other objectives of a firm

• Growth maximisation

• Market share maximisation

• Survival

Explain growth maximisation

• Firms may wish to expand as fast as possible to help increase market power/influence

• This may conflict with their objective of profit maxamisation

Explain market share maximisation

• May be a result of growth maximisation

• Involves increasing the percentage of market output a firm produces

• To accentuate or achieve monopoly power

Explain the survival objective

• In highly competitive markets firms may solely aim to survive

• Because in these markets firms are always threatened by the entry of new firms which may usurp their consumer base

• Thus pursuing the notion of “Adapt or perish”

Diagrams for price determination in a competitive market

• Firms in competitive markets are passive price takers

Explain the diagrams of price determination in a competitive market

• The market price in a competitive market is determined by the interaction between demand and supply

• In a perfectly competitive market firms can sell however much they want at the ruling market price

• Making PED perfectly elastic. Any change in price will drastically effect demand

• If price is above ruling price, firms will make no sales as consumers can easily find substitute goods

• and selling below market price will result in minimal sales

Profits are likely to be lower in which market structure? and why

• Competitive

• In a competitive market, profits attract more new firms into the market, lowering ruling market price

Diagrams to show how profits in a competitive market become low

Explain diagrams showing low profits in a competitive market

• Initially P1 is determined where market supply meets market demand.P1 being the price all firms charge

• At this price each firm makes large profits which attracts new firms into the market

• More firms mean supply will shift to the right. Resulting in more supply than demand

• Market price decreases and so does the profit generated by firms

Why are firms in a concentrated market not at much risk of competition lowering profits?

• They are protected by barriers to entry

• Which keep prices and profits high

What might threaten high profits in a concentrated market?

• As part of the competitive process, high profits create an incentive for firms to overcome barriers to entry

Define consumer sovereignty

• Through exercising their spending power, consumers collectively determine what is produced in a market

• Strongest in a perfectly competitive market

Why is consumer sovereignty strongest in a perfectly competitive market?

• Firms that produce goods other than those which consumers are prepared to pay for, do not survive in competitive markets

Define producer sovereignty

• Producers/firms in a market determine what is produced and for how much

• Strongest in concentrated markets

Why is producer sovereignty strongest in concentrated markets ?

• Monopolies posses significant market power to manipulate consumer wants via marketing devices

Strict definistion of a monopoly

• Refers to a pure monopoly

• Only one firm produces all of the output within a market

• No competition

Looser definition of a monopoly

• Refers to a market in which there is a dominant firm

• But there are also a few competing firms

Define monopoly power

• Power to act as a price maker

What may reduce monopoly power of a pure monopoly?

• Substitute goods produced in other industries

Explain how the monopoly power of kodak was reduced by Microsoft

• Kodak was a dominant firm in the global photography industry making film using cameras

• But lost monopoly power due to technical progress

• 1990s onwards digital cameras replaced film using cameras

• Despite high entry barriers for film using camera markets

• Barriers were low for digital market cameras

• Which became a practical substitute

Define a natural monopoly

• When a firm has complete control of a natural resource

• or there is only room for one firm to benefit from economies of scale

Example of a natural monopoly

• Utility companies like electricity providers require extensive infrastructure like transmission lines

• If multiple companies tried to build their own transmission lines it would be costly and wasteful

• Thus a single utility provider can serve the entire region at lower costs per unit

• Government will often regulate prices to prevent a firm from exploiting its monopoly power when selling a necessity.

Explain geographical causes of a monopoly

• Occurs when a single firm is the only provider of a good in a specific location

• e.g. a single grocery store in an isolated village.

• Entry for a second grocery store is restricted by the fact the market is too small

• But monopoly does not exist in an absolute sense as villagers can still travel to other out of town grocery stores→ may be inconvenient

Explain government created monopiles

• Governments can sometimes create a monopoly (other than in utility sectors) in markets they believe are too important to leave to competition.

• Industries like coal and railways were nationalised by labour government and turned into state owned monopiles as the government believed these industries were essential for the well being of the whole economy

• State ownership also ensures these industries operate in public interest.

Example of government creating a private monoply

• Private gov monopoly may be created to regulate the consumption of a good

• For example, giving a gambling franchise to 1 casino.

• Limits gambling as gov can implement regulations on the casino

• Less casinos= less competition

• Little acknowledgement of the casino market that could encourage gambling

Define patent

• A man made barrier to entry caused by government legislation

• protecting the right of a firm to be the sole producer of the patented good

• (unless firms grant royalties for other firms to produce the good)

Factors influencing monopoly power

• Barriers to market entry

• Number of competitors in the market

• Advertising

• Product differentiation

What is the effect of a barrier to market entry?

• Prevents new firms from entering the market and sharing the monopolists profits

What are natural barriers

• Barriers to entry that are not man made

• These include economies of scale and indivisibilities.

How are economies of scale and indivisibilities barriers to market entry ?

• Economies of scale allow established firms to produce at lower average costs than smaller new entrants who have higher average costs

• Indivisibilities prevent certain goods from being produced in plants below a certain size

What are artificial barriers?

• Barriers which are man made.

• Deliberate actions by firms in the market to prevent new firms from entering the market.

• E.g. patents, predatory pricing

How does the number of competitors in the market influence monopoly power?

• When there are more firms in the market it lessens the scope to exercise monopoly power as market share reduces.

• More firms competing lowers prices and barriers to entry decrease.

Define informative advertising

• Provides consumers and producers with useful information about goods/services

• This type of advertising increases competition as information is easily accessible

Define persuasive advertising

• Attempts to persuade customers that a good/service posses desirable characteristics that makes it worth buying

• This advertising reduces competition

• Customers become “captive customers” as they will be unwilling to buy cheaper substitutes

• As the persuasive advertisement will focus on how he good will improve the consumers feelings

Define saturation advertising

• Works in compliance with persuasive advertising

• When a firm floods the market with information and persuasion about its products

• This functions as a man made barrier to entry for smaller firms as they cannot afford this type of extensive advertising.

What is product differentiation

• Making a product different from others via design, functionality and method of production

• Increases monopoly power if amplified with advertising

Explain coca-colas success due to product differentiation/advertising

• Emphasis on persuasive advertising and brand image has made coca cola a global brand leader

• Slogan “taste the feeling”

• Recognisable logo

• PED is inelastic for coca cola

In a pure monopoly, the demand curve for the monopolists output is the market demand curve . Why?

• There is only 1 firm in the market that produces that output, so all market demand is going to be directed towards that 1 firm

What does the demand curve of a monopoly signify?

• Monopolist is the price maker. By choosing to set the price at which the product is sold, the demand curve dictates the maximum output that can be sold at this price.

• Alternatively a monopolist can be a quantity setter rather than a price maker.

• This is when the firm chooses the quantity of a good to sell rather than price. In this case the demand curve illustrates the maximum price at which the chosen quantity is sold.

Why may a monopolist try to escape the choice of being price maker/quantity setter?

• Choosing a high price reduces demand

• Restricting quantity can lead to forsaking potential profits

• Setting prices to high can incentivise more firms to enter the market

• (Instead they focus on shifting demand curve to the right via advertising)

What is a concentration ratio?

• A ratio which indicates the total market share of a number of leading firms in a market.

• 3:80%

• 3 largest firms in the market

• 80% = the combined market share of those 3 firms

Explain how the relevant diagram shows monopolies exploiting consumers

• Monopoly can increase profits by reducing market output

• The market output is less than it would be in competitive market (where price and quantity are determined by interactions by demand and supply)

• Restricting output allows monopoly to increase prices

• Higher prices and restricted output lead to resource misallocation.(when resources are not allocated in a way that maximises economic welfare)

Why does a monopoly restricting output and raising prices cause resource misallocation

• Higher prices mean consumers buy less of the good then they would have

• Firms may benefit from higher profits but consumers have to lower consumption

• This is especially damaging when the good produced by the monopoly is a necessity like energy (to heat homes)

Define productive efficiency

• Producing goods at the lowest possible costs

Why may a monopoly be productively inefficient compared to firms in a competitive market ?

• No barriers to entry in a competitive market and this reduces market price

• For firms to remain profitable they must find methods to reduce their cost of production

• The pressure to do this is less in a monopoly provided it is protected by high barriers to entry

Why may there be an absence of economies of scale in a concentrated markets? and how can this make a monopoly productively inefficient

• Monopolies aren’t threatened by competition so there’s no incentive to achieve economies of scale

• Profits may already be higher and there is no new entrants so further expansion may not be deemed necessary

• This may increase average costs in the long run as their is always potential for new competition.

How may firms competing against each other in concentrated markets reduce competition?

• Via collusion

• Which is a cooperation between firms to fix prices to sustain high profits

What is the price ring/ cartel agreement?

• Most common form of collusion

• Members (firms) of the “cartel” limit competition by fixing prices and controlling supplies within the market

• Effectively acting as a collective monopoly and discouraging new firms from entering the market

Why are price cartels illegal?

• They keep prices high

• Reduce innovation

• Anti-competitive

What is meant by a small market?

• Market where demand for a good is low

• E.g. private jet manufacturing

1 Benefit of monopoly

• Economies of scale

• Firm can produce at lower average costs

• May be passed onto consumers as low prices

Why may some firms not experience diseconomies of scale

• Firms develop better organisational structures or adopt a process of automation

• So after experiencing significant economies of scale and reaching minimum efficient sales

• average costs remain constant.

How can profits be a benefit to monopolies

• Profits can fund research and development

• Financing product innovation- converts the results of invention (new ideas) into marketable products

• Leading to better ways to make existing products and development of completely new products

• Beneficial to the entire economy and consumers

Why may patents be a good thing for monopiles

• Monopoly firms are protected by patents that prevent competitors from free riding on its success

Competition is a …..

• Dynamic process which takes place over a period of time

What is the only from of competition in perfectly competitive markets?

• Cost cutting competition

Why is price competition not viable in perfectly competitive markets?

• All firms are passive price takers

• Manipulating price will not increase sales or market share

• Only results in self defeating price wars that only ultimately benefit the consumer

Why do other forms of competition like advertising or product differentiation also not exist in perfect competition?

• All goods sold are homogenous

• No brand loyalty as substitutes are easily found

Why is cost cutting competition compatible with a competitive market?

• Each firm has an incentive to reduce costs in order to sustain profits

• But any profits made from cost cutting are temporary as market information is easily accessible

• other firms may utilise cost cutting strategies

What are other forms of competion?

• Price competition

• Advertising

• Brand imaging

• Quality - Point of sales service/after sale service

What is a negative implication of competition?

• Alerts consumers about available choices and their ability to choose substitutes

What is special offer pricing ?

• Firms introduce temporary special offers like discounted goods for a limited time.

What is limit pricing?

• Reducing price of goods just above average costs to deter new entrants

• Firms essentially sacrifice short run profit maximisation for long run profit maximisation by deterring the entry of new firms as the market will be deemed as unprofitable when using this pricing strategy

What is predatory pricing ?

• Limit price deters market entry

• Predatory pricing removes recent entrants of to the market

• This occurs when incumbent (existing) firms deliberately set prices below costs to force new market entrants out of business.

• Once these firms have successfully been ousted, existing firm restore their prices

• Considered highly anti competitive and exploitative