ECON — Module 7: Market Structures

What are the four market structures and their key distinguishing features?

Perfect competition: many firms, identical products, price takers, free entry/exit. Monopolistic competition: many firms, differentiated products, some pricing power, free entry/exit. Oligopoly: few large firms, interdependent, significant barriers to entry. Monopoly: one firm, unique product, price maker, high barriers to entry.

Is Diet Coke a monopoly product? Why or why not?

NO — Diet Coke has many close substitutes (other diet soft drinks, sparkling water, etc.). A monopoly requires no close substitutes. The fact that Coca-Cola is the only producer of Diet Coke specifically doesn't matter — monopoly is defined by the absence of close substitutes in the broader market, not by brand exclusivity.

Why does a perfectly competitive firm NOT need to lower its price to sell more output?

Because it is a PRICE TAKER. The market price is set by all buyers and sellers collectively, and the individual firm is too small to affect it. It can sell as much as it wants at the going market price. Its demand curve is perfectly horizontal (infinitely elastic).

Why does a monopolist HAVE to lower its price to sell more output?

Because it faces the entire downward-sloping market demand curve. To attract additional buyers, it must lower price — and crucially, it must lower the price for ALL units, not just the extra one. This is why the monopolist's marginal revenue is always below its price.

What is the profit-maximising rule that applies to BOTH perfectly competitive firms AND monopolists?

Both maximise profit where MR = MC (marginal revenue equals marginal cost). This is the universal profit-maximising condition. The difference: for a competitive firm P = MR, so the rule also means P = MC. For a monopolist, P > MR, so P > MC at the optimum — this is the source of monopoly deadweight loss.

To sell an extra unit, a perfectly competitive firm _____, and a monopolist _____.

Perfectly competitive firm: need not alter its price (it's a price taker). Monopolist: must lower its price (it faces a downward-sloping demand curve and must reduce price to attract the next buyer).

Why is a monopolist's marginal revenue always less than its price?

Because to sell one more unit, the monopolist must lower the price on ALL units sold, not just the extra one. The revenue gained from the new unit is offset by the revenue lost on all previous units now sold at the lower price. So MR < P always for a monopolist.

Why does the average cost curve slope downward for most monopolists?

Because the primary component of their costs is FIXED costs. As output increases, this fixed cost is spread over more and more units — so the cost per unit (average cost) falls. This is economies of scale, and it's why natural monopolies tend to emerge in industries with very high fixed costs (e.g. electricity networks).

What is a natural monopoly, and what causes it?

A natural monopoly exists when one firm can supply the entire market at lower cost than two or more firms could. It arises from very high fixed costs relative to variable costs — average cost continuously falls as output rises, so a single large firm is always more efficient than multiple smaller ones. Example: Auckland's water network.

What is deadweight loss in a monopoly, and what causes it?

Deadweight loss is the loss of total economic surplus that occurs because the monopolist restricts output below the socially efficient level and charges a price above MC. The units between the monopoly quantity and the competitive quantity would have generated value for society but are never produced.

How does government regulate monopoly to address inefficiency? Name two approaches.

1. Price regulation — cap price at MC (socially efficient) or AC (allows normal profit). 2. Breaking up the monopoly using competition law (e.g. Commerce Commission in NZ). Trade-off: regulating a natural monopoly at P = MC may mean the firm makes a loss (since AC > MC on the downward-sloping portion of AC).

What role does the Commerce Commission play in New Zealand?

The Commerce Commission enforces the Commerce Act, which prohibits anti-competitive behaviour — including price fixing, market allocation, and misuse of market power. It can block mergers that would substantially lessen competition and regulate the pricing behaviour of natural monopolies (e.g. Auckland Airport, Chorus).

What is market power, and what is its primary source?

Market power is the ability of a firm to set prices above marginal cost without losing all its customers. Its primary source is high barriers to entry — which are often created by high fixed costs, patents, control of key resources, or network effects that prevent rivals from entering profitably.

What is the difference between monopolistic competition and monopoly?

Monopolistic competition: MANY firms sell DIFFERENTIATED (but similar) products, and there is FREE ENTRY and EXIT. Each firm has some pricing power due to product differentiation but makes zero economic profit in the long run as new entrants erode it. Monopoly: ONE firm, no close substitutes, high barriers. Profit can persist in long run.

What is a key feature of oligopoly that distinguishes it from other structures?

Interdependence — each firm's pricing and output decisions depend on what rivals do. This leads to strategic behaviour, modelled using game theory. Example: if Air New Zealand cuts fares, Jetstar must decide whether to match them. Neither acts in isolation.