Chapter 4 - Market Structure

What is Perfect Competition?

A perfectly competitive market is one where no single firm has market power, and resources are allocated efficiently.

Does a perfectly competitive market exist in real life?

No, it is only an economic theory.

Characteristics of Perfect Competition

1. Infinite suppliers and consumers.

2. No firm has market power (firms are price takers).

3. Perfect information for producers and consumers.

4. Homogeneous products.

5. No barriers to entry or exit.

6. Firms are profit maximisers.

Why does perfect competition lead to allocative efficiency?

Rationing, signalling, and incentives work perfectly; price is set according to consumer preferences.

Why are firms productively efficient in perfect competition?

Firms minimize production costs to maximize profits and reduce X-inefficiency to compete effectively.

Can firms in perfect competition make supernormal profits in the long run?

No, because more firms enter the market, and supernormal profits are competed away.

Can dynamic efficiency be achieved in perfect competition?

No, because firms only make normal profits and cannot afford investments in research and development.

What is a monopoly?

A market with only one firm or where a single firm has 100% market share.

What allows monopolies to form?

1. Barriers to entry prevent competition.

2. Advertising and product differentiation make their product more desirable.

Do monopolies make supernormal profits in the long term? Why?

Yes, because no new firms can enter the market to compete away profits.

Are monopolies allocatively and productively efficient? Why or why not?

No, because they don’t produce at the lowest point of the AC curve (not productively efficient) and charge prices much higher than marginal cost (not allocatively efficient).

What is an oligopoly?

A market dominated by a few firms with high barriers to entry and differentiated products.

What are key characteristics of oligopolies?

1. Few dominant firms.

2. High barriers to entry.

3. Firms are interdependent.

4. Products are differentiated.

What are the two main strategies firms in oligopolies can use?

1. Competitive behavior (compete on price).

2. Collusive behavior (cooperate on price).

What are the two types of collusion?

1. Formal collusion: Firms agree on pricing (usually illegal).

2. Informal collusion: No agreement, but firms avoid competition.

How does the kinked demand curve explain price stability?

Price increase leads to elastic demand; consumers switch to competitors.

Price decrease leads to inelastic demand; competitors lower prices too.