Moduel Three: Market Structures, Competition, & Market Power

Market Power

The ability of a firm to influence prices, output, or market conditions instead of simply accepting market prices.

Perfect Competition

A market structure with many firms selling identical products where no single firm has market power.

Characteristics of Perfect Competition

Many buyers and sellers, identical products, easy entry and exit, and firms are price takers.

Price Taker

A firm that must accept the market price because it has no market power.

Monopoly

A market structure where one firm dominates the entire market.

Characteristics of Monopoly

Single seller, high barriers to entry, unique product, and significant market power.

Oligopoly

A market structure with a small number of large firms dominating the market.

Characteristics of Oligopoly

Few large firms, interdependent decision-making, barriers to entry, and potential for collusion.

Monopolistic Competition

A market structure with many firms selling differentiated products.

Characteristics of Monopolistic Competition

Many sellers, product differentiation, and relatively easy entry and exit.

Barriers to Entry

Obstacles making it difficult for new firms to enter a market.

Examples of Barriers to Entry

Patents, high startup costs, government regulations, control of resources, and economies of scale.

Natural Monopoly

A monopoly that exists because one firm can produce at a lower cost than multiple competing firms.

Economies of Scale

Cost advantages gained when production increases and average costs decrease.

Market Concentration

The extent to which a small number of firms dominate a market.

Concentration Ratio

A measure showing the percentage of market share controlled by the largest firms in an industry.

Four-Firm Concentration Ratio

The combined market share of the four largest firms in an industry.

Herfindahl-Hirschman Index (HHI)

A measure of market concentration calculated by summing the squares of each firm’s market share.

Formula for HHI

HHI = sum of the squared market shares of all firms in the market.

High HHI Meaning

A high HHI indicates a highly concentrated market with less competition.

Low HHI Meaning

A low HHI indicates a more competitive market.

Collusion

When firms cooperate to reduce competition and increase profits.

Explicit Collusion

A formal agreement between firms to coordinate prices or output.

Tacit Collusion

Informal coordination where firms indirectly cooperate without explicit agreements.

Cartel

A group of firms that collude to control prices or output.

Price Fixing

When firms agree to set prices instead of competing.

Bid Rigging

When firms secretly coordinate bids to reduce competition.

Output Restriction

When firms limit production to raise prices and profits.

Game Theory

The study of strategic decision-making between firms or individuals.

Prisoner’s Dilemma

A game theory model showing why firms may fail to cooperate even when cooperation benefits both.

Dominant Strategy

The best strategy regardless of what another player chooses.

Payoff

The result or reward from a strategic decision.

Nash Equilibrium

A situation where no player benefits from changing strategy while others keep their strategies unchanged.

Repeated Games

Games where firms interact multiple times over time.

Why Collusion Breaks Down

Firms may cheat to increase profits or face incentives to undercut rivals.

Price Leadership

When one dominant firm sets prices and other firms follow.

Predatory Pricing

Temporarily lowering prices to drive competitors out of the market.

Limit Pricing

Setting prices low enough to discourage new competitors from entering the market.

Market Share

The percentage of total sales controlled by a firm in a market.

Formula for Market Share

Firm Sales ÷ Total Market Sales

Elasticity of Demand

A measure of how much quantity demanded changes when price changes.

Inelastic Demand

Demand that changes little when price changes.

Elastic Demand

Demand that changes significantly when price changes.

Why Firms with Market Power Prefer Inelastic Demand

Consumers are less sensitive to price increases, allowing firms to raise prices more easily.

Contestable Market

A market where firms can easily enter and exit, increasing competition.

Why Barriers to Entry Matter

High barriers protect existing firms and reduce competition.

Competitive Advantage

A factor allowing a company to outperform competitors.

Differentiation

A strategy making products appear unique from competitors.

Cost Leadership

A strategy focused on becoming the lowest-cost producer.

Innovation

The creation of new products, technologies, or processes.

Creative Destruction

The process where innovation replaces older industries or technologies.

Network Effects

When a product becomes more valuable as more people use it.

Examples of Network Effects

Social media platforms, phone networks, and online marketplaces.

Switching Costs

The costs consumers face when changing from one product or company to another.

Patent

A government-granted right protecting inventions and reducing competition temporarily.

Copyright

Legal protection for original creative works.

Trademark

Legal protection for brand names, logos, or symbols.

Intellectual Property

Creations of the mind protected by law, including patents, copyrights, and trademarks.