3.4 market structures

why firms in perfect competition will be price takers

Firms in perfect competition are price takers because:

• There are many buyers and sellers, so no single firm can influence the market price.

• Products are homogeneous, meaning identical goods — consumers will always buy from the cheapest seller.

• Perfect information ensures consumers know all prices, so firms can't charge more than the market price.

list the characteristics of a monopoly and for each give an implication for the industry

Single Seller (One firm dominates the market;

The firm has price-setting power, leading to higher prices and potentially reduced consumer surplus.

2. High Barriers to Entry (Legal, technical, financial, or natural barriers)

New firms find it difficult to enter, allowing the monopoly to maintain long-run supernormal profits and reduce competition.

3. Price Maker

The firm can influence the market price by adjusting its output, resulting in allocative inefficiency (P > MC)

evaluation

While monopolies often reduce efficiency and raise prices, in some cases — like natural monopolies — they may be the most cost-effective provider, especially when regulated to protect consumers.

Monopoly and monopoly power

Monopoly refers to the market structure, while monopoly power refers to a firm’s ability to set prices above marginal cost and influence the market.

explain the sources of monopoly power for a firm

Barriers to Entry

Legal, financial, or structural obstacles that prevent new firms entering the market.

Reduces competition,maintain supernormal profits in the long run.

2. Economies of Scale

Large firms can produce at lower average costs, especially in capital-intensive industries.

Creates a cost advantage that deters smaller entrants

3. Legal Protection (e.g. Patents, Copyrights)

Government grants exclusive rights to produce a product.

Protects innovation but also gives temporary monopoly power (e.g. pharmaceuticals).

list the characteristics of a monopolistically competitive market and explain the behaviour of firms in this type of industry

Many Buyers and Sellers

No single firm has significant market power

2. Low Barriers to Entry and Exit

New firms can easily enter the market, especially in the long run.

3. Product Differentiation

Each firm offers a slightly different product (e.g. branding, quality, location).

Short run behaviour of firms in monopolistic competition

📉 Short Run

• Firms behave like monopolies:
  They profit-maximise by producing where MC = MR, and can earn supernormal profits if they have strong differentiation.

• Their demand curve is downward sloping, due to product differentiation.

🔑 Supernormal profits attract new firms to the market.

in monopolistic competition Behaviour of firms in the long run

• Due to low barriers to entry, new firms enter, increasing competition.

• The demand curve for each existing firm shifts left (more substitutes) and becomes more price elastic.

• Firms are forced to accept normal profits only in the long run — AR = AC at the profit-maximising point.

identify the similarities and differences between monopolistic competition and perfect competition

3 Similarities

1. Many buyers and sellers – No single firm dominates the market.

2. Low barriers to entry/exit – New firms can enter easily, so normal profits in the long run.

3. Profit maximisation – Firms produce where MC = MR.

❌ 3 Differences

1. Product type – Perfect: homogeneous; Monopolistic: differentiated.

2. Price power – Perfect: price takers; Monopolistic: some price-setting power.

3. Efficiency – Perfect: productively & allocatively efficient in long run; Monopolistic: not efficient.

Monopolistic competition and monopoly

The main difference is that a monopoly has one seller with a unique product and significant barriers to entry, while monopolistic competition features many sellers with differentiated products but no significant barriers to entry or exit. This leads to a monopoly having high price control and no competition, whereas monopolistic competitors have limited price control and face intense non-price competition like advertising

Firm in a monopolistically competitive industry making supernormal profits

Give a justification for why firms in monopolistic competition will earn normal profit in the long run , even if supernormal profits are being earned in the short run

1. the supernormal profits will attratc more firms

2. more firms enter due to low barriers to entry

3. consumer has greater choice and demand becomes diluted

4. 4 firms will continue to enter until normal profits are made

show the long run equillibrium in monopolistic competition

Explain using an example the meaning of the term "concentration ratio"

The concentration ratio measures the total market share of the top few firms in a market. It shows how dominant those firms are and helps identify if a market is competitive or oligopolistic.

A high concentration ratio (e.g. over 60%) suggests an oligopoly, where a few firms have significant market power.

Supermarkets

• Tesco – 27%

• Sainsbury’s – 15%

• Asda – 14%

• Morrisons – 10%

explain the implication and following characteristics of an oligopoly - High barriers to entry and exit

• Maintains market power of existing firms
  – Prevents new competitors from entering and driving prices down.
  – Firms like Tesco or Coca-Cola remain dominant for long periods.

• Less competitive pressure
  – Existing firms face less threat of new entrants, so may collude or engage in non-price competition instead of lowering prices.

explain the implication and following characteristics of an oligopoly - high concentration ratio

A high concentration ratio means that a few large firms dominate the market. For example, a CR4 of 80% means the top 4 firms control 80% of total market share.

• Market Power
  – Dominant firms can influence price, output, or even market structure.

• Interdependence
  – Firms closely monitor each other's actions, leading to price rigidity (e.g. kinked demand curve).

explain the implication and following characteristics of an oligopoly - product differentiation

Product differentiation is when firms make their products appear different or superior to those of rivals — through branding, quality, design, or customer service — even if the core product is similar.

• Coca-Cola and Pepsi offer very similar products, but differentiate through taste, packaging, and advertising.

• Consumers develop brand loyalty, allowing both firms to charge premium prices.

oligopoly

An oligopoly is a market structure dominated by a few large firms, where each firm has a significant share of the market and is interdependent in decision-making.

It is typically characterised by a high concentration ratio, barriers to entry, and non-price competition.

perfect competition

Perfect competition is a market structure where a large number of small firms sell an identical (homogeneous) product, and no single firm has market power.

Firms are price takers, and there is perfect information, no barriers to entry or exit, and perfect resource mobility.

Factors that make collusion more likely

Few Firms in the Market (High Market Concentration)

When there are only a small number of firms, it’s easier to communicate and coordinate. Each firm’s actions significantly impact others, so they’re more likely to cooperate to avoid price wars.

2. Similar Costs and Products

If firms have similar cost structures and sell similar (homogeneous) products, it's easier to agree on a common price. No firm has a cost advantage, so there's less incentive to cheat on the agreement.

game theory

Game theory studies how firms make interdependent decisions. In oligopolies, it shows that while collusion maximises joint profits, firms may cheat for short-term gain.

Explain the reasons for collusion

Maximise Joint Profits 💰

Firms act like a monopoly when colluding, reducing output and raising prices.
→ Higher supernormal profits for all.

2. Reduce Price Wars 🔪

Price competition harms all firms. Collusion stabilises prices and protects profit margins.

3. Avoid Uncertainty 📉

With cooperation, firms can predict rivals’ behaviour, helping with planning and investment.

Collusion

Collusion is when firms cooperate (explicitly or tacitly) instead of competing, usually to restrict output, fix prices, or limit competition, to increase joint profits.

why collusion may fail

• Incentive to cheat (prisoner’s dilemma – short-term gain from undercutting).

• Regulatory oversight – CMA or EU Commission may fine or break up cartels.

• Consumer backlash – lower demand if prices are too high.

• Difficult to sustain – especially with many firms or market changes.

Overt collusion

Overt collusion is when firms openly agree to work together instead of competing — for example, by fixing prices, limiting output, or dividing the market. These agreements are explicit and known, sometimes even formal.

Tacit collusion

Tacit collusion is when firms indirectly coordinate without any formal agreement — they follow each other’s behavior, like keeping prices high, to avoid competition.

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Key Features

• No explicit agreement → harder to prove and usually legal.

• Happens in oligopolies where firms are interdependent.

Cartel

A cartel is a formal agreement between competing firms (usually in an oligopoly) to restrict competition, typically by fixing prices, limiting output, or dividing markets.

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Key Features

• Type of overt collusion.

• Members act together like a monopoly to increase profits.

• Often illegal (e.g. under UK and EU law).

Price leadership

Price leadership occurs when one dominant firm sets the price, and other firms in the market follow rather than compete on price.

Kinked demand curve

how does the kinked demand curve show interdependence

• Above the kink: If a firm raises price, rivals are unlikely to follow — they’ll keep prices the same to gain market share. Demand is elastic here, because consumers will switch.

• Below the kink: If a firm cuts price, rivals are likely to match to avoid losing customers. Demand is inelastic, since no firm gains much from the cut.

Uk productivity

33% less than america

government could fund more apprenticeships,training,HS2 was an example of trying to combat this

Productivity

refers to the number of units per worker per hour

price war

A price war occurs when rival firms repeatedly undercut each other’s prices to gain or protect market share. It's common in oligopolistic markets, where firms are interdependent and react strategically to competitors' pricing.

how price war effects sales

• In the short run, sales volume may increase for some firms.

• But because prices are falling, total revenue may not rise — especially if demand is inelastic.

• For the market overall, revenues tend to fall as prices are aggressively slashed.

how price war affects profit

• Profit margins shrink as firms cut prices while costs remain the same.

• Can lead to short-term losses, especially for smaller or less efficient firms.

• In the long run, weaker firms may exit, leaving fewer, larger players — possibly allowing remaining firms to raise prices again (post-war).

price wars evaluation

Price wars benefit consumers in the short run through lower prices, but often lead to lower profits and can force smaller firms out, reducing long-term competition.

Their impact depends on:

• Elasticity: If demand is inelastic, revenue falls sharply.

• Firm efficiency: Only low-cost firms can sustain losses.

📌 Overall: Price wars are often unsustainable and may harm long-term market health, despite initial consumer gains.

predatory pricing

Setting prices below average cost to force rivals out of the market.

predatory pricing impact on : sales,revenue and profits

• Sales: Likely increase in short term as prices undercut rivals.

• Revenue: May rise due to higher volume, but not guaranteed if price drop is steep.

• Profit: Likely falls or becomes negative short-term as costs are higher than prices

predatory pricing evaluation

• Unsustainable: Loss-making prices can't last; if rivals survive, strategy fails.

• Illegal: Often breaches competition law (e.g. CMA in UK); risks fines and reputational damage.

• Consumer harm: Low prices short-term, but long-term risk of monopoly → higher prices, less choice.

non price strategy advertising and branding

• Explanation: Builds awareness, loyalty, and perceived quality.

• Sales: Increase (higher demand).

• Revenue: Rises as quantity sold increases.

• Profit: Can rise long-term, though high upfront costs reduce short-run profit.

product differentation as a non price strategy

• Explanation: Unique features, quality, or design to stand out from rivals.

• Sales: More elastic demand → boosts sales if successful.

• Revenue: Increases as consumers may pay more or switch from rivals.

• Profit: Higher margins possible; depends on R&D and development costs.