Detailed Study Notes on Market Structures, Price and Revenue Concepts, and Market Failures in Economics

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Market Structures

To influence price is determined by how price elastic the good is and how dominant the firm is to set price.

Barriers to Entry or Exit

These are the difficulties or invisible barriers that new firms face trying to enter or leave an industry. Firms enter an industry easily or can make it difficult for new entrants.

Some barriers are:

  • Legal patents

  • Brand name or trade logos

  • Control of raw materials

  • High advertising costs of existing firms

  • Extremely high set-up costs (as found in the oil industry)

  • Extremely high cost of land

  • Economies of scale of existing firms

  • Raising large sums of financial capital

The Number of Buyers and Sellers in the Industry

If there are few sellers they may enjoy monopoly power, while many buyers provide them the opportunity to achieve market power.

Type of Good Offered for Sale

If the good has very few good substitutes, then demand will be inelastic and there will be little or no competition. Examples include gasoline, electricity, and telecommunications.

Level of Profits

A few firms in an industry may record high profit levels. While few firms do earn high profit, the price elasticity of demand of the products that they trade in plays a major role in the profit earned. Profit may not be evenly shared among the firms in the industry.

Mobility of Factors

The mobility of the factors of production enables firms to adapt to differing types of production such as when labor and capital on a farm shifts to being used at a factory instead. These factors determine the level of competition in a market or industry, identified by four different market structures:

  • Perfect competition or a perfectly competitive market

  • Monopoly

  • Monopolistic competition

  • Oligopoly

Definition: Perfect Competition

Perfect or pure competition describes an industry with absolute, total, or pure competition and has the following features:

  • There are so many sellers and buyers that the action of one buyer or seller is insignificant, and therefore unable to influence the demand or supply curve.

  • Each firm’s product is identical to the products of other firms in the industry. This is called product homogeneity.

  • There are no barriers to entry or exit for any firm in this industry, creating more competition.

  • Perfect knowledge exists for all firms in this industry. Hence, no firm has any information advantage regarding raw material prices on other firms’ costs of production.

  • No firm will raise or lower prices since raising prices with perfect substitutes for competition will yield no sales.

  • Price elasticity of demand being perfect means a firm will not lower prices because it is possible for the small quantity brought to market to be sold at the ruling price. It would make no sense therefore to lower prices.

  • Perfect mobility is also unique to a perfect market. Factors of production are highly mobile and can switch to another firm producing identical product with considerable ease.

Real-world Example: US Currency Market

  • All $5, $20, or $100 bills are pretty much identical.

  • Knowledge is not perfect in the future but reliable daily (exchange rates quoted in newspapers).

  • Barriers to entry and exit are very low; easy for someone to sell (exit) US dollars. Purchasing (entry) is easy at times, but can be difficult during currency shortages, which may act as a barrier.

  • There are many buyers and sellers.

  • Each buyer is a price taker but may have some ability to set prices since US currency may sometimes become scarce.

Definition of Monopoly

A monopolist is simply a sole supplier and is therefore the firm and industry at the same time. This is a pure monopoly. A legal monopoly is defined as any firm controlling 25 percent of total market share.

Characteristics of Pure Monopoly

  • There is one seller and many buyers.

  • Very strong barriers to entry, e.g., very high set-up costs.

  • The monopolist is a price setter.

  • The monopolist’s control over supply enables the firm to set price or quantity but not both, as it controls supply, not demand.

  • The firm can offer a certain quantity for sale, and the demand curve would determine price or set a price, determining the demand curve.

  • Product branding (differentiation).

  • Examples of pure monopoly include natural monopolies, where a firm can supply an entire industry’s output at a lower cost than two or more firms together, such as state-owned water supply and electricity distribution.

Imperfect Competition

Between the extremes of perfect competition and monopoly lie market structures that compete imperfectly:

  • Monopolistic Competition: many buyers and sellers; ability to influence price but not as strong as monopolists.

  • Oligopoly: few large firms dominate the industry.

Oligopoly Characteristics

  • Few firms and many buyers.

  • Ability to set price depending on whether there is a leader among firms.

  • Price rigidity suggests that competition is based on non-price factors, such as promotion and advertising.

  • Interdependence; each firm's strategy is influenced by competitors.

Market Structure Summary

  • Market structure describes different characteristics of firms that determine their competitive ability.

  • Criteria determining market structure include the number of buyers and sellers, nature of the product, barriers to entry and exit, the ability to influence price and output, the demand curve faced, and the level of short- and long-run profits.

  • The four main market structures are perfect market, monopoly, monopolistic competition, and oligopoly.

Chapter Summary

  • Market structure influences pricing, profits, and competition level, defining how firms operate within the economy.