Name: Karina Permata Sari (29115447)

Program: GM 2

Business Economics Summary

Market Structure

Introduction
The pricing and output decision will actually be answered within the framework of four basic
types of markets: perfect competition, monopoly, monopolistic competition, and oligopoly.
Perfect competition and monopoly can be considered the two extreme market environments in
which a firm competes in terms of market power. In terms of market power, monopolistic
competition and oligopoly are somewhere between the two extremes of perfect competition and
monopoly. From a pedagogical standpoint, it is easier to understand and appreciate the
particulars of monopolistic competition and oligopoly if there is first a thorough understanding
of perfect competition and monopoly.

Perfect Competition (No Market Power)

The Characteristics are:
Large number of relatively small buyers and sellers
Standardized product
Very easy market entry and exit
Non-price competition not possible
Pricing and Output Decisions in Perfect Competition:
Key Assumptions of the perfectly competitive Market:
The firm is a price taker
The firm makes the distinction between the short run and the long run
The firms objective is to maximize its profit (or minimize loss) in the short run
The firm includes its opportunity cost of operating in a particular market as part of its
total cost of production
Observations in Perfectly Competitive Markets:
The earlier the firm enters a market, the better its chances of earning above-normal
profit
As new firms enter the market, firms must find ways to produce at the lowest possible
cost, or at least at cost levels below those of their competitors
Firms that find themselves unable to compete on the basis of cost might want to try
competing on the basis of product differentiation instead
Implications for Decision Making

Most important lesson is that it is extremely difficult to make money

Must be as cost efficient as possible
It might pay for a firm to move into a market before others start to enter

Monopoly (Absolute Market Power)

The Characteristics are:
One firm, firm is the industry
Unique product or no close substitutes
Market entry and exit difficult or legally impossible
Non-price competition not necessary
Pricing and Output Decision:
A monopoly market consists of one firm (the firm is the market)
Firm has the power to set any price it wants
The firms ability to set price is limited by the demand curve for its product, and in
particular, the price elasticity of demand
Implications for Decision Making:
Most important lesson is not to be arrogant and assume their ability to earn economic profit
can never be diminished
Changes in economics of a business eventually break down a dominating companys
monopolistic power

Monopolistic Competition (Market Power Based on Product Differentiation)

The Characteristics are:
Large number of small firms acting independently
Differentiated product: can set price at a level higher than the price established by perfect
competition
Market entry and exit relatively easy
Non-price competition very important
Use MR = MC rule to maximize profit
If earning above-normal profits, newcomers will enter the market
Market supply curve shifts out and to the right
Firms demand curve shifts down and to the left
Ultimately, in the long run, firms earn only normal profit

Oligopoly (Product Differentiation and/or The Firms Dominance of the

Market)

 The Characteristics are:

Small number of large mutually interdependent firms
Differentiated or standardized product
Market entry and exit difficult
Non-price competition important
Pricing in an Oligopolistic Market
Mutual interdependence: relatively few sellers create a
situation where each is carefully watching the others as it
sets its price
Implication: kinked demand curve model Basic
assumption is that competitor will follow a price decrease
but will not make a change in reaction to a price increase
If reduce price and competitors match the price cut then
move along more inelastic demand segment Di
If increase price and competitors do not follow then
move along the more elastic segment Df
Price leader: one firm in the industry takes the lead in
changing prices, and assumes that other firms:
Figure 1 Marginal Revenue
Will follow a price increase
Curve has kink (at A)
But will not go even lower in order not to trigger a
price war
Non-price leader: firm that leads the differentiation of products on other, non-price
attributes

Competing in Imperfectly Competitive Markets

The key to the pricing power of firms in monopolistic competition and oligopoly is their ability
to differentiate their product so they are not mere price takers who are subject to the tyranny of
supply and demand. All efforts to do so are referred to in economics as non-price competition.
We could define the non-price competition as any effort made by firms in order to change the
demand for their product (other than the price).
Non-price determinants of demand:

tastes and preferences

income
prices of substitutes and complements

number of buyers
future expectations of buyers
financing terms


Strategy for firms in Imperfect Competition
Strategy: the means by which an organization uses its scarce resources to relate to the
competitive environment in a manner that is expected to achieve superior business
performance over the long run.
Strategy is important when firms are price makers and are faced with price and non-price
competition as well as threats from new entrants into the market
More important for firms in imperfectly competitive markets than those in perfectly
competitive markets or monopoly markets
Managerial economics: the use of economic analysis to make business decisions involving
the best use of an organizations scarce resources
Industrial organization: studies the way that firms and markets are organized and how
this organization affects the economy from the viewpoint of social welfare
Structure-Conduct-Performance (S-C-P) paradigm: says structure affects conduct which
affects performance
structure: number of firms in industry, conditions of entry, product differentiation
conduct: pricing strategies, advertising, product development, legal tactics, collusion
performance: maximization of societys welfare

Porters Five Forces model: illustrates the various factors that affect the ability of any
firm in the industry to earn a profit

Figure 2 The Porter Competitive Framework