Summary Notes:

Market Structures
Please note that these slides only summarize
key points discussed under the topic on Market
Structures. You are expected to supplement
your review for finals using your own notes
taken from lectures I conducted during classes.

I wish you all the best in your review!

Types of Business Organizations

• Sole proprietorships
• Partnerships
• Corporations
• Cooperative associations
Imputed and Opportunity Costs

• Imputed cost – a value assigned to

any cost item that is not recorded in
the books
• Opportunity cost – the gains in
allocating these resources to uses
other than in the business in
question
 Pure Competition
Characteristics:
 Large number of firms
 Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
 Freedom of entry and exit into and out
of the industry
 Firms are price takers – have no control
over the price they charge for their product
 Each producer supplies a very small proportion
of total industry output
 Perfect Competition
 One extreme of the market structure spectrum
 Characteristics:
 Large number of firms
 Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
 Freedom of entry and exit into and out
of the industry
 Firms are price takers – have no control
over the price they charge for their product
 Each producer supplies a very small proportion
of total industry output
 Consumers and producers have perfect knowledge about
the market
Efficient Allocation of Resources

• Firms would be forced to produce goods

which consumers want most
• Prices charged will be reasonable to
both producers and consumers
• Firms are forced to use the most
efficient, least-cost methods
• Firms cannot afford to produce goods of
inferior quality
 Monopolistic or Imperfect Competition
Characteristics:
 Large number of firms in the industry
 May have some element of control over price due to
the fact that they are able to differentiate their product
in some way from their rivals – products are therefore
close, but not perfect, substitutes
 Entry and exit from the industry is relatively easy –
few barriers to entry and exit
 WHAT IS MONOPOLISTIC COMPETITION?

 Monopolistic competition is a market structure

in which:
• A large number of independent firms compete.
• Each firm produces a differentiated product.
• Firms compete on product quality, price, and
marketing.
• Firms are free to enter and exit.
 WHAT IS MONOPOLISTIC COMPETITION?

Large Number of Firms

 Like perfect competition, the market has a large
number of firms. Three implications are:
 Small market share
 No market dominance
 Collusion impossible
 WHAT IS MONOPOLISTIC COMPETITION?

Product Differentation
 Product differentiation
 Making a product that is slightly different from the
products of competing firms.
 A differentiated product has close substitutes but
it does not have perfect substitutes.
 When the price of one firm’s product rises, the
quantity demanded of that firm’s product
decreases.
 WHAT IS MONOPOLISTIC COMPETITION?

Competing on Quality, Price, and Marketing

 Quality
 Design, reliability, service, ease of access to the
product.
 Price
 A downward sloping demand curve.
 Marketing
 Advertising and packaging
 WHAT IS MONOPOLISTIC COMPETITION?

 Entry and Exit

 No barriers to entry.
 A firm cannot make economic profit in the long
run.
 WHAT IS MONOPOLISTIC COMPETITION?

 Identifying Monopolistic Competition

 Two indexes:
• The four-firm concentration ratio
• The Herfindahl-Hirschman Index
 WHAT IS OLIGOPOLY?

 Another market type that stands between

perfect competition and monopoly.
 Oligopoly is a market type in which:
• A small number of firms compete.
• Natural or legal barriers prevent the entry
of new firms.
 WHAT IS OLIGOPOLY?

Small Number of Firms

 In contrast to monopolistic competition and
perfect competition, an oligopoly consists of a
small number of firms.
• Each firm has a large market share
• The firms are interdependent
• The firms have an incentive to collude
 WHAT IS OLIGOPOLY?

 Interdependence
 When a small number of firms compete in a
market, they are interdependent in the sense that
the profit earned by each firm depends on the
firms own actions and on the actions of the other
firms.
 Before making a decision, each firm must
consider how the other firms will react to its
decision and influence its profit.
 WHAT IS OLIGOPOLY?

 Temptation to Collude
 When a small number of firms share a market,
they can increase their profit by forming a cartel
and acting like a monopoly.
 A cartel is a group of firms acting together to limit
output, raise price, and increase economic profit.
 Cartels are illegal but they do operate in some
markets.
 Despite the temptation to collude, cartels tend to
collapse.
 WHAT IS OLIGOPOLY?

Barriers to Entry
 Either natural or legal barriers to entry can create
an oligopoly.
 Natural barriers arise from the combination of the
demand for a product and economies of scale in
producing it.
 If the demand for a product limits to a small
number the firms that can earn an economic
profit, there is a natural oligopoly.
 GAME THEORY

 Game theory
 The tool used to analyze strategic behavior—
behavior that recognizes mutual interdependence
and takes account of the expected behavior of
others.
 GAME THEORY

What Is a Game?
 All games involve three features:
• Rules
• Strategies
• Payoffs
 Prisoners’ dilemma
 A game between two prisoners that shows why it
is hard to cooperate, even when it would be
beneficial to both players to do so.
 GAME THEORY

 Nash equilibrium
 An equilibrium in which each player takes the
best possible action given the action of the
other player.
 Monopoly

 Monopoly power – refers to cases where firms

influence the market in some way through their
behaviour – determined by the degree
of concentration in the industry
 Influencing prices
 Influencing output
 Erecting barriers to entry
 Pricing strategies to prevent or stifle competition
 May not pursue profit maximisation – encourages unwanted
entrants to the market
 Sometimes seen as a case of market failure
 A monopoly is the sole supplier of a
product with no close substitutes
The most important characteristic of a
monopolized market is barriers to entry 
new firms cannot profitably enter the
market
Barriers to entry are restrictions on the
entry of new firms into an industry
 Legal restrictions
 Economies of scale
 Control of an essential resource

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 Economies of Scale
A monopoly sometimes emerges naturally
when a firm experiences economies of
scale as reflected by the downward-
sloping, long-run average cost curve

In these situations, a single firm can

sometimes supply market demand at a
lower average cost per unit than could two
or more firms at smaller rates of output

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 Price Discrimination
A monopolist can sometimes increase
economic profit by charging higher prices
to customers who value the product more

The practice of charging difference prices

to different customers when the price
differences are not justified by differences
in cost is called price discrimination

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 Conditions for Price
Discrimination
Conditions
 The demand curve for the firm’s product must
slope downward  the firm has some market
power and control over price
 There are at least two groups of consumers for
the product, each with a different price
elasticity of demand
 The producer must be able, at little cost, to
charge each group a different price for
essentially the same product
 The producer must be able to prevent those
who pay the lower price from reselling the
product to those who pay the higher price
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 Examples of Price
Discrimination
Because businesspeople face
unpredictable yet urgent demands for
travel and communication, and because
employers pay such expenses,
businesspeople are less sensitive to price
than householders

Telephone companies are able to sort out

their customers by charging different
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rates based on the time of day
 Perfect Price Discrimination

If a monopolist could charge a different

price for each unit sold, the firm’s
marginal revenue curve from selling one
more unit would equal the price of that
unit  the demand curve would become
the marginal revenue curve

A perfectly discriminating monopolist

charges a different price for each unit of
the good
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