Unit 4 - Market Structure

Market Structure
Price and Output Determination
Short run and Long run
 Market Structure : Important Ingredient

• Market Power

“market power is simply the

power of a firm to establish
the price of its
products.”
 Competition and Market Types
• Competition: The most important indicator of
the degree of competition is the ability of
firms to control the price and use it as a
competitive weapon.
• Market Entry and Exit: Directly affects the
ability of a firm to earn economic profit in the
long run.
Comparison of Four Market Types by Characteristics
Affecting the Degree of Competition
 Few Examples
• Perfect Competition
– Markets for agricultural
products
– e.g., corn, wheat, coffee
– Financial instruments
(e.g., stocks, bonds,
foreign exchange),
– precious metals (e.g.,
gold, silver, platinum)
• Monopoly
– government-sanctioned
monopolies exist in
many communities, and
these monopolies
provide services such
electricity distribution.
– Patent laws sometimes
provide companies with
temporary monopolies.
 Few Examples
• Monopolistic • Oligopoly
Competition – playing field of big
– Small business like businesses.
boutiques, luggage – oil refining, certain types of
stores, shoe stores, computer hardware and
software, chemicals and
stationery shops,
plastics, processed foods,
restaurants, repair tobacco, steel, automobile,
shops, laundries, and copper, and soft drinks
beauty parlors. – Fortune 500 (American
– Race to be different companies) and the
BusinessWeek Global 100
 Video
Video discuss about various
market structure using animation.

https://www.youtube.com/watch?
v=9Hxy-TuX9fs
 Perfect Competition
• Homogenous Product (all prefect substitute)
• All firms have access to factors of production
• Large number of buyers and sellers
• Firm price take and industry price maker
• Free entry and exit
• Perfectly elastic demand curve
• Perfect knowledge /information
• Profit maximization assumed as key objective
Industry and Firm
Firm can incur losses or normal profit in short run too.
 Adjustment to Long run equilibrium
• If most firms are making abnormal (economic) profits
in the short run, this encourages the entry of new firms
into the industry driven into the market by the profit
motive.
• This will cause an outward shift in market supply
forcing down the ruling market price.
• The increase in market supply will eventually reduce
the price until price=long run average cost.
• Other things remaining the same, there is no further
incentive for movement of firms in and out of the
industry and a long run equilibrium has been
established.
New firm entry in the long run
Shut Down Price (Short Run)
 Evaluation of Assumptions of
Perfect Competition
• Most firms have some amount of price-setting power –
they are price makers not price takers.
• Dominance in real world markets of differentiated /
branded products.
• Highly complex products, there always information gaps
facing consumers.
• Impossible to avoid search costs even with the spread of
digital/web technology.
• Patents, control of intellectual property, control of key
inputs are all ignored by the competitive model.
• Rare for entry and exit in an industry to be costless.
 Characteristics of Competitive Markets
• Lower prices because of many competing firms. The cross price elasticity
of demand for one product will be high suggesting that consumers are
prepared to switch their demand to the most competitively priced
products in the marketplace.
• Low barrier to entry – the entry of new firms provides competition and
ensures prices are kept low.
• Lower total profits and profit margins than in monopoly.
• Greater entrepreneurial activity. For competition to be improved and
sustained there needs to be a genuine desire on behalf of entrepreneurs
to innovate and to invent to drive markets.
• Economic efficiency
– Competition will ensure that firms move towards productive efficiency
– The threat of competition should lead to a faster rate of technological
diffusion, as firms have to be responsive to the changing needs of
consumers. (Dynamic efficiency)
 Real World - Imperfect
• Suppliers may exert control over the quantity of goods and
services supplied and also exploit their monopoly power by
having control over market prices.
• On the demand side, consumers may have monopsony
(buying) power against their suppliers because they purchase
a high percentage of total demand.
• There are always some barriers to the contestability of the
market and far from being homogenous; most markets are full
of heterogeneous products due to product differentiation.
• Most consumers have imperfect information and preferences
are influenced by persuasive marketing.
• There may be imperfect competition in related markets such
as the market for key raw materials, labor and capital goods.