Economics 4

23.12.
2011
http://www.bized.ac.uk
Market Structure
Copyright 2006 Biz/ed
Market Structure
Market structure identifies how a market
is made up in terms of:
The number of firms in the industry

The nature of the product produced
The degree of monopoly power each firm has
The degree to which the firm can influence price
Profit levels
Firms behaviour pricing strategies, non-price
competition, output levels
The extent of barriers to entry
The impact on efficiency
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Market Structure
Perfect
Competition
Pure
Monopoly
More competitive (fewer imperfections)
Market Structure
Perfect
Competition
Pure
Monopoly
Less competitive (greater degree

of imperfection)
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Market Structure
Pure
Monopoly
Perfect
Competition
Monopolistic Competition
Oligopoly
Duopoly Monopoly
The further right on the scale, the greater the degree

of monopoly power exercised by the firm.
Features of the four market structures

Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
Oligopoly
Few
Restricted
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Monopoly
One
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
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Market Structure
Importance:
Degree of competition affects
the consumer will it benefit
the consumer or not?
Impacts on the performance
and behaviour of the
company/companies involved
Market Structure
Models a word of warning!
Market structure deals with a number of economic
models
These models are a representation of reality to help
us to understand what may be happening in real life
There are extremes to the model that are unlikely
to occur in reality
They still have value as they enable us to draw
comparisons and contrasts with what is observed
in reality
Models help therefore in analysing and evaluating
they offer a benchmark
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Market Structure
Characteristics of each model:
Number and size of firms that make up

the industry
Control over price or output
Freedom of entry and exit from the industry
Nature of the product degree of
homogeneity (similarity) of the products in
the industry (extent to which products can
be regarded as substitutes for each other)
Diagrammatic representation the shape
of the demand curve, etc.
Market Structure
Characteristics: Look at these everyday products what type of
market structure are the producers of these products operating
in?
Mercedes CLK Coupe
Remember to
think about the
nature of the
product, entry and
exit, behaviour of
the firms, number
and size of the
firms in the
industry.
Canon
SLR Camera
Bananas
You might even

have to ask what
the industry is??
Electric
Guitar
Jazz
VodkaBody
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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
Monopolistic or Imperfect
Competition
Where the conditions of perfect
competition do not hold, imperfect
competition will exist
Varying degrees of imperfection give
rise to varying market structures
Monopolistic competition is one of these
not to be confused with monopoly!
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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
Consumer and producer knowledge
imperfect
Competition
Some important points about
monopolistic competition:
May reflect a wide range of markets
Not just one point on a scale
reflects many degrees
of imperfection
Examples?
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Competition
Restaurants
Plumbers/electricians/local builders
Solicitors
Private schools
Plant hire firms
Insurance brokers
Health clubs
Hairdressers
Funeral directors
Estate agents
Damp proofing control firms
Competition
In each case there are many firms
in the industry
Each can try to differentiate its product
in some way
Entry and exit to the industry is relatively free
Consumers and producers do not have perfect
knowledge of the market the market may
indeed be relatively localised. Can you imagine
trying to search out the details, prices,
reliability, quality of service, etc for every
plumber in the UK in the event of an
emergency??
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Oligopoly
Competition between the few
May be a large number of firms in the
industry but the industry is dominated
by a small number of very large producers
Concentration Ratio the proportion

of total market sales (share) held by
the top 3,4,5, etc firms:
A 4 firm concentration ratio of 75% means
the top 4 firms account for 75% of all
the sales in the industry
Oligopoly
Example:
Music sales
The music industry has

a 5-firm concentration
ratio of 75%.
Independents make up
25% of the market but
there could be many
thousands of firms that
make up this
independents group.
An oligopolistic market
structure therefore
may have many firms
in the industry but it is
dominated by a few
large sellers.
Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html
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Oligopoly
Features of an oligopolistic market
structure:
Price may be relatively stable across the industry
kinked demand curve?
Potential for collusion
Behaviour of firms affected by what they believe their rivals
might do interdependence of firms
Goods could be homogenous or highly differentiated
Branding and brand loyalty may be a potent source of competitive
advantage
Non-price competition may be prevalent
Game theory can be used to explain some behaviour
AC curve may be saucer shaped minimum efficient scale
could occur over large range of output
High barriers to entry
Duopoly
Market structure where the industry is
dominated by two large producers
Collusion may be a possible feature
Price leadership by the larger of the two firms may
exist the smaller firm follows the price lead
of the larger one
Highly interdependent
High barriers to entry
Cournot Model French economist analysed
duopoly suggested long run equilibrium would see
equal market share and normal profit made
In reality, local duopolies may exist
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Monopoly
Pure monopoly where only
one producer exists in the industry
In reality, rarely exists always
some form of substitute available!
Monopoly exists, therefore,
where one firm dominates the market
Firms may be investigated for examples
of monopoly power when market share
exceeds 25%
Use term monopoly power with care!
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
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Monopoly
Origins of monopoly:
Through growth of the firm
Through amalgamation, merger
or takeover
Through acquiring patent or license
Through legal means Royal charter,
nationalisation, wholly owned plc
Monopoly
Summary of characteristics of firms
exercising monopoly power:
Price could be deemed too high, may be
set to destroy competition (destroyer or
predatory pricing), price discrimination
possible.
Efficiency could be inefficient due to lack
of competition (X- inefficiency) or
could be higher due to availability of high profits
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Monopoly
Innovation - could be high because
of the promise of high profits, Possibly
encourages high investment in research
and development (R&D)
Collusion possible to maintain
monopoly power of key firms
in industry
High levels of branding, advertising
and non-price competition
Contestable Markets
Theory developed by William J. Baumol,
John Panzar and Robert Willig (1982)
Helped to fill important gaps in market
structure theory
Perfectly contestable market the
pure form not common in reality but a
benchmark to explain firms behaviours
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23.12.2011
Contestable Markets
Key characteristics:
Firms behaviour influenced by the threat
of new entrants to the industry
No barriers to entry or exit
No sunk costs
Firms may deliberately limit profits made
to discourage new entrants entry limit
pricing
Firms may attempt to erect artificial
barriers to entry e.g
Contestable Markets
Over capacity provides the
opportunity to flood the market
and drive down price in the event
of a threat of entry
Aggressive marketing and branding
strategies to tighten up the market
Potential for predatory
or destroyer pricing
Find ways of reducing costs and
increasing efficiency to gain competitive
advantage
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23.12.2011
Contestable Markets
Hit and Run tactics enter the
industry, take the profit and get
out quickly (possible because of
the freedom of entry and exit)
Cream-skimming identifying
parts of the market that are high
in value added and exploiting
those markets
Contestable Markets
Examples of markets exhibiting
contestability characteristics:
Financial services
Airlines especially flights
on domestic routes
Computer industry ISPs, software,
web development
Energy supplies
The postal service?
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23.12.2011
Market Structures
Final reminders:
Models can be used as a comparison they are not
necessarily meant to BE reality!
When looking at real world examples, focus on the behaviour
of the firm in relation to what the model predicts would
happen that gives the basis for analysis and evaluation of
the real world situation.
Regulation or the threat of regulation may well affect
the way a firm behaves.
Remember that these models are based on certain
assumptions in the real world some of these assumptions
may not be valid, this allows us to draw comparisons and
contrasts.
The way that governments deal with firms may be based on a
general assumption that more competition is better than less!
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23.12.

Copyright 2006 Biz/ed

The number of firms in the industry

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More competitive (fewer imperfections)

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Less competitive (greater degree

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The further right on the scale, the greater the degree

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Features of the four market structures

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Number and size of firms that make up

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Mercedes CLK Coupe

You might even

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Concentration Ratio the proportion

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The music industry has

Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html

Copyright 2006 Biz/ed

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