Market Structures
Subject: Economics
Topic: 4
Cambridge Code: 0455 / 2281
Perfect Competition
Perfectly competitive market - Many firms, identical products, free entry
Characteristics
- Many buyers and sellers: No individual firm controls price
- Homogeneous product: Identical goods (no differentiation)
- Perfect information: Buyers and sellers informed
- Firms are price takers: Accept market price
- Free entry and exit: No barriers to start/leave
- Normal profit long-run: Just covers opportunity cost
Demand Curve
Perfectly elastic (horizontal):
- Firm can sell any amount at market price
- Any price increase = zero sales
- AR = MR = Price
Equilibrium
Short run:
- Firm produces where MR = MC
- May make supernormal profit
- May make loss
Long run:
- Free entry eliminates supernormal profit
- Exit eliminates losses
- P = AC = MC (normal profit)
- Productively and allocatively efficient
Real Examples
- Agricultural products (wheat, corn)
- Foreign exchange markets
- Perfect competition rare in reality
Monopoly
Monopoly - One firm, unique product, high barriers to entry
Characteristics
- One seller: Controls entire market supply
- Unique product: No close substitutes
- Barriers to entry: Prevents competition
- Price maker: Sets quantity and price
- Supernormal profit: Long-run possible
- Downward-sloping demand: AR > MR
Barriers to Entry
Natural barriers:
- Large capital requirements
- Economies of scale (only room for one)
- Control of essential resources
Created barriers:
- Patents and intellectual property
- Government licenses
- Exclusive contracts
- Predatory practices
Demand and Revenue
Firm faces whole market demand:
- Downward sloping
- To sell more, must lower price
- MR < AR (Price) due to quantity effect
- MR falls faster than AC
Equilibrium
Profit maximization:
- Produce where MR = MC
- Charge price from demand curve at that quantity
- Makes supernormal profit (can persist)
- Productively? At MR=MC, but AC not minimum (excessive AC)
- Allocatively inefficient (P > MC)
Problem with Monopoly
- Underproduction: Produces less than competitive market
- Higher prices: Higher than competitive price
- Supernormal profit: Allocative inefficiency
- X-inefficiency: Lack of competition reduces efficiency
- No incentive to innovate: Complacent
Oligopoly
Oligopoly - Few large firms, differentiated products, some barriers
Characteristics
- Few large firms: Each has market power
- High market concentration: Dominated by few
- Differentiated products: Brand loyalty important
- Interdependence: Firms' decisions affect each other
- Barriers to entry: Capital requirements
- Variable profit: Can be supernormal
Behavior
Pricing strategies:
- Sensitive to rivals' prices
- Price wars possible but rare (damaging)
- Often stable prices
- Non-price competition important
Non-price competition:
- Advertising
- Product differentiation
- Brand loyalty
- Design and quality
- Customer service
Examples
- Car manufacturers (5-10 major firms)
- Oil companies
- Carbonated soft drinks
- Airlines
- Supermarkets
Monopolistic Competition
Monopolistic competition - Many firms, differentiated products, free entry
Characteristics
- Many firms: But fewer than perfect competition
- Differentiated products: Brand loyalty and switching costs
- Free entry and exit: Easy to enter
- Some market power: Can charge above MC
- Non-price competition: Heavy advertising
- Normal profit long-run: Long-run equilibrium
Equilibrium
Short run:
- Produce where MR = MC
- Charge price from demand curve
- May make supernormal profit
Long run:
- Free entry erodes profit
- PC gets lower demand and higher costs
- Eventually P = AC (normal profit)
- Not productivelyor allocatively efficient
- Excess capacity exists
Examples
- Restaurants
- Fashion retailers
- Coffee shops
- Software apps
- Medical practices
Comparison of Market Structures
| Feature | Perfect | Monopolistic | Oligopoly | Monopoly |
|---|---|---|---|---|
| # Firms | Many | Many | Few | One |
| Product | Identical | Differentiated | Differentiated | Unique |
| Entry | Free | Free | Restricted | Blocked |
| Price | Taker | Setter | Interdependent | Setter |
| LR Profit | Normal | Normal | Supernormal | Supernormal |
| Efficiency | Both | Neither | Poor | Neither |
| AR = MR | Yes | No | No | No |
| Ads | None | Heavy | Heavy | None |
Price Discrimination
Price discrimination - Charging different prices for same product
Requirements
- Market power: Ability to set price
- Different price elasticities: Customer groups differ
- Prevent resale: Customers can't resell (services often)
Types
1st degree: Each customer pays maximum willing 2nd degree: Volume discounts (more units cheaper) 3rd degree: Different market segments different prices
Examples
- Cinema tickets (student discounts)
- Air fares (business vs leisure)
- Version software (full vs lite)
- Pharmaceuticals (different countries)
Effect
- Increases total profit
- Increases consumer surplus loss
- Can increase output (allocative efficiency improves)
Key Points
- Perfect competition: Many firms, efficient, but rare
- Monopoly: One firm, inefficient, high barriers
- Oligopoly: Few firms, interdependent, realistic competitive
- Monopolistic competition: Many firms, differentiated, normal profit long-run
- Market power: Ability to set price (not price taker)
- Price discrimination: Different prices, same product
- Efficiency varies by market structure
- Real markets usually oligopolistic or monopolistically competitive
Practice Questions
- Identify market structure from description
- Draw demand and revenue for each structure
- Compare profit between structures
- Analyze barriers to entry
- Predict price discrimination
- Compare efficiency between structures
- Analyze non-price competition
Revision Tips
- Know characteristics of each structure
- Understand differences clearly
- Know AR and MR relationships
- Practice drawing demand curves
- Know profit maximization for each
- Understand efficiency implications
- Practice real-world examples