An Introduction to Market Structures (DP IB Economics)

What are Market Structures?

• Market structures are the characteristics of the market in which a firm or industry operates

  • These characteristics typically include

    • The number of buyers

    • The number and size of firms

    • The type of product in the market (homogenous or differentiated)

    • The types of barriers to entry and exit

    • The degree of competition between the firms in the market
      

• Market structures can be separated into perfect competition & imperfect competition
  

• Imperfect competition includes the following market structures

  • Monopolistic
    A market structure is one in which there are many firms offering a similar product but with some product differentiation e.g nail salons

  • Oligopoly
    A market structure in which a few large firms dominate the industry with each firm having significant market power

  • Monopoly
    A market structure in which there is a single supplier of a particular product & has the power to influence the market supply & price

The Meaning of Market Power

• Market failure can be caused through the abuse of market power
   

• Signs of market failure include

  • The ability of suppliers to have control of prices

  • The ability of suppliers to restrict output in a market, so as to raise prices

  • A lack of allocative efficiency

  • A lack of productive efficiency

• Governments often regulate markets and intervene to prevent or reduce the abuse of market power through antitrust laws (anti monopoly) or competition policy

• Market power refers to the ability of a firm to influence and control the conditions in a specific market, allowing them to have a significant impact on price, output, and other market variables

• Market power allows a firm to set prices above the competitive level or restrict output

• Market power can be measured using indicators like market share, concentration ratios, or barriers to entry

  • A higher market share or concentration ratio suggests a greater degree of market power
     

The level of market power changes for each market structure
 

• The closer a firm is to being a monopoly, the higher the concentration ratio, market share and market power

  • Competition is greatly diminished and the benefits of competition are likely to be lost
     

• The closer a firm is to being perfectly competitive, the lower the concentration ratio, market share and market power

  • Competition is enhanced and the significant benefits of competition are likely to be gained
      

• It is important to distinguish between market power and market competition

  • In competitive markets, no single firm has substantial market power, and prices and outputs are determined by the forces of supply and demand

  • In markets with limited competition or where firms have significant market power, market outcomes can deviate from the ideal of perfect competition

Characteristics of Perfectively Competitive Markets

• The characteristics of perfect competition are as follows

1. There are many buyers and sellers: due to the number of market participants sellers are price takers

2. There are no barriers to entry and exit from the industry: firms can start-up or leave the industry with relative ease which increases the level of competition

3. Buyers & sellers possess perfect knowledge of prices: this assumption presupposes perfect information e.g if one seller lowers their price then all buyers will know about it

4. The products are homogenous: this means firms are unable to build brand loyalty as perfect substitutes exist and any price changes will result in losing customers
    

A perfectly competitive market on the top which experiences allocative & productive efficiency

 
Diagram Analysis

• The firm does not have any market power so it is unable to influence the price & quantity

  • The firm is a price taker due to the large number of sellers

  • The firm's selling price is the same as the market price, P = MR = AR = Demand
     

• The firm produces at the profit maximisation level of output where MC=MR (Y)

• The firm is productively efficient as MC=AC at this level of output

• The firm is allocatively efficient as AR (P)=MC

• The firm is unlikely to experience dynamic efficiency as it is unlikely to have abnormal profits to reinvest

Characteristics of Imperfectively Competitive Markets

• Imperfect competition includes the following market structures 

  • Monopolistic

  • Oligopoly

  • Monopoly
      

Characteristics of Imperfectively Competitive Market Structures

Diagrammatic Illustration of Imperfect Competition

An imperfect market on the bottom in which inefficiencies exist at the profit maximisation level of output

Diagram Analysis

• The firm is a price maker

  • This means that its revenue curves are downward sloping

• The firm produces at the profit maximisation level of output where MC=MR (A)

• The firm is not productively efficient as AC > MC at this level of output (B-A)

  • Productive efficiency would occur at point E where MC=AC

• The firm is not allocatively efficient as AR (P) > MC at this level of output (D-A)

  • Allocative efficiency would occur where AR=MC

• The firm is likely to experience dynamic efficiency as it will be able to reinvest its profits so as to increase innovation