Market System and Market Structure

Learning Objectives
explain the working of the market system
explain the market structures of perfect competition, monopoly,
oligopoly and monopolistic competition and indicate their
implications for the behaviour of firms
demonstrate the applicability of these predictions to the real
world
understand the measurement of competition by concentration
ratios
survey differences in industrial concentration between industries,
countries and over time
indicate what determines market structure and what determines
the behaviour of firms

Market
The market is a place where buyers and sellers of
a product are brought together. The nature and
location of the market depends on the product.
Firms sell the goods and services they produce to
households on the product markets
In the factor markets firms are buying resources
such as labour and raw materials.
A free market system is one in which the basic
economic choices are made through the
market, without any intervention by the
government.


Market Structure
Market structure refers to the amount of
competition that exists in a market between
producers.
The degree of competition can be thought of as
lying along a continuum with very competitive
markets at one end and markets in which no
competition exists at all at the other end.

Structureconductperformance
model
Structural factors
Amount of actual competition: (a) seller concentration;
and (b) buyer concentration.
Existence of potential competition.
Cost conditions.
Demand conditions.
Existence of barriers to entry.
Conduct factors
Pricing policy.
Amount of advertising.
Merger behaviour
Product differentiation.
Performance factors
Profitability.
Technological innovation.

Perfect competition
So many sellers and buyers that not one of them
can influence price
The good sold is homogeneous (identical)
Perfect knowledge exists (prices and costs)
Perfect mobility exists
No barriers to entry or exit
Pure or perfect competition is rare in the real world, but the model is
important because it helps analyze industries with characteristics similar to
pure competition. This model provides a context in which to apply revenue
and cost concepts developed in the previous lecture. Examples of this model
are stock market and agricultural industries.
Characteristics
1. Many sellers: there are enough so that a single sellers decision has no
impact on market price.
2. Homogenous or standardized products: each sellers product is identical to
its competitors.
3. Firms are price takers: individual firms must accept the market price and
can exert no influence on price.
4. Free entry and exit: no significant barriers prevent firms from entering or
leaving the industry.

An example of perfect
competition?
The nearest example to perfect competition is
probably the fruit and vegetable market in the
centre of a large town.

Market structures
Implications of perfect competition for conduct and performance of firms in an
industry
Monopoly
No competition
One single producer
Can also be a group of producers acting
together to control supply (OPEC)
Pure Monopoly
Pure monopoly exists when a single firm is the sole producer of a product for
which there are no close substitutes. Examples are public utilities and
professional sports leagues.
Characteristics
1. A single seller: the firm and industry are synonymous.
2. Unique product: no close substitutes for the firms product.
3. The firm is the price maker: the firm has considerable control over the
price because it can control the quantity supplied.
4. Entry or exit is blocked.

Barriers to Entry

Economies of scale is the major barrier. This occurs where the lowest unit
cost and, therefore, low unit prices for consumers depend on the existence
of a small number of large firms, or in the case of monopoly, only one firm.
Because a very large firm with a large market share is most efficient, new
firms cannot afford to start up in industries with economies of scale.
Public utilities are known as natural monopolies because they have
economies of scale in the extreme case. More than one firm would be
inefficient because the maze of pipes or wires that would result if there were
competition among water companies or cable companies.
Legal barriers also exist in the form of patents and licenses, such as radio and
TV stations.
Ownership or control of essential resources is another barrier to entry, such
as the professional sports leagues that control player contracts and leases on
major city stadiums. companies to lose their monopoly position.

Implications of monopoly for the conduct and performance of firms in an industry
An example of monopoly?
Public utilities, like gas, electricity, water and so
on

Comparisons of Monopoly &
Perfect Competition
Prices higher under a monopoly
Monopolies usually offer less choice

Oligopoly
A small number of producers supply a product

There is interdependence between the firms
Lack of price competition in the market
Non-price competition (branding / advertising)
Oligopoly exits where few large firms producing a homogeneous or
differentiated product dominate a market. Examples are automobile and
gasoline industries.
Characteristics
1. Few large firms: each must consider its rivals reactions in response to its
decisions about prices, output, and advertising.
2. Standardized or differentiated products.
3. Entry is hard: economies of scale, huge capital investment may be the
barriers to enter.

Implications of oligopoly for conduct and performance of firms in an industry
Monopolistic Competition
A market structure of monopolistic competition
exists when all of the conditions for perfect
competition are met except for the existence of
a homogeneous good
The good is slightly differentiated in some way,
either by advertising and branding or by local
production

Monopolistic competition refers to a market situation with a relatively large
number of sellers offering similar but not identical products. Examples are fast
food restaurants and clothing stores.
Characteristics
1. A lot of firms: each has a small percentage of the total market.
2. Differentiated products: variety of the product makes this model different
from pure competition model. Product differentiated in style, brand name,
location, advertisement, packaging, pricing strategies, etc.
3. Easy entry or exit.
An example of monopolistic
competition?
There are many examples of this type of industry:
for example, the paint industry where ICI is the
only producer of Dulux but there are many other
types of paint on the market.

Implications of monopolistic competition for the conduct and performance of firms
in an industry
Implications of theory for behaviour of firms
Summary
The Role of Market Structure
1. Pure competition: the small size of competitive firms and the fact hat they earn zero
economic profit in the long run leads to serious questions as to whether such producers can
finance substantial R&D programs. The firms in this market structure would spend no
significant amount. However, firms of the same industry may gather their resources and
develop R&D programs.

2. Monopolistic competition: there is a strong profit incentive to engage in product
development in this market structure as the firms depend on product differentiation to stand
out from a large number of rivals. However, most firms remain small which limits their ability
to secure inexpensive financing for R&D and any economic profits are usually temporary.
Therefore, spending on R&D is limited in this market structure.

3. Oligopoly: many of the characteristics of oligopoly are conducive to technical advances
including: their large size, ongoing economic profits, the existence of barriers to entry and a
large volume of sales. Firms in oligopoly spent the highest amount on R&D among the four
different market structures.

4. Pure monopoly: monopoly has little incentive to engage in R&D as the profit is protected by
absolute barriers to entry, the only reason for R&D would be defensive to reduce the risk of a
new product or process which would destroy the monopoly.