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Market Structures

Market Structures

  • The behaviour and performance of firms will depend upon which market structure they are thought to fit into
  • The three main market structure are: monopoly, oligopoly and monopolistic competition
  • Care has to be taken in defining the market, either in terms of products or geographically.
    • g. there is more competition for the leisure industry on the whole than there is for cinemas.
  • Economist look at certain key indicators to ascertain what market structure a firm is operating in, there are:
    • Barriers to entry/exit
    • Market concentration ratio
    • Type of profits earned in the long run
    • Behaviour of firms
    • Performance of firms

Barriers to Entry and Exit

  • A barrier to entry is an obstacle to new firms entering a market
    • g. in the 1940s the barrier that stopped other firms broadcasting due to the legal monopoly was a legal one – the law stopped them
  • Other barriers of entry include:
    • High start-up costs
      • Potential firms may have difficulty raising the finance, and be concerned about the risks involved
    • Brand names
      • Customers may be loyal to a specific brand, and hence reluctant to try new ones
    • Economies of scale
      • Established firms have lower costs of production, and so probably can afford to make a profit at a lower average revenue.
    • Limit pricing
      • Established firms may deliberately set their prices low to discourage new firms from entering the market.
    • There are also barriers to exit, the three main ones being:
      • Sunk costs
        • These are costs that cannot be recovered should a firm leave the market
      • Advertising expenditure
        • Should a company have spent a lot on a long-term advertising contract, this money cannot be recovered
      • Contracts
        • A firm may be legally obliged to supply a product for a period of time
      • Sometimes, awareness of barriers to exit act as barriers to entry, as a firm will be less likely to enter a market if they’re aware of the costs that could be incurred upon leaving it.

Monopoly

  • In a Monopoly market, there are high barriers to entry.
    • In 1932 to 1955, the BBC was a pure monopoly, because the firm was the industry.
  • In a Monopoly the firm is a price maker

 

  • A private sector monopolist is likely to want to maximise profit
    • Profits are maximised where MR = MC

 

  • In some markets, it can be more efficient to have just one firm, this is called a natural monopoly
  • This is called a natural monopoly

This probably occurs due to the existence of economies of scale and the avoidance of wasteful duplication (e.g. water supply)

 

  • As well as a pure monopoly, there exists a legal monopoly and a dominant monopoly
    • The former refers to a firm that has a market share of 25% or more
    • The latter refers to a firm with a 40% or more market share.

Oligopoly

  • An oligopoly is a market with a high 3-5 firm market concentration ratio
    • Such a market structure is dominated by a few large firms
  • There are high barriers to entry and exit, which allow firms to earn supernormal profits in the long run
  • The product that is produced is usually differentiated
  • Firms are price makers
  • There is a high level of non-price competition
    • Firms often seek to attract customers by ways other than charging a lower price
  • Firms are interdependent of each other
    • In making decisions on things like advertising campaigns, firms will consider what their rivals will do

 

  • Analysing the behaviour of firms operating under conditions of oligopoly is difficult, as firms may adopt a variety of strategies
  • One strategy is to cut the price in order to gain a larger market share
    • This would cause other firms to match the price cut, and so the original firm is likely to cut the prices again, as the original cut would become redundant
    • This constant lowering of prices is called a price war, and is detrimental to all firms
    • As a result, it is not a popular strategy, due to the high risk and its often lack of long-term benefits

 

 

  • Firms may seek to reduce the risk of a price war by colluding with rivals, forming a cartel
    • In such situations, the firms produce separately but sell at one agreed price.
      • They are, in effect, acting as a monopoly
    • Cartels are illegal in most countries, including the UK, but this doesn’t stop all firms acting in this way.
  • In practise, as members of a cartel have an incentive to cheat, formal collusion tends to break down over time.
  • Tacit collusion may occur, where firms follow the price strategy of a leading firm

 

  • Game Theory plays an important part in oligopolists’s
    • This is where a firm will strongly consider the reactions of other firms when making a decision, and base their decisions off of this hypothetical action

Monopolistic Competition

  • This market structure has a high degree of competition between firms
    • This produces a product that is similar but slightly different from that of its rivals (homogeneous product)
  • It is characterised by a large number of small firms
  • Low barriers to entry and exit
  • Non-price competition
  • Each firm faces a downward sloping demand curve, and is a price taker.

 

  • The lack of barriers to entry and exit means that normal profit is earned in the long run
  • In the short run, if market demand increases, incumbent firms will earn supernormal profit
    • As a result, firms outside the market will be attracted by these high profits, and enter the market
    • Subsequently, their entry will cause market the supply curve to shift to the right, driving down price until normal profit is earned again
  • A monopolistically competitive firm will seek to increase demand by increasing customer loyalty, usually in the firm of making their products as distinctive as possible
    • This could be through things like advertising, after-sales service, better location of outlets or improved quality.