Market Structures

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    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.

     

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