[Study Note] Economics – Market Structures

The types of Markets.

The following notes are the basic concepts in the mainstream (Capitalistic, neo-classical) Economics.

[Perfect Competition]

Conditions

  • A large number of sellers and buyers
  • Homogeneous products
  • Freedom of entry into and exit from the market

Features

  • Suppliers are price takers
  • Price (P) = Marginal Revenue (MR)
    • Extra revenue of an additional unit is the same as the current price
  • Long-run Equilibrium
    • Companies earn normal profits
    • P = MR = MC (Marginal Cost) = AC (Average Cost)
  • The perfectly competitive market will be efficient regarding resource allocation and productivity.
    • Companies produce products at the minimum of Average Costs (AC) curve – lowest unit cost possible – and there is no waste of resources.

[Monopoly]

Conditions

  • Pure monopoly: a single company has 100% of market share
  • More generally, a monopoly exists when a single company dominates a market.
  • There is a barrier to entry.

Features

  • The company is a price maker.
  • Marginal Revenue (MR) is a downward-sloping, and the MR curve is below the demand curve. In this condition, to sell more, the price must be lowered for all units.
  • The product output (Q) is determined when MR and MC meet, where the profit is maximized. (MR = MC)
    • At this point, the price is higher, and the quantity is smaller than the market equilibrium.
    • The company makes an abnormal profit because the price is higher than the average cost (P > AC)
  • The monopoly market is allocatively / productively inefficient.
    • Consumers pay more
    • The company does not use its resources fully because it does not operate at the most efficient output level
    • Companies in monopoly might not be innovative (less R&D spending and fewer new products).

[Oligopoly]

Conditions

  • A few companies dominate the market.
  • Not easy for a new company to enter the market

Strategies

  • Collusion: Major companies join together (a cartel) and act as if they were a monopoly
  • Competition: A small number of companies compete with each other

Features

  • In a competitive oligopoly, the price tends to stick as it is.
    • If one company raises the price => others will remain the same => the demand will fall as the revenue
    • If one company lowers the price => others will follow => no change of market share and the revenue of all companies will fall
    • Therefore, the price competition is not common, and rather companies prefer differentiation (branding and marketing)
  • Cartels
    • Collusion can be explicit (OPEC) or implicit (Price leader)
    • The market works like a monopoly
      • Price is set above the Average Cost (AC)
      • Quantity is less than the equilibrium
      • The market is allocatively / productively inefficient.

Price Wars

  • Some companies might cut the price temporarily to drive other competitors out of a market.
  • Customers might benefit the low price in the short term, but in the long term, winning companies may exploit the market with the power of monopoly.

[Monopolistic Competition]

Conditions

  • Similar to perfect competition
  • Many buyers and sellers
  • Easy entry and exit
  • Differentiated products rather than the homogeneous products

Features

  • Like Monopoly, Marginal Revenue (MR) is downward and below the demand curve.
  • In the short run, the output is set when MR equals MC. And the price is set above the average cost (P > AC) => Abnormal profits
  • Unlike Monopoly, the entry is allowed. In the long run, the demand and price are adjusted until normal profits are made.
  • In the monopolistic competition, many companies can get abnormal profits until it is stabilized. Therefore, the market, in general, is allocatively (P>MC) / productively (P > AC) inefficient.

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