[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.