Introduction to Firms, Industries and Market Structure
Market Power
Firm (business) = an organisation which employs factors of production to produce/sell a
good/service
Industry = a group of firms producing identical goods/services
- Industries are characterised by market structures
- A market structure has the following characteristics
1. No. of firms in the industry
2. The level of product differentiation (how similar/different the products are)
3. Barriers to entry (how easy/difficult it is for new entrants (firms) to enter the industry)
4. Market power = the extent to which each individual firm can control the price
- MARKET FAILURE occurs when free market fails to achieve allocative efficiency - when
demerit products are over-consumed and over-produced and merit products are under
consumed/underproduced in society
The 4 Market Structures
- The two extreme market structures are perfect competition and monopoly
1. Perfect Competition
firms in perfect competition have no market power, but are ALWAYS allocatively efficient (MC
= AR) so there is no market failure
• Very large number of very small firms in the industry
• Firms sell homogeneous (identical) products
• There are no barriers to enter the market
• Consumers, firms have perfect knowledge about prices and quality of goods
2. Monopolistic Competition
• A large number of small firms
• No barriers of entry
• Product differentiation = firms make their products different from each other
• Some market power (but less than in monopoly)
• Firms are not allocatively efficient and will underproduce
• E.g. nail salons/hairdressers on High street try to make their product different from others
and the little firms try to be a monopoly
3. Oligopoly
• A small number if large firms
• These large firms are interdependent as the actions of one firm will affect the market
position of the others
• High barriers of entry – very hard for new entrants to enter the industry
• High degree of market power
• No allocative efficiency
• E.g. car industry companies and airlines
4. Monopoly
, have the greatest amount of market power
• A singles seller in the industry (in reality a monopolistic industry consists of one firm that
dominates the markets with a large market share)
• A firm produces/sells a unique product with no substitutes
• Monopolist is NOT allocatively efficient and will underproduce
• E.g. an electricity company which has obtained an exclusive right from local authority to
provide electricity
- Competition is when many buyers and sellers are interacting with no ability to influence the
price of the product. Firms have no market power.
- The higher the level of market power, the lower the level of competition
, Monopolistic Competition
Features:
1. Large no. firms
2. Firms are small relative to market size
3. Firms are free to enter/leave the market (no barriers)
4. Goods are differentiated
5. Firms have MARKET POWER and are PRICE MAKERS
6. There is no perfect information, but it is fairly open
7. Possible for Abnormal profits/losses in the short-run but not in the long-run
WAYS OF DIFFERENTIATION = NON-PRICE COMPETITION
= the process of distinguishing a product or service from others, to make it more attractive to a
particular target market
Brand name
Colour
Packaging
Appearance
Skill level
Quality of service
Product development (special features, limited editions,
innovations)
After sale service (delivery service, technical support,
warranties)
Differentiation leads to brand loyalty >> the firms have small power on price setting
Price Makers means downward sloping demand curve
SHORT-RUN PROFITS
LONG-RUN EQUILIBRIUM
Market Power
Firm (business) = an organisation which employs factors of production to produce/sell a
good/service
Industry = a group of firms producing identical goods/services
- Industries are characterised by market structures
- A market structure has the following characteristics
1. No. of firms in the industry
2. The level of product differentiation (how similar/different the products are)
3. Barriers to entry (how easy/difficult it is for new entrants (firms) to enter the industry)
4. Market power = the extent to which each individual firm can control the price
- MARKET FAILURE occurs when free market fails to achieve allocative efficiency - when
demerit products are over-consumed and over-produced and merit products are under
consumed/underproduced in society
The 4 Market Structures
- The two extreme market structures are perfect competition and monopoly
1. Perfect Competition
firms in perfect competition have no market power, but are ALWAYS allocatively efficient (MC
= AR) so there is no market failure
• Very large number of very small firms in the industry
• Firms sell homogeneous (identical) products
• There are no barriers to enter the market
• Consumers, firms have perfect knowledge about prices and quality of goods
2. Monopolistic Competition
• A large number of small firms
• No barriers of entry
• Product differentiation = firms make their products different from each other
• Some market power (but less than in monopoly)
• Firms are not allocatively efficient and will underproduce
• E.g. nail salons/hairdressers on High street try to make their product different from others
and the little firms try to be a monopoly
3. Oligopoly
• A small number if large firms
• These large firms are interdependent as the actions of one firm will affect the market
position of the others
• High barriers of entry – very hard for new entrants to enter the industry
• High degree of market power
• No allocative efficiency
• E.g. car industry companies and airlines
4. Monopoly
, have the greatest amount of market power
• A singles seller in the industry (in reality a monopolistic industry consists of one firm that
dominates the markets with a large market share)
• A firm produces/sells a unique product with no substitutes
• Monopolist is NOT allocatively efficient and will underproduce
• E.g. an electricity company which has obtained an exclusive right from local authority to
provide electricity
- Competition is when many buyers and sellers are interacting with no ability to influence the
price of the product. Firms have no market power.
- The higher the level of market power, the lower the level of competition
, Monopolistic Competition
Features:
1. Large no. firms
2. Firms are small relative to market size
3. Firms are free to enter/leave the market (no barriers)
4. Goods are differentiated
5. Firms have MARKET POWER and are PRICE MAKERS
6. There is no perfect information, but it is fairly open
7. Possible for Abnormal profits/losses in the short-run but not in the long-run
WAYS OF DIFFERENTIATION = NON-PRICE COMPETITION
= the process of distinguishing a product or service from others, to make it more attractive to a
particular target market
Brand name
Colour
Packaging
Appearance
Skill level
Quality of service
Product development (special features, limited editions,
innovations)
After sale service (delivery service, technical support,
warranties)
Differentiation leads to brand loyalty >> the firms have small power on price setting
Price Makers means downward sloping demand curve
SHORT-RUN PROFITS
LONG-RUN EQUILIBRIUM
