Market Structure

Perfect Competition

Perfect competition is a market structure where there is a multitude of small firms, each producing identical or homogenous goods. Given its characteristics, no single firm influences the price of the product it sells. It's considered the most efficient market structure in theory. However, due to the stringency of its conditions, there are only some perfectly competitive markets in reality such as the foreign exchange market.

Here are the notable features of Perfect Competition:

Many Buyers and Sellers: With many consumers and producers, all willing and able to buy/sell the product at a specific price, no single participant can dictate market conditions. This decentralises power and promotes competition.
Homogeneous Products: All firms produce identical goods. With no difference in quality or attributes, the consumer is indifferent about the source of purchase.
Low Barriers to Entry and Exit: The ease of starting or leaving a business in this market structure ensures a competitive environment, preventing any firm from dominating the market.
Perfect Information: Both buyers and sellers have complete knowledge about market prices, product quality, and production methods. This prevents information asymmetry and fosters fair trade.
Firms Aim to Maximise Profits: Firms in this market aim to sell where marginal costs (MC) meet marginal revenue (MR), optimising their profit. This is where the firm's supply curve (MC curve above the minimum AVC) intersects with the market price line.
Price Taker: Firms in Perfect Competition are price takers due to the large number of participants and the homogeneous nature of the goods. Any attempt to increase the price will lead to losing customers to competitors.
Efficient: Perfect competition promotes allocative and productive efficiency. Allocative efficiency occurs as products are priced at P=MC. Productive efficiency occurs at the minimum point of the average total cost (ATC) curve, where the firm operates at maximum efficiency.
Profits: In the short run, these firms can make sub-normal, normal, or supernormal profits. However, in the long run, they only earn normal profits due to the lack of barriers to entry. New firms entering the market erode any supernormal profits, while sub-normal profits will lead to firms exiting.
Innovation and R&D: Firms in perfect competition need more incentive to innovate or conduct R&D due to perfect information flow. Competitors can instantly replicate any new product, eliminating any competitive advantage.

Long-run Normal Profits in Perfect Competition

In Perfect Competition, firms earn normal profits in the long run due to the absence of barriers to entry or exit. Let's examine this using firm and market diagrams.

Firm Diagram:

Draw the marginal cost (MC) curve and the average total cost (ATC) curve, where the ATC curve intersects the MC curve at its minimum point.
The price (P1) that the firm receives for its product is determined by the market and is given by a horizontal demand (D) curve, which also represents the firm's average revenue (AR) and marginal revenue (MR). The demand curve is at the price level determined by market demand and supply.
The firm maximises its profit where MC = MR. However, in the long run, the firm can only make normal profits as the price falls or rises to the minimum point of the ATC curve.

Market Diagram:

Draw the downward-sloping market demand curve (D) and the upward-sloping market supply curve (S). Their intersection determines the equilibrium price (P1) and quantity (Q1).
If firms earn supernormal profits in the short run, new firms will be attracted to the market. This increases market supply (shift from S to S1), driving down the price until firms just cover their costs (including a normal profit). Price and output will now be at P2 and Q2, respectively.
If firms make subnormal profits, some will exit the market. This decreases market supply (shift from S to S2), driving up the price until firms cover their costs. Price and output will now be at P3 and Q3, respectively.

Monopoly

A Monopoly is a market structure with a single product or service seller without close substitutes. Here, the monopolist is the price maker and can significantly dictate the market's conditions. An example of a monopoly would be the Google search engine.

Features of Monopoly include:

Single Seller: A monopolist is the only seller in the market, granting it the power to control supply and, consequently, the market price.
Unique Products: The monopolist offers a product or service with no close substitutes, providing the monopolist with significant market power.
High Barriers to Entry: These can be legal (patents, licenses), natural (high start-up costs), or strategic (predatory pricing). This ensures that the monopolist remains the sole provider of the product.
Firms Aim to Maximise Profits: Like all firms, monopolies aim to sell where MC = MR to generate maximum profits. However, unlike in perfect competition, a monopolist can set a price above this level due to a lack of competition.
Price Setter: Monopolies, due to their control over the product and its market, can influence the price of their product, unlike firms in perfect competition.
Inefficient: Monopolies are allocative inefficient as they charge a price higher than MC. They're also unlikely to be productively efficient as their goal is to maximise profits, not to produce at the lowest cost.
Profits: In the long run, monopolies can earn supernormal profits due to the high barriers to entry. This allows monopolies to continue to earn profits above the normal level, as new entrants cannot compete and erode these profits.
Innovation and R&D: While monopolies have the necessary funds for research and development due to sustained supernormal profits, the lack of competition may reduce the incentive to innovate.

Long-run Supernormal Profits in Monopoly

In a Monopoly, a single firm has control over the entire market. Barriers to entry prevent new firms from entering, allowing monopolists to earn supernormal profits in the long run.

Monopoly Firm Diagram:

Draw the downward-sloping market demand (D) and marginal revenue (MR) curves. The MR curve lies below the D curve because to sell more, the monopolist must lower the price for all units sold, not just the additional units.
Draw the MC curve and the ATC curve, where the ATC curve intersects the MC curve at its minimum point.
The monopolist maximises its profit at the output level, where MC equals MR. From this output level, draw a vertical line to the D curve to find the monopolist's price.
Supernormal profits are shown as the rectangle bounded by the ATC at the profit-maximising output level, the price, and the y-axis. These supernormal profits can be sustained in the long run due to barriers to entry.

Monopolistic Competition

Monopolistic competition refers to a market structure exhibiting specific characteristics of perfect competition and monopoly. It includes many producers, like perfect competition, but these producers sell differentiated products, a feature of monopoly. Examples of industries characterised by monopolistic competition include hawker stores and tuition centres.

Features of monopolistic competition include:

Many Small Sellers: Monopolistic competition comprises many small firms, each with a small market share. As a result, they do not significantly influence the overall market price.
Product Differentiation: Each firm in a monopolistic competition market produces slightly different products, separating them from their competitors. This product differentiation could be physical or perceived differences created through marketing and branding.
Low Barriers to Entry and Exit: Like the perfect competition, firms can enter and exit the market easily. This makes the market highly competitive and limits the ability of existing firms to maintain supernormal profits in the long run.
Profit Maximisation: Similar to other market structures, firms in monopolistic competition aim to maximise their profits by setting their output where marginal cost equals marginal revenue.
Market Power: Despite having numerous sellers, each firm holds some degree of market power due to product differentiation. They can set their own prices to a certain extent, which is reflected in a downward-sloping demand curve.
Inefficiency: Monopolistic competition leads to allocative inefficiency as firms charge a price higher than marginal cost due to their market power. It also likely results in productive inefficiency as firms do not produce at the lowest point on their average total cost curve.
Profits: In the short run, firms in a monopolistically competitive market can earn supernormal, normal or subnormal profits. However, in the long run, they will only make normal profits due to easy entry and exit. Supernormal profits attract new firms, increasing competition and driving down prices. Conversely, subnormal profits lead to firms exiting the market, decreasing competition and driving up prices.

Oligopoly

Oligopoly refers to a market structure where few firms dominate the market. Examples include the automobile industry, airline industry, and telecommunication companies. An oligopoly presents a higher risk of collusion as firms can profit from cooperative behaviour.

Features of Oligopolies include:

Few Large Sellers: Oligopoly is characterised by a small number of large firms. Each firm's decisions significantly impact the market.
Homogeneous/Differentiated Products: Products in an oligopolistic market can be homogeneous (like steel) or differentiated (like smartphones).
High Barriers to Entry: Oligopolies usually have high barriers to entry, such as high start-up costs, access to key technologies, or regulatory hurdles. This maintains the market dominance of the existing firms.
Profit Maximisation: In an oligopoly, firms aim to maximise profits by producing where marginal cost equals marginal revenue.
Market Power: Each firm in an oligopoly has substantial market power due to the small number of firms. They have the ability to set prices but must consider the likely reactions of their competitors.
Pricing Decisions: Firms in an oligopoly are typically hesitant to change prices. If one firm lowers its price, others follow suit, leading to a price war. Conversely, price increases are likely to be ignored by rivals, leading to a loss of market share.
Inefficiency: Like monopolies and monopolistic competition, oligopolies are also allocative inefficient as they charge a price higher than the marginal cost. They are unlikely to be productively efficient as their objective is to maximise profits rather than produce at the lowest cost possible.
Mutual Interdependence: Each firm's decisions in an oligopoly, especially regarding pricing and output, depend on the expected behaviour of other firms in the market. This makes the firms mutually interdependent, leading to strategic behaviour and the potential for collusion.

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