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Market Structure

REVIEW NOTES

1. Market Structure

1.1 Pure (or perfect) competition

1.2 Pure monopoly
1.3 Monopolistic competition
1.4 Oligopoly
1.5 Oligopolistic monopoly

2. Government’s Role in Maintaining Market and Structure and Performance

2.1 Mergers and conglomerates

2.2 Concentration ratio
2.3 Laffer Curve

3. Market Structure

Market Assumptions Short-run analysis Long-run analysis

structure
Pure (or Large number of  The demand The standard theory
perfect) buyers and sellers schedule is perfectly assumes that all firms
competition acting independently elastic (horizontal) are equally efficient.
Homogeneous of because the firm is a This means that the
standardized product price taker. It must minimum point on the
Firms having free sell at the market average total cost curve
entry into and exit price. is the same for all firms.
from the market (no  For profit Consequently, when
barriers to entry) maximization, the entry causes price to
Perfect information firm equates prices equal the minimum of
No control over and marginal cost. If the average total cost,
prices price is less than no firms are earning
No non-price average variable cost, economic profits.
competition the firm should shut However, if they will
down (to minimize earn economic profits
losses). in the long run.
Because price equals

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MS MICROECONOMICS. Market Structure
Market Assumptions Short-run analysis Long-run analysis
structure
marginal cost,
allocation of resources
is optimal.
Firms produce the ideal
output, the output at
which average cost is
lowest.
Price is lower and
output greater than in
any other market
structure.
Pure  Single firm  The demand curve is  Price exceeds marginal
monopoly  Unique product negatively sloped. cost. Thus, resources
with no close Thus, marginal are underallocated.
substitutes revenue lies below  The firm produces less
 Blocked entry of demand and is than the idea output.
other firms. negatively sloped.  Price is higher and
 Significant price  For profits output lower than in
control maximization, the pure competition.
 Goodwill firm equates
advertising marginal revenue
with marginal cost
unless price is less
than average variable
cost (the shutdown
case).
Monopoly Large number of  The demand curve is  Price exceeds marginal
competition firms that act non- negatively sloped cost. Thus, resources
collusively. and MR lies below are underallocated.
Differentiated demand and is also f. Price exceeds average
products. negatively sloped. total cost, indicating
Relatively easy entry  For profits productive inefficiency
into market. maximization, the (output does not reach
Some price control firm equates MR and the lowest-unit-cost
Large amounts of MC, unless price is level).
nonprice less than average  Firms produce less
competition variable cost (the than the ideal output,
(advertising =, shutdown case). and the industry is
brands, etc.)  Firms may incur populated by too

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 MICROECONOMICS. Market Structure MS
Market Assumptions Short-run analysis Long-run analysis
structure
losses or earn many firms that are
economic profits in too small. These
the short run. In the conditions are often
long run, firms tend referred to as the
to earn a normal waste of monopolistic
profit. competition.
 Price is higher and
output less than in
pure competition.
Oligopoly Few firms. The The short-run and  The price rigidity
decisions of rivals do long-run analyses are normally found in
not go unnoticed. indeterminate oligopolistic markets
Products can be because of the effect can be explained in
differentiated of each company on part by the kinked
(autos) or the other companies. demand curve theory.
standardized (steel). Because competitors
Prices tend to be respond to price
rigid (sticky) because changes by one of the
of the firms in an oligopolistic
interdependence industry, the demand
among firms. curve for an
Entry is difficult oligopolistic tends to
because of entry be kinked.
barriers, which can  If other firms do not
be match a price
 Natural, e.g., an decreases by an
absolute cost oligopolistic, it will
advantage capture more of the
 Created, e.g., market. If other firms
ongoing advertising, match the price
patents decrease, less of the
market will be capture.

4. Pure Monopoly

4.1 Blocked entry allows the monopolist to earn an economic profit in the long run,
given sufficiently low costs and adequate demand.
4.2 The following compares monopoly with pure competition. The monopolist, by
setting MR equal to MC (point M), earns an economic profit in the long run (area
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MS MICROECONOMICS. Market Structure
PMAGE). The competitor sets PC (MR in pure competition) equal to MC (point C)
and earns no economic profit in the long run.

4.3 A natural monopoly exists when economic or technical conditions permit only
one efficient supplier. Very large operations are needed to achieve low units
costs and prices (economies of scale are great). Thus, the long-term average
cost of meeting demand is minimized when the industry has one firm.

5. Monopolistic Competition

6. Oligopoly
6.1 The price rigidity normally found in oligopolistic markets can be explained in part
by the kinked demand curve theory. Because competitors respond to price
changes by one of the firms in an oligopolistic industry, the demand curve for an
oligopolistic tends to be kinked.
6.1.1 If other firms do not match a price decreases by an oligopolistic, it will
capture more of the market. If other firms match the price decrease, less
of the market will be captured.

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 MICROECONOMICS. Market Structure MS

d
D

Price

d1 D1

Quantity

If: DD1 is the firm’s demand curve when competitors do not

respond to changes in the current price (A).

d-d1 is the firm’s demand curve when competitors match

any price decrease.

D-D1 is the firm’s demand curve when competitors do not

respond to increase in the current price decreases.

6.2 Price leadership is typical in oligopolistic industries. Under price leadership, price
changes are announced first by a major firm in the industry. Once the industry
leader has spoken, everyone else in the industry matches the price charged by
the leader.
6.3 A cartel arises when a group of oligopolistic firms join together for price-fixing
purposes. This practice is illegal except in international markets. For example,
the international diamond cartel DeBeers has successfully maintained the market
price of diamonds for many years by incorporating into the carter almost all
major diamond-producing sources.
6.4 A group boycott can also affect demand and prices. A boycott is a concerted
effort to avoid doing business with a particular supplier.
6.5 Oligopolistic industries include automobiles and steel.

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MS MICROECONOMICS. Market Structure
9.1 Government’s Role in Maintaining Market Structure and Performance

9.1 The two evils of monopoly power are

9.1.1 Higher price for the product (compared to perfect competition)
9.1.2 Lower quantity produced (compared to perfect competition)
9.2 Monopoly power decreases as the number of firms increases. Therefore,
antitrust policy seeks to limit monopoly power and promote competition.
9.3 The effect of the size of a business on competition is a much-debated topic.
Arguments for and against big business include the following:
9.3.1 For big business
 A larger scale operation is necessary for innovation (e.g., a large
company can afford more research and development.
 Economies of scale
9.3.2 Against big business
 Inequitable flow of wealth to firms with market power
 Expansion of output restrictions
 Lack of incentive for innovation by a large company that may be
able to afford it
9.4 One major way firms become large is through mergers. The three types of
mergers are
9.4.1 Vertical mergers- union of two companies, one of which supplies inputs
(e.g., raw, materials) for the other
9.4.2 Horizontal mergers- union of two companies that engage in the same or
similar activities
9.4.3 Conglomerate mergers- union of two unrelated companies
9.5 Two approaches to formulating and implanting antitrust policy are
9.5.1 Performance
 Market performance
 Rate of technological growth
 Efficiency and profit
9.5.2 Industry market structure
 Number and size of competitors
 Distribution of buyers and sellers
 Ease of entry
 Product differentiation
9.6 Concentration ratio is the percentage of an industry’s output produced by its four
largest firms. Statistical studies often rely on the concentration ratio as a
measure of monopoly market power in an industry. One disadvantage of the
concentration ratio is that it does not measure the allocation of market power
when an industry consists of only a few firms.

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 MICROECONOMICS. Market Structure MS
9.6.1 The Herfindahl index addresses this issue. It equals the sum of the
squared market shares of the firm in the industry. The larger the index,
the greater the market power in the industry.
9.7 Taxes
9.7.1 License fee – a lump-sum tax that must be paid if a firm is to operate
 Short-run effect. The tax raises average cost but does not
change marginal cost. Thus, the firm’s output decision remains
unchanged.
 Long-run effect. In a competitive industry, firms are not making
profits after the tax. Some firms leave the industry. The industry
price is higher, and total industry output is lower.
9.7.2 Profits tax. This tax does not change the firm’s revenue or cost
functions. This implies that the output to maximize pretax profits also
maximizes after-tax profits. Hence, a firm’s optimal output is unchanged.
9.7.3 Per-unit tax. This tax, e.g., sales, exercise, and value-added taxes, creates
a difference between demand price (what consumers are willing to pay)
and the price a firm receives. The effect is to decrease marginal revenue.
The firm’s response is to lower the quantity produced by moving down
the marginal cost curve.
9.8 Governmental action is something anticompetitive. Examples are
9.8.1 Patent, copyright, trademark, and trade name protection
9.8.2 Price supports, such as for certain agricultural commodities, or price
ceilings, e.g., on utility rates
9.8.3 Licensing of television and radio stations
9.8.4 Tariffs, import quotas, and other restrictions on foreign producers’
access to domestic markets
9.8.5 Costs driven up by governmental regulation
9.8.6 Larger, more established companies benefiting by governmental
spending.

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MS MICROECONOMICS. Market Structure
MULTIPLE CHOICE QUESTIONS
Market structure
1. Which of the following is not a key assumption of perfect competition?
A. Firms sell a homogeneous product
B. Customers are indifferent about which firm they buy from
C. The level of a firm's output is small relative to the industry's total output
D. Each firm can price its product above the industry price

2. Which of the following statements concerning pure monopolies is correct?

A. The monopolist's marginal revenue curve lies below the monopolist's demand
curve
B. The demand curve of a monopolies is perfectly elastic
C. The point of profit maximization for a monopoly is where average total revenue
equals average total cost
D. The supply curve of a monopoly is perfectly inelastic

3. When markets are perfectly competitive, consumers

A. Are able to avoid the problem of diminishing returns
B. Do not receive any consumer surplus unless produces choose to overproduce
C. Must search for the lowest price for the products they buy
D. Have goods and services produced at the lowest cost in the long run

4. Which of the following statements concerning pure monopolies is correct?

A. The demand curve of a monopolist is perfectly elastic
B. The price at which monopolist maximizes its profit is where price equals both
marginal cost and marginal revenue
C. A monopolist's marginal revenue curve lies below its demand curve
D. For a monopolist, there is a unique relationship between the price and the
quantity supplied

5. Natural monopoly conditions, which often lead to governmental regulation, exist

when
A. Consumer demand for a product is perfectly elastic
B. Consumer demand is inversely related to the business cycle
C. Total average costs are declining
D. Marginal costs are rising

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6. Monopolistic competition is characterized by
A. A relatively large group of sellers who produce differentiated products
B. A relatively small group of sellers who produce differentiated products
C. A monopolistic market where the consumer is persuaded that there is perfect
competition
D. A relatively large group of sellers who produce a homogeneous product

7. Economic markets that are characterized by monopolistic competition have all of the
following characteristics except
A. One seller of the product
B. Economies or diseconomies of scale
C. Advertising
D. Heterogeneous products

8. Compared with firms in a perfectly competitive market, a monopolist tends to

A. Produce substantially less but charge a higher price
B. Produce substantially more and charge a higher price
C. Produce the same output and charge a higher price
D. Produce substantially less and charge a lower price

9. The distinguishing characteristic of an oligopolistic markets is

A. A single seller of a homogeneous product with no close substitute
B. A single seller of a heterogeneous product with no close substitute
C. Lack of entry and exit barries in the industry
D. Mutual interdependence of firm pricing and output decisions

10. An oligopolist faces a "kinked" demand curve. This terminology indicates that
A. When an oligopolist lowers its price, the other firms in the oligopoly will match
the price reduction, but if the oligopolist raises its price, the other firms will
ignore the price change
B. An oligopolist faces a non-linear demand for its product, and price changes will
have little effect on demand for that product
C. A oligopolist can sell its product at any price but after the "saturation point"
another oligopolist will lower its price and, therefore, shift the demand curve to
the left
D. Consumers have no effect on the demand curve, and an ologopolist can shape
the curve to optimize its own efficiency

11. Patents are granted in order to encourage firms to invest in the research and
development of new products. Patents are an example of
A. Vertical Integration
B. Market Concentration
C. Entry Barriers
D. Collusion
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MS MICROECONOMICS. Market Structure

12. A market with many independent firms, low barriers to entry, and product
differentiation is best classified as
A. A Monopoly
B. Monopolistic Competition
C. An Oligopoly
D. Pure Competition

13. The marginal cost curve is the supply curve for the firm in
A. Pure Competition
B. Pure Monopoly
C. Monopolistic Competition
D. Oligopoly

14. The large capital outlay necessary for the equipment is an example of a(n)
A. Minimum efficient scale
B. Created barrier
C. Production possibility boundary
D. Entry barrier

15. The manner in which cartels set and maintain price above the competitive market
price is to
A. Require cartel members to restrict output
B. Avoid product differentiation in order to decrease demand for the product
C. Advertise more so market demand increases
D. Increase cost so price must rise

16. A company operating in a perfectly competitive market has been paying P10 per hour
for labor and P20 per hour to rent a piece of capital equipment. The firm can use
labor and capital in any desired proportions to produce its product. If wages rise to
P20 per hour and capita equipment rentals rise to P22 per hour, in the long run the
firm will
A. Use relatively more equipment and relatively less labor in its production.
B. Use relatively more labor and relatively less equipment in its production.
C. Use less of both and equipment in its production, but in the same proportions as
before.
D. Lower its average equipment-output ration and raise its average labor-output
ratio.

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 MICROECONOMICS. Market Structure MS
17. A horizontal merger is best defined as a merger of
A. A manufacturing company and its supplier
B. Two or more firms in different industries
C. Two or more firms in different stages of the production process
D. Two or more firms in the same industry

18. Which of the following examples best describes a vertical merger?

A. A grocery store in the same market
B. A grocery store buying another grocery store in a state where the first company
does not do business
C. A hot dog producer buying a soft drink manufacturer
D. A brewer buying a glass company

19. A high concentration ratio is

A. An indicator of monopolistic power
B. An indicator of a highly competitive industry
C. Consistent with the law of demand
D. Consistent with monopolistic competition

The next two questions are based on the following information. Companies A, B, and
C had the following results for last year as reported on financial statements prepared
in conformity with generally accepted accounting principles:
A B C
Sales P100,000 P200,000 P400,000
Costs of goods sold 60,000 120,000 200,000
Gross profit 40,000 80,000 200,000
Other expenses 10,000 20,000 80,000
Net income P30,000 P60,000 P120,000
Shareholders' P500,000 P300,000 P900,000
equity

20. Assets are equal to shareholders' equity. The company has no long-term debt
outstanding. The cost of internally-generated equity capital is 12%. Which company
had the highest economic profit?
A. Company A
B. Company B
C. Company C
D. Cannot be determined from information given

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MS MICROECONOMICS. Market Structure
21. Which company had the highest accounting income?
A. Company A
B. Company B
C. Company C
D. Two were equal

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