3Learning Pack Part 5 Market Structures

There is a spectrum of competition. The most competitive market structure is perfect competition (which you don t need to know about for IGCSE).The least competitive market structure is pure monopoly. Somewhere in between is monopolyand oligopoly.

Competition Although perfect competition is an extreme model, competition certainly exists. A competitive market will tend to have: Lots of few firms Firms who have little influence over market price A situation where new firms are free and able to enter the market The degree of competition in a market depends upon the extent to which the above are true.

Advantages of competition If there is lots of competition then if a firm earns big profits, other firms will be encouraged to join and enter the market. This means that the firms won t make big profits in the long run. This is good for customers because profits will not get added to costs and so prices will be lower.

The profit motive will encourage firms to be more efficient.

The profit motive will encourage firms to develop new products and new technology

The profit motive will encourage firms to compete over quality and design.

The profit motive will encourage firms to produce the products people want. In competitive markets firms won t be able to control price or supply so the only thing

they can do to increase profit is to become more efficient. This is because if the degree of competition is high, firms are price takers.

Disadvantages of competition

Resources may not be distributed to members of society fairly because there are winners and losers in competition.

There might be undesirable side effects such as pollution which profit-maximizing firms wouldn t care about.

Even if firms have an incentive to develop new technology, if the market is very competitive, they won t have big enough profit to afford research and development. Also they might be worried that other firms will just copy them.

Monopoly In some markets one or a handful of dominant firms may have sufficient market power to restrict competition and influence the price and quantity traded to their favour. This is known is monopoly.

Pure monopoly is where only one firm exists in the market. However, the legal definition of monopoly tends to specify a particular proportion of the market that one firm dominates. For instance if one firm has a 25% market share then this is known as a monopoly in the UK. (This is specifically mentioned in the syllabus so make sure that you know it!)

How monopolies restrict prices

Barriers to entry: this prevents other firms from entering the market; this reduces their markets shares and profits.

Natural

1.Economies of scale: An increase in size of a firm means that they may be able to reduce the average cost of producing each unit of output. If one firm can reduce the average cost of producing the entire market supply then smaller firms added together are called a natural monopoly.

2.Capital size: The supply of a product may involved the input of such a vast amount of capital equipment that firms will find it hard to buy or hire their own.

3.Historical reasons: A business may have a monopoly because it was first to enter the market of a product and therefore built up an established customer base.

4.Legal considerations: A government can create a legal monopoly with the sole right to supply a new and innovative good or service. This is due to new products and ideas being copyrighted to protect them from other firms copying them and therefore possibly reducing their profit.

Artificial

1.Restrictions on supplies: New firms will only enter am industry if they can be supplied the raw materials for their products. This means that monopoly firms can threaten their suppliers that if they supply any firms then they will get their supplies from another supplier. This is likely to work if there are only a few suppliers and if there suppliers rely heavily on the monopolist for business

2.Predatory pricing: This occurs when a large firm cuts it prices, even if it means losing money in the short run, in order to force new and smaller competing firms out of business. Once the new competitor has been eliminated then the dominant firms can raise its prices again.

3.Exclusive Dealing: This is when a monopoly prevents retailers from stocking the products of competing firms. This is effective when the product that the firm is selling is extremely popular and the retailer would lose too much trade if they did not sell it. 4. Full line forcing: This is similar to exclusive dealing. This means that a large multi-product firm will only supply a retailer if they stock and sell their full range of products.

Disadvantages of monopoly

1. Less consumer choice Explanation: By restricting competition from rival producers and products a monopoly offers the consumer less choice than would occur in a competitive market. 2. Higher prices Explanation: A monopoly can restrict market supply to set a higher market price than would otherwise occur in a competitive market. If consumer demand is more price inelastic then demand will not contract by much. 3. Lower product quality Explanation: When there is little or no competition, the monopolist has no incentive to increase the quality of the good or service it supplies. The firm may reduce the quality in order to reduce production costs as to make more profit.

4. X ineffiency Explanation: Faced with little or no competition and they earn high profits they may make less effort than a competitive firm to ensure that their resources are used inefficiency. This means that they are more likely to have inefficiently used resources.

5. Problems with government monopoly (note: this is not quite the same as in the book so you will have to think for yourself!) Explanation: Many government-owned monopolies suffer the same disadvantages as private sectors ones, with governments often abusing their market power to raise prices in order to increase government revenues.

Advantages of Monopoly List the advantages (at least 3) with short explanations below Increased quality: They earn a lot of money and so they can spend it on improving their product or service. Lower price for consumers: They are a large company so they can then afford to lower production costs, which can be passed on to consumers with lower prices More efficient production process: They earn a lot of money and so they can spend it on a more efficient production process.

Oligopoly

An oligopoly exists if a small number of firms dominate the supply of a particular good or service to the market.

KEY FEATURES OF OLIGOPOLY

* A few firms selling similar product

* Each firm produces branded products

* Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits.

* Interdependence between competing firms. Businesses have to take into account likely reactions of rivals to any change in price and output

THEORIES ABOUT OLIGOPOLY PRICING

There are four major theories about oligopoly pricing:

(1) Oligopoly firms collaborate (collude) to charge the monopoly price and get monopoly profits (so the advantages and disadvantages would be the same as monopoly)

(2) Oligopoly firms compete on price so that price and profits will be the same as a competitive industry (so the advantages and disadvantages would be the same as with competition)

(3) Oligopoly price and profits will be between the monopoly and competitive ends of the scale (so the advantages and disadvantages would be somewhere in between monopoly and competition)

THE IMPORTANCE OF PRICE AND NON-PRICE COMPETITION

Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition. Price competition can involve discounting the price of a product (or a range of products) to increase demand.

Non-price competition focuses on other strategies for increasing market share. Consider the example of the highly competitive UK supermarket industry where non-price competition has become very important in the battle for sales

Mass media advertising and marketing Store Loyalty cards Banking and other Financial Services (including travel insurance)

In-store chemists / post offices / crches Home delivery systems Discounted petrol at hyper-markets Extension of opening hours (24 hour shopping in many stores) Innovative use of technology for shoppers including self-scanning machines Financial incentives to shop at off-peak times Internet shopping for customers

PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS When one firm has a dominant position in the market the oligopoly may experience price leadership. The firms with lower market shares may simply follow the pricing changes prompted by the dominant firms. We see examples of this with the major mortgage lenders and petrol retailers.

Example of an Oligopoly You need to know about a real world example of an Oligopolistic market. So: Write a newspaper article investigating an oligopolistic industry of your choice. Include: Key features of the industry Who is the market leader? Who are the other firms? Is it a cartel? Is there any competition? What kind? Price or non-price? Give your opinion about whether or not you think the oligopoly is harmful (or a good thing) for the wider economy and society.