Market structure: is a term for the conditions which exist in a market.

How to distinguish between different types of market structures?

The number of firms in the market

 only one firm;
 many firms

The nature of the product

 Homogeneous: Customers are indifferent to the price they pay
 Differentiated(unique): Customers are willing to pay a different price

The ease of entry into / exit from the market structure

Perfect Competition

Characteristics

 Many sellers – a lot of different firms compete to supply an

identical(homogeneous) product. [E.g. Agricultural products such as wheat,
corn, or rice]
 Have a small share of the market: due to fierce competition
 Due to the perfection of competition, firms are price takers. If any firm did try to
sell at a high price, it would lose customers to competitors. If the price is too low,
they may incur a loss.

[For Example, if the market price is $10 per unit and a firm decides to lower its price to
$8, but its average cost of production is $9, the firm is losing $1 per unit sold.]

 Relatively free entry into and exit from the market: This means that there
must not be anything which makes it difficult for the firms to enter or leave the
industry, that is to start or stop producing the product.

Profit levels:

 Normal profit: The minimum profit needed to keep firms producing in the long
run. Earning just enough to cover the costs of running the business and also
compensated the owner for the opportunity cost of their time and resources.
 Supernormal (abnormal) profit: Profit above normal, which attracts new firms,
increasing supply and lowering prices to restore normal profit.
  Losses and firm exit: If demand falls, firms may incur losses, leading to exit,
reduced supply, higher prices, and a return to normal profits.

Advantages

 High consumer sovereignty: consumers will have a wide variety of goods and
services to choose from, as many producers sell similar products. Products are
also likely to be of high quality, in order to attract consumers.
 Low prices: as competition is fierce, producers will try to keep prices low to
attract customers and increase sales.
 Efficiency: to keep profits high and lower costs, firms will be very efficient. If they
aren’t efficient, they would become less profitable. This will cause them to raise
prices which would discourage consumers from buying their product. Inefficiency
could also lead to poor quality products.
 Incentivised to respond quickly to consumer demands or cut costs, gain a
competitive advantage and earn higher profits.
 Price pressure: High competition may lower prices, but not necessarily to a level
below cost.

Disadvantages:

 Wasteful competition: in order to keep up with other firms, producers will

duplicate items; this is considered a waste of resources.
 Mislead customers: to gain more customers and sales, firms might give false
and exaggerated claims about their product, which would disadvantage both
customers and competitors.

Monopoly

 Dominant firms who have market power to restrict competition in the market are

called monopolies.

 Pure monopoly: there is only a single seller who supplies a good or service.

Example: Indian Railways, public utilities (e.g., Water, Electricity), patent-

protected Products
Characteristics

 Dominate 100% share of the market

 Price makers: Since customers have no other firms to buy from, monopolies can

raise prices – that is they are able to influence prices as it will not affect their

profitability. These high prices result in monopolies generating excessive or

supernormal profits.

Supernormal profits: profit above that needed to keep a firm in the market in the long

run.

 Lack of competition: because the market faces high barriers to entry –

obstacles preventing new firms from entering the market.

Barriers to entry

1. High start-up costs (sunk costs), expensive paperwork, large capital

requirement, regulations etc

2. High brand loyalty: through branding and advertising or pricing structures that

other firms couldn’t possibly compete with, those also act as barriers to entry.

3. The scale of production: producing on a large scale enables them to produce at

a low unit cost. Any new firm, unable to produce as much, is likely to face higher
unit costs and therefore will be unable to compete.

4. Access to resources and retail outlets

Why do monopolies arise?

  Success over time: A firm may dominate by cutting costs and adapting to
consumer preferences, driving out rivals.

 Mergers and takeovers: These can reduce the number of firms to one, creating
a monopoly.
 Initial monopoly: A firm may control a resource (e.g., all gold mines) or be
granted monopolistic powers by the government, preventing competition. Patents
also restrict other firms from producing the product.

Disadvantages:

As there are no (or very little) other firms selling the product,
Lesser output is low and thus there is little consumer choice.
consumer
sovereignty

 Restrict the supply to push up prices

 Fail to respond quickly to customer demands and to
Inefficiency develop new products

Lack of competition diminishes the incentive to raise quality,

Lower quality knowing that customers cannot switch to rival products. (But
since they make a lot of profit, they may invest a lot in research
and development and increase quality).

Why are monopolies not always bad?

 Produce more output than what individual firms in a competition do, and thus
benefit from economies of scale. This is when it prevents the wasteful duplication
of capital equipment. For example, it would be expensive, and possibly unsafe, to
have a number of different firms laying and operating rail tracks.
 High profits would also enable it to spend on R&D and, therefore, it may
introduce new, improved variations.
 They can still face competition from overseas firms.
 They could sell products at lower price and high quality if they fear new firms
may enter the market in the future.