Market Structure

Perfect Competition Monopolistic Oligopoly Monopoly

Competition

Definition Large number of Large number of Few dominant firms Only one firm
firms small firms, still whose behavior is present in the
retain a certain interdependent, each industry
degree of market command a large
power proportion of market
share & have strong
monopoly power
Number of Large number of Large number of Small number of large Single producer 
producers/sellers buyers & sellers  buyers & sellers firms relative to single firm
no indiv can market size  constitutes the
influence price of consider how its whole industry, the
product actions will affect its demand curve for
- Buy & sell at rivals and how rivals the firm is also the
market demand are likely to react industry demand
& supply curve

Market power Price taker, but able Control either price Indeterminate due to Control either price
to set quantity or output, NOT both. many outcomes or output, NOT both.
 due to downward which can result from  due to downward
sloping demand firm’s interaction. sloping demand
curve. Competitive  rigid curve.
Cooperative  more
leeway in setting
prices
(refer to models of
oligopoly for
explanation)
Nature of Products Homogenous Differentiated Homogenous No close substitutes
product products - Pure/perfect for the product
- Buyers show no - Quality, design, oligopoly  only 1. No other firm
preference for packaging, 1 price can produces similar
any product branding & prevail, however products that
method of as firm’s demand vary slightly from
promotion is not perfectly monopolist
- Some degree of price elastic, firm 2. Low CED & PED.
control over its has control over
own prices pricing policy
Demand relatively - E.g. metals,
price elastic due to chemicals, petrol
large no. of close Differentiated
substitutes - Imperfect
oligopoly, less
fear of immediate
reaction from
 rivals as rivals
may perceive
change in price to
be due to
modifications
made to product,
this increases
price setting
ability. (but rivalry
&
interdependence
still exists)
- Cars, airlines
Knowledge of Perfect knowledge Imperfect knowledge Imperfect knowledge Imperfect knowledge
Products - Seller knows - Imperfect info - Incomplete info - Consumers not
prices rival regarding regarding fully aware of
charge, market production production costs &
costs, COP & methods and methods & prices production of
available prices - Consumers not product
production tech. - Cost structures fully aware of cost
- Buyers complete differ as some & production of
info on every firms may enjoy product
seller’s price, more favourable
quality & locations/lower
availability of rentals
products  will
not purchase @
price higher than
prevailing market
price
Barriers to entry No/Low barriers to No/Low barriers to Substantial barriers to High barriers to entry
(conditions that entry entry entry - Firms not free to
prevent/impede the - FOP perfectly - FOP relatively Natural Barriers enter the
entry of new firms mobile & mobile - Exploit IEOS , industry 
into an industry. It available to firms - Firm lower its average cost for retain
can limit the amt of at uniform price price, its gains in the firm falls supernormal
comp faced by  no cost adv. sales will be continuously over profits in the
existing firms in the - No transaction & spread thinly a very large long run
industry) transportation over many of its output, MES @ Natural Barriers
cost rivals so that the high output level 1. Very huge fixed/
- Minimal extent to which - High fixed/sunk sunk costs
fixed/sunk cost each of the rival costs relative to the
- firm suffers is Artificial barriers size of market
negligible  less - Legal barriers demand  need
likelihood of - Collusion/merger to operate in
retaliation  s & acquisitions large scale
determine - Non-price output
price/output competition production to be
policies w/o a. Product able to exploit
consideration of differentiation IEOS, making
possible b. Advertising – high huge fixed/sunk
 reactions of rival expenditures cost viable (e.g.
firms  greater existing firms production of
price setting expend on power & utilities)
ability advertising could Artificial Barriers
- Large number of be a deterrent to 1. Product
firms  no new firms differentiation &
collusion  fairly entering the brand loyalty
high degree of industry as it 2. Contrived
comp still exists. greatly increases barriers (e.g.
their cost cartel), exclusive
c. Rules/regulation ownership/
by govt control of
essential raw
materials
3. Legal protection
in the form of
exclusive rights
(patents,
copyrights,
franchises,
licenses) granted
by govt
Profitability in the Supernormal, Supernormal, Supernormal, normal, Supernormal,
short run normal, subnormal normal, subnormal subnormal profit normal, subnormal
profit profit profit (refer to
graphs)
Decision to cease SR: Total revenue < SR: Total revenue < SR: Total revenue < SR: Total revenue <
production total variable cost total variable cost total variable cost total variable cost
AR < AVC AR < AVC AR < AVC AR < AVC
LR: TR < TC, AR<AC LR: TR < TC, AR<AC LR: TR < TC, AR<AC LR: TR < TC, AR<AC
(LR equilibrium is the (LR equilibrium is the (LR equilibrium is the (LR equilibrium is the
output level where output level where output level where output level where
LRMC = MR, total LRMC = MR, total LRMC = MR, total LRMC = MR, total
revenue is at least revenue is at least revenue is at least revenue is at least
equal to total cost) equal to total cost) equal to total cost) equal to total cost)
Profitability in the Normal Normal Supernormal profits Supernormal profits
long run - Earn - High barriers to - High barriers to
supernormal entry. entry.
profits in SR 
low BTE  entry
of new firms 
demand for each
firm’s product
falls, demand
more price
elastic due to
availability of
more substitutes
 normal profits
Allocative efficiency Allocative efficient Allocative inefficient Allocative inefficient Allocative inefficient,
P = MC - P > MC, however - P > MC level of production at
 P> MC only P>MC. If additional
marginally, unit of good is
(relatively price produced, MB(=P)
elastic demand will exceed MC,
curve), extent of hence society will be
allocative better off with the
inefficiency is production of this
limited additional unit.
Productive Efficiency Firm POV: Firm POV: X – inefficient ( same Firm’s perspective:
- Productive - Productive argument as Can either be
efficient efficient  profit monopoly) efficient or X-
Society POV: maximizing Unlikely to produce at inefficient. X-
- Productive motive & normal MES. Output is Inefficient due to
efficient profits in the LR usually below MES ability to earn
Society POV: supernormal profits
- Inefficient, not @ in the LR (Operating
MES at a point above
- Wasteful use of LRAC)
resources due to Society’s POV:
product May or may not be
differentiation  producing at MES.
persuasive Only by coincidence
advertising  if it is producing at
represents MES
largely a form of
economic waste
- However, if it
provides better
consumer info
which helps to
move mkt
structure to a PC
one, then not
wasteful
Equity Spread opportunities Equitable Exacerbate inequity Exacerbate inequity
and wealth widely  - Spread as supernormal as supernormal
low BTE & normal opportunities & profits are profits are
profits wealth  low concentrated at the concentrated at the
BTE & normal hands of the few hands of a selected
Do not rectify pre- profits dominant producers few monopolies at
existing inequity at the expense of the expense of
consumers who pay consumers who pay
high prices for a high prices for a
limited quantity of limited quantity of
goods goods
Innovation No incentive for Incentive to innovate Encourage Can either reduce
innovation for product innovation, however pace of innovation or
- Perfect info  differentiation to pace of innovation fund expensive R & D
innovations earn normal profits can also be slow. projects (refer to
quickly in LR  ability to (refer below) monopoly desirable
replicated, will innovate is limited  part)
 not be able to engage in innovation
reap fruits of which emphasizes on
innovation product
- Normal profits  differentiation as
unable to these incur relatively
undertake R & D lower costs
- Homogenous compared to
products groundbreaking
innovation
Consumer Choice No consumer choice Consumer - Can choose the - Do not have a
 homogenous sovereignty firm from which choice as to
products enhanced  wide they would like to which variant of
Choice of producers variety of choices purchase from as the product to
still present Consumers value & there is product purchase given
Consumer enjoy increased differentiation that the product
sovereignty  react choice on offer & - Tend to engage in of a monopolist
to consumer demand greater variety due multiple branding is unique
responsively to product whereby a firm - No choice of
differentiation produces producer as only
essentially the monopolist is
same/ similar producing the
products under good
different brand - Consumer
names  offers sovereignty is
consumers restricted &
illusion of wider consumer
choice (e.g. surplus is
cigarettes) appropriated by
monopolist.
Examples Hair salons, Airline industry, Microsoft, SISTIC
restaurants, retail pharmaceutical firms,
shops, provision crude oil,
shops, bubble tea telecommunications
kiosks, hawker service, taxi
centre food, tuition companies, banks,
centres, music petrol
schools companies/kiosks

Monopoly: How it maintains its position

Erecting barriers to entry:

1. Significant cost reduction arising from economies of large scale production (IEOS) (natural
barrier), large MES in relation to market demand
- New firms tend to begin operation on a smaller scale, and hence incur a higher unit cost of
production as the firm is unable to produce at the MES initially. Existing monopoly on the other
hand is already operating at a larger scale and is able to enjoy substantial IEOS, hence producing
 at a lower average cost. With lower unit cost, monopolist can deliberately reduce the price of its
products to ward off potential entrants  discourages entrance of new potential firms
2. Gaining control over supplies of inputs, outlets, or through patents/copyrights
- Done via product differentiation (extent to which the existing firm is able to gain control of
essential raw materials/convince customers that there is no such close substitute for its product)
a. Engaging in intensive advertising campaigns
b. Investing in extensive research & development to continually develop new
products/improve on the production process
c. Seeking and obtaining legal protection in the form of exclusive rights (e.g.
patents,copyrights, market franchises, licenses
3. Elimination of competition
a. Price cutting
b. Dumping (deliberately selling below MC/AC) (e.g. china accused by USA for dumping of
products like TV sets)
c. Mergers and acquisitions

** BTE can be temporary in nature. Potential firms are drawn by supernormal profits earned, they
will and can devise new technologies and price strategies to break into the market.

Why monopoly is desirable.

1. Able to reap substantial IEOS.

In industries where MES is high, the monopolists are able to enjoy significant IEOS. They can operate
on a lower marginal cost compared to firms in competitive industries and this may result in lower
prices & higher output if available IEOS is substantial. (with reference to a diagram) output levels is
higher for monopoly than perfect comp. this also translates to lower prices in monopoly despite
monopolist selling its product at a price above its mc  Higher consumer surplus

2. Ability to conduct R & D

- Due to its ability to retain supernormal profits in the LR. Hence, consumers are likely to benefit
from new products while the economy benefits from the new investments. This is esp. the case
when a monopolist faces a credible threat from a potential entrant.
(E.g. existence & growth of Microsoft has facilitated vast development in Information
Technology and world economic growth)
3. Monopoly enjoys greater stability
- Hence, it contributes to a more stable economy especially in terms of employment. E.g.
monopolists survive better under adverse economic conditions as they can better sustain losses
with funds accumulated from past supernormal profits made. Stability is another equally
important economic goal to an economy, of no less importance to the ultimate objective of high
living standards, including that of the consumers.
3. Theory of contestable market
- Argues that what is crucial in determining price and output is not whether the industry is
actually a monopoly or perfectly competitive but whether there is a real threat of competition
- Perfectly contestable market  costs of entry & exit by potential rivals are zero, and when such
entry can be made very rapidly.
- This theory implies that the sheer threat of this happening will ensure that the firm in the
market will keep it prices down and produce as efficiently as possible. If not, rivers would enter
& potential competition may become actual competition  supernormal profits not as large
- Market power of monopoly may be severely constrained by potential industry entrants.
Monopolists operating in contestable markets may benefit consumers more than firms
operating under pc, as they are able to achieve EOS & they keep their prices & profits low 
need not be less efficient.
4. Ability to execute price discrimination (refer to lec notes)

Why monopoly is undesirable

1. Allocatively inefficient
2. Inequity
3. Consumer choice
4. Innovation – a reduced pace of innovation
- Complete barriers to entry  dominant position of monopoly is secured. Hence, there is no
need for a monopolist to innovate and improve quality of its product ( anti thesis: theory of
contestable market)
- Innovation erodes the value of monopoly’s existing products, it tends to favour status quo.
e.g. discovery of a cheaper and faster microprocessor by INTEL will lower the price of all its
existing microprocessors.

5. X- inefficient
- Slack in its organizational and cost, inefficient production techniques, lax cost
controls(overstaffing, unnecessary spending), operating at a point above the LRAC curve
(inefficient from firm’s POV)
- Due to ability to make supernormal profit in the LR and the lack of pressure/competition, any
increase in cost can be passed to consumers in the form of an increase in price as demand is
relatively price inelastic
- However, with growth in international competition, X-inefficiency has increasingly been reduced
as markets become increasingly global in scale. In addition, with the removal of protectionistic
barriers, companies also face fiercer competition from abroad
6. Ability to execute price discrimination (refer to lec notes)

Models of Oligopoly

a. Cooperative model/ Collusive Oligopoly (drawing of imperfect competition curve)

- Collusion if a formal/informal agreement among oligopolies on what prices to charge and how to
divide the market. The main motive for collusion is to reduce the unpredictability of rivals’
reactions to changes in price. Collusion also increases the profits of the group as a whole
- Limit competition: set output quotas, fixed prices, limits on the extent of product
promotion/development, agreements not to poach each others’ markets.
1. Cartels (e.g. Organisation of Petroleum Exporting Countries (OPEC))
- Cartel  formal agreement whereby members collude to act like a monopoly to maximize
profits. Marginal cost curve is the horizontal sum of the individual members’ MC curves
- Agree on a cartel price  compete using non-price strategies
- Agree to divide the market according to current market share  fragile, resulting in unstable
outcomes
- Strong incentive to cooperate (profit maximization aim) but has an incentive to cheat in order to
increase its profit above its share of the joint profit
2. Tacit collusion : Price leadership
- Situation where oligopolies take care not to engage in price cutting, excessive advertising etc.
unwritten rules of collusive behavior such as price leadership which occurs when price set by
one producer is accepted as the market price by other producers
- Prices are stable, only changes when leader initiates a change. Price leader selects price &
output combination which will maximize his profits  similar to monopoly.

b. Competitive models (kinked demand curve)

- Match each other’s price reductions not price increase. If firm increase price, other firms will not
increase their prices, only when the firm reduces it prices will the other firms match that
reduction  price rigidity
- Demand is relatively price elastic when firm increases its price, price inelastic when price is
reduced. Demand curve for the oligopoly will therefore be kinked at the prevailing market price.
- Region of indeterminancy  MR has a discontinuous section below the kink, should MC
fluctuate within this region, firm will absorb the higher costs and leave the existing price-output
combination unchanged

Price competition
- Price wars/predatory pricing occurs when there is considerable excess capacity in industry so
that each firm tries to extend its share of the market
- Undercut each other’s prices  drive rivals out of the industry so remaining firms may have a
larger share of market  suffer losses in short run.
- Survivors of intense and prolonged price wars are likely to be the firms with more resources to
withstand the price war  gain larger market share which translates to higher profitability

Non- price competition

- Product differentiation  establish real/imaginary differences/ through varying conditions of

sale  raise consumers’ awareness of products and make demand more price inelastic
- Huge funding towards R & D and large scale advertising  large amt of profits can be gained and
has the ability to erect BTE, real incentive for oligopolies to maintain their grip of market share.

Existence of oligopolies

1. Sensitive industries, results in government intervention and regulation of the number of

firms that can be present in the industries. E.g. Telecommunication industry (Singtel,
Starhub, M1)
 2. State of Singapore’s economy  open economy which allows foreign direct investment
(FDI). Foreign firms which enter the industry are big and have large capital. To be able to
compete with these foreign firms, local firms must be large as well. Example, in the banking
industry. POSB and DBS were encouraged by government to merge to compete with foreign
banks like Standard Chartered, HSBC.

Why oligopolies are desirable

1. Exploitation of IEOS
- Few dominant firms, output of each firm is sufficiently large enough for it to reap IEOS 
possible for unit cost to be lower in an oligopolistic market.
2. Innovation
- Significant BTE  reap rewards from R & D and earn supernormal profits in LR  strong
incentive for innovation
- Sufficient financial resources to engage in R & D.
3. Consumer choice (refer to above)

Undesirable

1. Allocative inefficient
2. Productive inefficient
3. Inequity
4. Innovation
- Pace of innovation can be slow in collusive/entrenched oligopolies  lack of competition from
other dominant firms & potential entrants may deter such firms from undertaking R & D. (same
as monopoly reason)

Is perfect competition the most ideal?

1. Static model (lack innovation)  what is optimum now may be sub-optimum in the future,
esp taking into account slow pace of innovation
2. May not deliver optimum allocation of resources if externalities are present (discrepancy
b/w private & social costs)
3. Lack of variety of products
4. Lack of supernormal profits in LR  source of funds for R & D