Unit 3

Business economics

3.9 Introduction to market structure

A2 Economics

Adapted from tutor2u™

Business economics

• This unit develops the content of units 1 and

examines how the pricing of, and nature of

competition between, firms is affected by the

number and size of market participants. At the

end of this unit, students should be able to

analyse the pricing and output decisions of

firms in different contexts. They should also be

capable of making an appraisal of government

intervention aimed at promoting competitive

markets.

Adapted from tutor2u™

• Students should be able to:

– Compare different market structures with reference to economic efficiency and performance

3.9 Behaviour of firms

Adapted from tutor2u™

• Background Reading:

– Phil Allan Unit 3 p. ?

– Nutter p. ?

3.9 Behaviour of firms

Adapted from tutor2u™

What is market structure?

• Market structures are the organisational and other characteristics of a market that influence how a firm behaves, especially in terms of setting price and determining output.

• We tend to focus on those characteristics of a market which affect the degree of competition between firms and their pricing decisions

• Traditionally we emphasise:

1. The number and size distribution of buyers and sellers

2. The existence or absence of barriers to entry and exit and number of potential new entrants

Adapted from tutor2u™

Structural characteristics of a market

• The number of firms and extent of overseas competition

• The market share of the largest firms (concentration ratio)

• The nature of costs in the short and long run

• The degree to which an industry is vertically integrated up and down the supply chain

• The extent of product differentiation / homogeneity (similarity)

• The price and cross price elasticity of demand for different products within the market

• The number and size of buyers of the industry’s product

• The turnover of customers (“market churn”) – affected by brand loyalty and the effects of advertising and marketing

• Access to market information

• Level of inter-dependence of firms actions

Adapted from tutor2u™

3.9 Market structures - types

• Types vary from NO competition to PERFECT COMPETITION

– Pure Monopoly – one firm

– Duopoly – two firms

– Oligopoly – a few firms

– Monopolistic Competition – many firms with some individual advantages

– Perfect Competition – many very similar firms

Adapted from tutor2u™

Highly Competitive High Degree of Market Power

Perfect CompetitionFarmingStocksCurrencies

Monopolistic CompetitionRestaurantsSmall BuildersSolicitors

OligopolySupermarketsBanksElectrical Goods

MonopolyGas WaterElectricityTele-communications

3.9 Market structures - types

Adapted from tutor2u™

3.9 Market structures - types

• PJV’s thinking

– Monopolistic Competition is often called Imperfect Competition, whereas grammatically anything that is not perfect is imperfect including monopoly

– Both a partially open door and a fully open door are NOT shut.

– Q: When is a door, not a door?

– Ans: When it is a piece of fruit cake!

Adapted from tutor2u™

3.9 Market structures

• Click here mind map on market structure

Adapted from tutor2u™

Changing market structure in retailing

Adapted from tutor2u™

The conduct / behaviour of firms

• How does market structure affect pricing, output and other decisions of businesses within the market

• Are there dominant firms?

• Is there evidence of anti-competitive behaviour?

– Collusive pricing agreements

– Predatory pricing?

– Vertical restraint?

• How important is non-price competition?

• Is there interdependence between firms

• Do businesses behave strategically to retain profits by deterring the entry of new competitors in the long run?

Adapted from tutor2u™

Performance indicators

• Trends in real price levels over time

• Size of business profits – evidence of excess profits?

• How much spending on research and development – does it lead to a fast pace of technological advance and innovation?

• How much spending on human capital, does it lead to rising labour productivity in the industry?

• Does the conduct of firms give rise to efficient outcomes?

1. Allocative efficiency

2. Productive efficiency

3. Dynamic efficiency

Adapted from tutor2u™

Has the telecoms industry achieved efficiency?

Adapted from tutor2u™

The usual causal view

Market structure

Conduct of Firms

Performance

Adapted from tutor2u™

The feedback critique (1)

Market structure

Conduct of Firms

Performance

The conduct of firms in a market can affect market structure – e.g. merger and takeover activity

Adapted from tutor2u™

Price and non-price competition?

Adapted from tutor2u™

The feedback critique (2)

Market structure

Conduct of Firms

Performance

The actual performance of firms in the market affects market structure – e.g. rising dominance of best performing businesses – examples: pharmaceuticals, food retailing

Adapted from tutor2u™

The feedback critique

• Performance can affect structure

– Top performing firms will gain market share at expense of rivals

– This gives them more market power

– Fine line between market dominance and economic efficiency?

• Market conduct affects structure

– E.g. decisions about research and development and marketing

• Strategic behaviour of firms especially in oligopoly makes it difficult to rely on the structure conduct performance model

• The theory of contestable markets is a development of this approach and stresses the dynamic nature of market competition especially when a market is open