Chapter 5: Market Structures

Markets are classified into Perfect Competition, Monopoly, Monopolistic Competition, and Oligopoly based on the degree of competition. Firm pricing and allocative efficiency vary by market structure.

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1. Perfect Competition

A market with many buyers and sellers, where everyone is a Price Taker.

1. Characteristics: Homogeneous products, free entry and exit, perfect information.
2. Short-run Equilibrium: Production occurs where $P = MC$. Economic profit or loss is possible.
3. Long-run Equilibrium: Due to entry and exit, firms earn only Normal Profit (Economic Profit = 0).
4. Efficiency: Resource allocation is most efficient, and social welfare is maximized ($P = MC$).

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2. Monopoly

A market where only one firm exists in an industry.

1. Causes: Barriers to entry (patents, control of resources, economies of scale - Natural Monopoly).
2. Equilibrium: The firm faces a downward-sloping demand curve. It sets quantity where $MR = MC$ and determines price from the demand curve, resulting in $P > MC$.
3. Evaluation: Allocation is inefficient, and Deadweight Loss occurs.
4. Price Discrimination: Charging different prices to different consumers for the same good to increase profit.

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3. Monopolistic Competition

A market with many firms, but with Product Differentiation.

• Characteristics: Non-price competition (advertising, branding). In the long run, economic profit is 0, but excess capacity remains.

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4. Oligopoly

A market dominated by a few large firms, characterized by high Interdependence.

(1) Characteristics and Strategies

• Kinked Demand Curve Model: Explains price rigidity.
• Cartel (Collusion): Firms act together like a monopoly, but the incentive to cheat (betray) always exists.

(2) Game Theory

A tool to analyze strategic choices of oligopolistic firms.

• Nash Equilibrium: A state where no player has an incentive to change their strategy given the strategy of the other player.
• Prisoner’s Dilemma: A situation where rational choices by individuals lead to a worse outcome for both.

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Key Checklist

• What is the economic profit in the long-run equilibrium of a perfectly competitive market? (Answer: 0)
• Is Marginal Revenue (MR) always lower than Price (P) for a monopoly? (Answer: Yes)
• Which market structure differentiates through ‘brand’ or ‘design’? (Answer: Monopolistic Competition)
• What model explains why firms in an oligopoly do not easily change prices? (Answer: Kinked Demand Curve Model)