MARKET STRUCTURE

• Efficiency


  How well the market allocates resources, and the relationship between scarce inputs and outputs
• Allocative efficiency


  • Resources are used to produce goods and services which consumers want and value most highly and social welfare is maximised, where P=MC
• Productive efficiency


  • A firm produces at the lowest average cost so the fewest resources are used to produce each product, where MC=AC in the short run
• Dynamic efficiency


  • Resources are allocated efficiently over time, with investment bringing new products and new production techniques
• 1. inefficiency


  • A firm fails to minimise its average costs at a given level of output, often due to lack of competition
• Perfect competition


  A market with a high degree of competition, where demand for the firm's goods is perfectly elastic and prices are solely determined by interaction of demand and supply
• Characteristics of perfect competition

  • Many buyers and sellers
  • Freedom of entry and exit
  • Perfect knowledge
  • Homogenous product
• Profit maximising equilibrium in perfect competition

  1. Firm produces where MC=MR

  2. In short run can make normal, supernormal or loss

  3. In long run can only make normal profit
• Efficiency in perfect competition

  • Productively efficient (MC=AC)
  • Allocatively efficient (P=MC)
  • Not dynamically efficient (no incentive to innovate)
• Monopolistic competition


  A form of imperfect competition, with a downward sloping demand curve, lying between perfect competition and monopoly
• Characteristics of monopolistic competition

  • Large number of buyers and sellers
  • No barriers to entry/exit
  • Differentiated products
• Profit maximising equilibrium in monopolistic competition


  1. In short run can make supernormal, normal or loss

  2. In long run can only make normal profit
• Efficiency in monopolistic competition

  • Not allocatively or productively efficient (MR≠MC)
  • Likely dynamically efficient (incentive to innovate)
  • Offers greater variety but may not be at lowest cost
• Oligopoly

  A market structure with a few firms that dominate the market and have the majority of market share
• Characteristics of oligopoly

  • Differentiated products
  • Concentrated supply (high concentration ratio)
  • Interdependent firms
  • Barriers to entry
• Concentration ratio


  Percentage of total market held by a particular number of firms
• Collusive behaviour

  Firms make collective agreements that reduce competition
• Non-collusive behaviour

  Firms compete without collusion
• Collusive oligopoly


  1. Firms agree on prices, market share or advertising (overt or tacit collusion)

  2. Cartel - formal collusive agreement

  3. Price leadership - one firm dominates pricing

  4. Barometric firm - one firm leads on pricing
• Non-collusive oligopoly

  Firm's behaviour depends on how it thinks others will react (game theory)
• Cartel

  No firm is likely to set their prices/output at the level they would not ideally choose and there is constant temptation to break the cartel
• The more successful the cartel, the greater the incentive to break it
• It is important for firms to be the first to break the cartel and not the firm who is left to deal with the after effects
• Tacit collusion

  Firms may be involved in price leadership and barometric firm
• Price leadership


  One firm has advantages due to its size or costs and becomes the dominant firm, other firms will tend to follow this firm because they would be fearful of taking on the firm on in any form of price war
• Barometric firm price leadership

  A firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow their leader
• Other examples of tacit collusion

  • Unwritten rules about keeping advertising low or not trying to take each other's customers
• Non-collusive oligopoly


  The behaviour of a firm will depend on how it thinks other firms will react to its policies, game theory can be used to examine the best strategy a firm can adopt for each assumption about its rivals
• Game theory

  Explores the reactions of one player to changes in strategy by another player, aims to examine the best strategy a firm can adopt for each assumption about its rival's behaviour and provides insight into interdependent decision making that occurs in competitive markets
• Duopoly

  There are two identical firms
• Strategies a firm could take

  • Maximin policy
  • Maximax policy
• Maximin policy

  Firms work out the strategy where the worst possible outcome is the least bad
• Maximax policy


  Firms work out the policy with the best possible outcome
• If the maximin and maximax strategies end up with the same solution, this is called the dominant strategy
• Dominant strategies aren't that common in real life and the best strategy for a firm tends to depend on what the other firm does
• Nash Equilibrium

  Neither player is able to improve their position and has optimised their outcome based on the other players expected decision, they have no incentive to change behaviour, unless someone else changes theirs
• Game theory is used as an explanation for why firms in oligopoly tend to have stable prices
• There is no dominant strategy for X

  The maximin strategy will be to keep prices unchanged, as profits will not change, whilst the maximax policy is to raise prices, as they could gain £5m. Most firms will want to reduce risk and so adopt the maximin strategy; they will keep prices unchanged
• Firm Y will also choose to leave its prices unchanged


  If they raise price they could lose £5m whilst the worst that could happen if they don't change is for profits to remain the same
• Therefore, both firms will leave their price unchanged and there is a Nash equilibrium since neither firm is able to improve their position given the position of the other player