PERFECT COMPETITION

 Market Structure: Perfect Competition,

Monopoly, Monopolistic Competition,
Oligopoly
 Assumptions

1  Short and long run equilibrium

MARKET & MARKET STRUCTURE
 Market : Any arrangement that enables buyers and sellers
to contact for transactions.
 Market contents 2 kinds of competition :
1) Price competition
2) Non-price competition
 The relationship among sellers is called the
Marker Structure of the sellers.

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 PRICE COMPETITION
 Seller competes among each other by sitting a lower
price.

Non-price competition
Sellers competes in area like product quality,advertising,

packaging and service other than price.

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 MARKET STRUCTURE
Perfect Pure
Competition Monopoly

More competitive (fewer imperfections)

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 Market Structure
Perfect Pure
Competition Monopoly

Less competitive (greater degree

of imperfection)

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 Market Structure
Pure
Perfect
Monopoly
Competition

Monopolistic Competition Oligopoly Duopoly Monopoly

The further right on the scale, the greater the degree

of monopoly power exercised by the firm.

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Economic analysis identifies four types of
market structure

1. PERFECT COMPETITION
2. MONOPOLY
3. OLIGOPOLY
4. MONOPOLISTIC COMPETITION
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1. PERFECT COMPETITION
 Conditions for perfect competitive market:
 Many buyers and sellers, small relative to the market.
 Products are identical or Homogenous Products.
 Free Entry or exist (No barriers to new firms entering the
market).
 Perfect Knowledge of market Opportunities
 Prices are determined by the interaction of aggregate demand
and aggregate supply.
 Firms are so small that cannot affect the price in the market.
 If raise prices, consumers switch to another firm.
 Price takers.
 Example: wheat farmers.

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 Firms face perfectly elastic demand.
MARKET STRUCTURE
 Examples of perfect competition:
Financialmarkets – stock exchange,
currency markets, bond markets?
Gold Market
 To what extent?

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 PERFECT COMPETITION

 Free entry and exit to industry

 Homogenous product – identical so no consumer
preference
 Large number of buyers and sellers – no individual
seller can influence price
 Sellers are price takers – have to accept the market
price
 Perfect information available to buyers and sellers

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 1) Perfect Competition

 Homogenous Products: The goods are sold by different

sellers as exactly alike from the consumers regard.

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FREE ENTRY AND EXIT:

 Firms are free to enter or leave the market. They

do not face restriction on competing with other
sellers.

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PERFECT INFORMATION:
 All the buyers and sellers know the aspects of the
market, including price, quality and quantity of the
good
 Market information such as new design and latest
technology are available.

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INDIVIDUAL SELLERS HAVE NO
INFLUENCE ON THE MARKET:

 In a perfectly competitive market, there are many

buyers and sellers, since all the buyers and sellers
know the aspects of the market, goods are
homogenous, so no individual seller can affect the
market price, because his output just takes up a
little part of the whole market output.

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2. MONOPOLY
 A monopoly is a firm that sells a good that does not have
close substitutes.
 In other words, a monopoly is a firm that can ignore the
actions of all other firms.
 Ifit can ignore them, they are not producing close enough
substitutes.
 Reasons for monopolies
 Entry Blocked by Government Action
 Patents and copyrights.
 Public franchises.

 Control of a Key Resource

 Natural Monopoly

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 MONOPOLY:

 High barriers to entry

 Firm controls price OR output/supply
 Abnormal profits in long run
 Possibility of price discrimination
 Consumer choice limited
 Prices in excess of MC

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 MONOPOLY
 Entry is completely blocked:
only 1 producer in the market and no entry in monopoly.
 Monopolists may sell homogeneous or
heterogeneous goods:
The goods or services sold by a monopolist may be
homogeneous.
 A monopolist may also sell heterogeneous goods or
services.

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 Information of the market is imperfect:
No perfect information in the market. Neither the
sellers nor buyers know all aspects of the market.

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HOW ARE MONOPOLIES FORMED
 By government franchise:
When the government grants a franchise to a firm
to operate as the only producer of a good, a
franchised monopoly is created.

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 By patent and copyright:
When a producer has invented a new product, he can apply
to the government for a patent. It gives him the exclusive
rights to use his new product for a certain period, within
this period, nobody can use his new product without his
green light.

Copyrights give writers, composers and artists exclusive

rights over their ideas for a certain period.

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ECONOMIES OF SCALE: NATURAL
OLIGOPOLIES

 When minimum efficient scale (MES) for a typical firm

is a relatively large percentage of market
 only a few large firms survive since small firms can’t
compete
 Market becomes an (natural) Monopoly
 Remember, MES is defined as the lowest level of output
at which it can achieve minimum cost per unit
 The output level at which the LRATC first hits bottom

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 Huge capital requirement and economies of
scale:
The firm needs to produce a huge output to enjoy the
benefits of economics of scale. After it has fully established
itself,
== it’s average cost of production is lower than the
potential competitors.
== it’s output may be very big and so it can satisfy the
entire market demand.

As a result, other firms will be discouraged or give up from

entering the market.
It called natural monopoly.
Example: MTR
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MONOPOLISTIC COMPETITION:
HYBRID OF PERFECT COMPETITION AND MONOPOLY, SHARING
SOME OF FEATURES OF EACH

 Many buyers and sellers

 Products differentiated
 Relatively free entry and exit
 Each firm may have a tiny ‘monopoly’ because of the
differentiation of their product
 May have some element of control over price due to the
fact that they are able to differentiate their product in some
way from their rivals – products are therefore close, but
not perfect, substitutes
 Downward-sloping demand-curves
 Consumer and producer knowledge imperfect
 Examples – restaurants, professions – solicitors, etc.,
building firms – plasterers, plumbers, etc. 23
 MONOPOLISTIC COMPETITION
Features of both perfect competition and monopoly are present.

 Similar features to perfect competition

- A large no. of sellers and buyers.
For example, thousands of hair salons, boutiques in HK.

- Free entry and exit.

New firms have to compete with existing firms for business.

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 Different
features from perfect competition
- The goods sold are heterogeneous:
The product sold by different sellers as different. The
differentiation may rise from differences in quality,
package design, advertisements, etc.

- Imperfect information of the market:

Neither the sellers nor buyers know all aspect of the
market.
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SOME BEHAVIOUR OF FIRM UNDER MONOPOLISTIC COMPETITION
 Monopolistic competition are price searchers
They need to search for the particular price that
maximizes profits.

 Non – price competition:

For example, advertising, offering gifts and
organizing lucky .

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 OLIGOPOLY –
COMPETITION AMONGST THE FEW
 Industry dominated by small number of large firms
 High barriers to entry
 Products could be highly differentiated – branding or
homogenous
 Non–price competition
 Price stability within the market - kinked demand curve?
 Potential for collusion?
 Abnormal profits
 Behaviour of firms affected by what they believe their rivals

might do – interdependence of firms

 High degree of interdependence between firms

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 DUOPOLY:

 Industry dominated by two large firms

 Possibility of price leader emerging – rival will
follow price leaders pricing decisions
 High barriers to entry
 Abnormal profits likely

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 OLIGOPOLY
 Oligopoly – market is dominated by several sellers
 Duopoly –there are only 2 sellers
Features of an oligopoly :
 Imperfect information of the market, neither sellers nor consumers
are fully aware of the cost, price, quality and quantity sold by
different sellers.
 Several dominant sellers, in an oligopolists market a large share of
the market demand is satisfied by several major firms.
 Sellers are interdependent, oligopolists will consider their
competitors’ responses in deciding their business.

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 Oligopolists sell heterogeneous or homogeneous goods:
For example: The Coca Cola Company sell Bonaqua
Mineralized Water and Coca Cola Soft Drink.
It’s products are homogeneous.

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 Entry is restricted or difficult:
- The existing firms are well-established, the oligopolists enjoy
the benefits of economies of scale, new firm have to pay a huge
cost when competing with the existing firms.

- The existing firms have already built up their names and

gained customers’ good will. New firms need to advertise
heavily to compete with the existing firms.
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 The government may set up rules to govern entry.
 SOME BEHAVIOUR OF FIRMS UNDER OLIGOPOLY
 Oligopolists are price searchers:
They need to search for the particular price that
maximizes profits.
 The possibility of a ‘price war’:
oligopolistic sellers are interdependent. If 1 seller lowers
its price to attract more business, other sellers will follow.
A price war will break out, and some sellers may go out
of business.

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 Price
leadership:
The dominant sellers may act as an leaders in initiating
changes in price, the smaller firm will follow.

 Non – price competition:

Sellers often engage in non-price competition to promote
their product.
For example, banks give some gifts to the customers who
take up their credit card services.

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REVIEW SESSION 3

PERFECT MONOPOLISTIC
CHARACTERISTIC OLIGOPOLY MONOPOLY
COMPETITION COMPETITION

Number of firms Many Many Few One

Identical or
Type of product Identical Differentiated Unique
differentiated

Ease of entry High High Low Entry blocked

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SUMMARY ON FOUR TYPES OF
MARKET Market Structure
Perfect Monopolistic
Competition Competition Oligopoly Monopoly
# of Firms Many Many Few One
Product Identical Differentiated Either No close substitute
Differentiation
Barriers to None None Big Insurmountable
Entry
Control over None Some Considerable Considerable or
Price Regulated
Concentration 0 Low High 100
Ratio
Long Run 0 0 0 0
Economic
Profit
Examples Wheat Processed Automobiles Local 35
Food, Brand Electricity, Water
Clothing