Market structures

1. Economists sort markets along a spectrum using four features: how many firms there are and how large they are, how far the product is differentiated, how high the barriers to entry and exit are, and how good buyers' and sellers' information is.
2. These features decide the single thing that drives a firm's behaviour: how much power it has over its own price. The more firms there are, the more identical the product, and the freer entry is, the less power any one firm holds.
3. At one extreme, perfect competition has so many firms selling an identical good that each is a pure price taker. At the other, a monopoly is the only seller and the strongest price maker. Monopolistic competition and oligopoly lie in between.
4. Two results follow from structure: the shape of the firm's demand curve (flat for a price taker, downward sloping for a price maker) and how much profit survives in the long run (only normal profit where entry is free, supernormal profit where barriers are high).

The four structures at a glance

Perfect competition

1. Very many small firms each sell a homogeneous (identical) product, so buyers have no reason to prefer one seller and will switch to anyone charging even slightly less.
2. There is freedom of entry and exit and perfect information, so no firm has a cost or knowledge advantage and any profit is quickly noticed by potential entrants.
3. Each firm's output is tiny relative to the market, so it cannot influence the price and must accept it: it is a price taker.
4. Its demand curve is therefore horizontal at the market price, giving P = AR = MR, because every extra unit sells at the same fixed price, so average and marginal revenue both equal that price.
5. The market price itself is set by total supply and demand; the firm only chooses how much to produce, maximising profit where MC = MR.

1. In the short run a firm can earn supernormal profit, normal profit or a loss, depending on where its average cost sits relative to the price.
2. In the long run, supernormal profit attracts entry, which raises market supply and lowers the price until only normal profit remains; losses cause exit until the price rises back to normal profit.
3. Because the long-run outcome is P = MC (allocative efficiency) at the lowest point of AC (productive efficiency), perfect competition is the efficiency benchmark. The full performance comparison is developed in 7.6.4.

Worked example: P = AR = MR

Monopoly

1. A single firm is the whole industry, so the firm's demand curve is the market demand curve and slopes downward.
2. To sell an extra unit the monopolist must lower the price on all units, so marginal revenue is below average revenue at every output (MR < AR) and falls twice as steeply.
3. Very high barriers to entry, such as economies of scale, patents, legal licences, control of a key resource or strong brands, keep rivals out, so supernormal profit is not competed away and survives into the long run. Barriers are covered fully in 7.6.3.
4. The firm maximises profit where MC = MR, then reads the price up to the demand (AR) curve, so price is set above marginal cost (P > MC).

1. Against this, a monopolist's size can bring large economies of scale, and its supernormal profit can fund research and development, so it is not always worse for consumers; the full evaluation is developed in 7.6.4.

Monopolistic competition

1. Many firms compete, but each sells a slightly differentiated product through brand, quality, style or location, which gives it a little price-setting power.
2. Its demand curve therefore slopes gently downward and is relatively elastic, because many close substitutes exist: raise the price a little and most, but not all, customers switch away.
3. Firms compete heavily on non-price factors such as branding, service and location, not just on price.
4. Barriers to entry are low, so short-run supernormal profit attracts new firms; entry shifts each existing firm's demand curve to the left until only normal profit remains in the long run.
5. The long-run equilibrium leaves firms with spare (excess) capacity, producing below the lowest point of AC, so they are less efficient than under perfect competition, though consumers gain wider variety and choice.

Oligopoly

1. A few large firms dominate, shown by a high concentration ratio, the combined market share of the largest few firms (covered in 7.6.5).
2. High barriers to entry protect the incumbents, so they can earn supernormal profit in the long run.
3. The defining feature is interdependence: because each firm is large, one firm's price or output change noticeably affects the others, so every firm must anticipate rivals' reactions before it acts.
4. Interdependence pulls firms in two directions: they may collude, through a formal cartel or a tacit understanding, to raise prices together and behave like a monopoly, or they may compete fiercely in a price war that harms them all.
5. To avoid destructive price wars, firms often keep prices stable and compete instead through advertising, loyalty schemes and product features, known as non-price competition.
6. Price stability is often explained by the kinked demand curve: rivals match a price cut but ignore a price rise, so demand is elastic above the current price and inelastic below it, and the firm gains little either way from changing price. This model is developed fully in 7.8.5.

Natural monopoly

1. Fixed and infrastructure costs are enormous, such as a national grid, a rail network or a water pipe system, so average cost keeps falling as output rises: the huge fixed cost is spread over ever more units.
2. Long-run average cost is still falling across the whole range of market demand, so a single large firm can supply the entire market at a lower average cost than two or more smaller firms could.
3. Competition would wastefully duplicate the fixed network, a second set of pipes or rails, pushing each firm back up its falling AC curve and raising costs for everyone.
4. Because it is still a monopoly, left unregulated it would restrict output and charge a high price, so natural monopolies are usually regulated by a price cap or run in public ownership; this intervention is developed in Themes 3 and 8.

How well do real markets fit these models?

1. The four structures are useful benchmarks, because classifying a market by its number of firms, differentiation, barriers and information predicts whether firms are price takers or price makers and how much profit survives in the long run.
2. But few real markets match a model exactly: perfect competition is almost never observed, and many markets sit between the pure cases, showing features of both monopolistic competition and oligopoly.
3. The models are also largely static, so they can understate contestability and dynamic change: a market that looks like a monopoly may still be disciplined by the threat of entry or by new technology.
4. On balance, the models remain a valuable starting point, but it depends on the market, so they are best used as a guide to likely behaviour rather than a precise label, judging each real market on how closely its four characteristics fit.

Is more competition always better?

1. More competition usually helps consumers: with many rivals, price is driven down towards marginal cost, improving allocative efficiency, and firms are pushed to the lowest point of average cost and cannot afford X-inefficiency, so productive efficiency rises and prices fall.
2. But very atomistic competition can be worse in some settings, because many tiny firms each produce a small output and stay high on the long-run average cost curve, forgoing economies of scale, and free entry competes profit down to normal, leaving little supernormal profit to fund research and development, so dynamic efficiency may suffer.
3. In a natural monopoly more competition is clearly harmful, because duplicating a pipe or rail network pushes each firm back up its falling average cost curve, so one large firm supplies at a lower cost per unit than several rivals could.
4. Contestability also matters, because even a single firm may keep price near cost and stay efficient if entry and exit are cheap, since the threat of new entrants disciplines its behaviour; how easily rivals could join can matter more than how many compete today.
5. On balance, more competition is usually better for price and efficiency in ordinary many-firm consumer markets, but it depends on the industry, the size of the economies of scale available and how contestable the market is; where scale economies are very large, as in a natural monopoly, a single large but regulated firm can serve consumers more cheaply than fragmented competition.