Market Structures and Equilibrium - Managerial Economics
1. Perfect Competition (PC)
Characteristics:
- **Many Buyers and Sellers**: No single buyer or seller can influence the price; all are price takers.
- **Homogeneous Products**: Goods are identical in the eyes of consumers.
- **Free Entry and Exit**: New firms can enter or exit the market without restriction, promoting competition.
- **Perfect Information**: Consumers and producers have full knowledge of prices, technology, and
availability.
- **No Transportation Costs or Government Intervention**.
Market Equilibrium:
- **Short Run (SR)**: Firms produce where MR = MC. They may make supernormal profits, normal profits, or
losses depending on cost and demand conditions.
- **Long Run (LR)**: Economic profits attract new entrants, driving profits to zero. All firms make normal
profits. Equilibrium occurs where P = MC = ATC.
Efficiency:
- **Allocative Efficiency**: Price equals marginal cost (P = MC), reflecting consumer preferences.
- **Productive Efficiency**: Firms operate at the minimum point of ATC, indicating efficient use of resources.
- **Dynamic Efficiency**: Less likely, as profit potential is limited, reducing incentives for innovation.
2. Monopoly
Characteristics:
- **Single Seller**: Only one firm supplies the entire market.
- **No Close Substitutes**: Consumers have no alternatives.
Market Structures and Equilibrium - Managerial Economics
- **High Barriers to Entry**: Legal (patents), technological, or resource-based.
- **Price Maker**: The monopolist sets the price by controlling the output level.
Price Discrimination:
- **First-Degree**: Charging each consumer their maximum willingness to pay (rare in practice).
- **Second-Degree**: Prices vary based on quantity or product version (e.g., bulk pricing).
- **Third-Degree**: Charging different prices to different groups (e.g., student or senior discounts).
Market Equilibrium:
- **Short Run**: Profit maximization occurs where MR = MC; price is set above this point on the demand
curve.
- **Long Run**: Profits persist due to barriers preventing entry.
Efficiency:
- **Allocative Inefficiency**: P > MC, meaning some consumers willing to pay more than MC do not get the
product.
- **Productive Inefficiency**: May not produce at lowest cost.
- **Deadweight Loss**: Lost welfare due to underproduction relative to perfect competition.
3. Monopolistic Competition
Characteristics:
- **Large Number of Firms**: Each has a small market share.
- **Product Differentiation**: Through branding, quality, location, or style.
- **Free Entry and Exit**: Ensures that firms only earn normal profit in the long run.
Market Structures and Equilibrium - Managerial Economics
- **Some Price Control**: Due to brand loyalty.
Market Equilibrium:
- **Short Run**: MR = MC; firms can earn abnormal profits or losses.
- **Long Run**: Entry/exit forces profits to normal. Demand curve becomes tangent to ATC; excess capacity
remains.
Efficiency:
- **Allocative Inefficiency**: P > MC.
- **Productive Inefficiency**: Not producing at minimum ATC.
- **Greater Consumer Choice**: But at a cost of inefficiency.
4. Oligopoly
Characteristics:
- **Few Firms**: Dominant market players are interdependent.
- **High Entry Barriers**: Include economies of scale, brand loyalty, and legal restrictions.
- **Product May Vary**: Homogeneous (steel) or differentiated (cars).
- **Strategic Behavior**: Firms must consider rivals' reactions when making decisions.
Types of Oligopoly:
- **Collusive**: Firms cooperate to maximize joint profits (may form cartels).
- **Non-Collusive**: Firms act independently but are aware of mutual interdependence.
Market Equilibrium:
Market Structures and Equilibrium - Managerial Economics
- **Collusion Models**: Like cartel, set joint profit-maximizing price/output.
- **Kinked Demand Curve**: Assumes firms match price cuts but not hikes, leading to price rigidity.
- **Cournot and Bertrand Models**: Explain outcomes under different assumptions about competition.
Efficiency:
- **Generally Inefficient**: Due to market power and reduced competition.
- **Potential for Innovation**: Due to abnormal profits.
5. Collusive Oligopoly
Definition:
- A form of oligopoly where firms agree (formally or informally) to limit competition.
Features:
- **Price Fixing**: Firms agree on a common price, avoiding price wars.
- **Market Sharing**: Dividing the market by geography or customer type.
- **Output Restrictions**: Limiting total industry output to raise prices.
- **Barriers to Entry Reinforced**: By the collusive behavior.
- **Illegal in Many Jurisdictions**: Antitrust laws prohibit such conduct.
Implications:
- **Consumer Harm**: Higher prices, restricted output, and less innovation.
- **Legal Risk**: Firms can face fines or be broken up if found guilty of collusion.
