(Quiz 1 ) Week 5 - Market Power

Market Structures

• Economists classify industries into four main market structures: Perfect Competition, Monopolistic Competition, Oligopoly, and Monopoly.
• Perfect competition is the only market structure where firms lack market power, meaning they cannot influence market prices.
• Classification of an industry into a market structure depends on three characteristics:
  • Number of firms in the industry
  • Similarity of goods or services produced
  • Ease of entry for new firms

Characteristics of Market Structures

• Perfect Competition:
  • Many firms
  • Identical products
  • High ease of entry
• Monopolistic Competition:
  • Many firms
  • Differentiated products
  • High ease of entry
• Oligopoly:
  • Few firms
  • Identical or differentiated products
  • Low ease of entry
• Monopoly:
  • One firm
  • Unique product
  • Entry is blocked

Average and Marginal Revenue

• Average Revenue (AR) is calculated by dividing total revenue by the number of units sold.
• Marginal Revenue (MR) represents the change in total revenue from selling an additional unit.
• In perfectly competitive markets, MR equals the price of the good, while firms sell identical products.

Perfectly Competitive Market

• A perfectly competitive firm cannot affect the market price and is considered a price taker.
• Profit maximization occurs where Marginal Revenue (MR) equals Marginal Cost (MC).

Entry and Exit in the Long Run

• Economic profits attract new firms into an industry, while losses encourage exit.
• Monopolies maintain long-term economic profits due to high barriers to entry preventing new firms from entering the market.
• In a monopolistically competitive market, economic profit is short-lived as low barriers allow new firms to enter, driving profits to zero in the long run.

Effects of Competition on Profits

• Short-run economic profits in monopolistically competitive markets lead to increased product variety and decline in demand for incumbent firms.
• Conversely, short-run economic losses lead to firm exit, reducing product variety and increasing demand for remaining firms.
• Firms earning zero economic profit still obtain a positive accounting profit, making them willing to remain in the market.

Origins of Monopolies

• Monopolies arise from barriers to entry that inhibit competition, with four main reasons:
  • Government restrictions prevent multiple firms from entering a market.
  • Control of essential raw materials by one firm.
  • Significant network externalities in service or product supply.
  • Large economies of scale that lead to natural monopoly.