Question 1: What is a market structure? Answer 1: A market structure is a way of describing how firms are organized in industries. There are four main market structures: monopoly, oligopoly, monopolistic competition, and pure competition. Economists can categorize any firm as belonging into one of these four structures. You can also think of a market structure as a filing system. For example, a person may have piles of papers on his or her desk, including bank statements, phone bills, credit card bills, paycheck stubs, homework assignments, and baseball schedules. To organize these papers, he or she might create different folders, such as incoming money (in which he or she would place the bank statements and paycheck stubs), outgoing money (for the credit card and phone bills), school work (for the homework), and fun (for the baseball schedules). Economists use a similar system; they can place a firm into a particular file based on certain characteristics. Question 2: What do market structures tell us? Answer 2: Market structures can tell economists how firms are organized; how they compete; and what impact they have on consumers, government, and other firms. In other words, if we know what type of market structure a firm is in, we can make reasonable guesses about how they will act in the future. This is valuable information because it allows governments to regulate, consumers to anticipate, and other firms to articulate possible responses. As an example, you have two best friends. One, Sally, is a great conversationalist she can talk all day. Another, Chris, keeps conversations short and to the point. Your cell phone rings, and you see that Sally's name pops up. If she is calling when you do not have free weekend or night minutes, you may let it go to voicemail because you expect she will talk a long time, and that will be expensive. If it is Chris, you may pick up because she is more likely to keep the conversation brief. Market structures are like caller ID in that they can let other economic agents know what to expect. A monopolist may act a certain way while an oligopolist may do something quite different. Question 3: What is a monopoly? Answer 3: A monopoly has the following three characteristics (Wessels, 1
2000): It is the only firm selling the good. It has no current or potential rivals. Its good has no close substitutes. To be the only firm selling a good or providing a service means just that: There are no others whatsoever. This means there is 100% total control over the market. No other firm or organization can be offering the good in the near future, and the monopoly is usually able to squash all potential new entrants. A monopoly's good has no substitutes. This means that there are no comparable goods on the market. Sometimes when you get a prescription filled, you have a choice between a generic drug and a name-brand drug. In this case, the prescription has potential substitutes. However, when there is no substitute, you are forced to buy the only choice. Question 4: Are monopolies bad or good for the economy? Answer 4: Sometimes monopolies are very harmful to an economy. If a single firm gets control over a vital resource, then it can raise prices and force consumers to buy needlessly expensive goods. Governments will usually step in to prevent this by regulating prices or forcing the monopoly to break up to create competition. Other times, monopolies can be beneficial to the economy. For example, think of the power lines coming into your home. A firm usually has a monopoly on electricity transmission in your area. This type of firm is called a natural monopoly because it makes economic sense to limit competition. If anyone could put up power lines, there might be 10 sets of wires along the street on many different poles. Also, the cost to service and maintain these various lines would be prohibitively expensive. In exchange for having a natural monopoly, the electricity firm agrees to price regulations. Question 5: What is an oligopoly? Answer 5: To be classified as an oligopoly, an industry can only have a handful of large firms (and a few very small niche firms). Also, it is very difficult for new firms to enter into the industry. The firms' products can be similar or different, but the action of one firm will impact the others in the 2
oligopoly. In many cases, industries become oligopolies because of economies of scale, which means that firms can make very inexpensive products by using large manufacturing equipment. Think of a complicated product like a car: It would take years for a person to personally build a car from scratch, and producing cars this way would not be practical. A large factory and an assembly line of workers and machines are needed to manufacture a car. This means that it usually takes a lot of money to break into an oligopoly, and new firms will also have to endure losses at first. This keeps oligopolies established, and some of the largest American firms are in oligopolies. Question 6: What is a cartel? Answer 6: A cartel is a group of firms in an oligopoly that get together and agree to cooperate to the detriment of consumers and other firms. The benefit of cooperation is that the oligopolists can charge higher prices to consumers by limiting output. Consequently, consumers end up with less than they otherwise might have consumed. This is called the welfare effect because consumers have lower welfare. (By welfare, well-being is meant and not a government assistance program.) Some cartels are legal while others are not. Also, there are international cartels that operate above the laws of any single country. In the United States, the Department of Justice has authority over prosecuting cases involving this market structure. Question 7: What is monopolistic competition? Answer 7: Monopolistic competition has the following characteristics: There are many sellers, similar but not identical products, and easy entry and exit into the industry. In any given locality, there are probably dozens of monopolistic competitors. Consumers will be able to distinguish one product from another, and no two products will be exactly alike. This is a market structure with low barriers to entry, which means that even individuals can start a firm. The monopolistically competitive firm has a monopoly over its unique product or service. This allows for product differentiation and marketing. One goal of the monopolistically competitive firm is to convince consumers that its 3
product is superior, thus allowing the firm to charge higher prices. Question 8: Is monopolistic competition good for consumers? Answer 8: Generally, monopolistic competition is good for consumers because they receive greater variety, expanded choice, and competitive prices. Due to the fact that each firm tailors its product to suit a certain set of tastes and preferences, a product is created for many different consumers. So, a broad cross section of consumers may be better served by several smaller firms with specialized products. As each firm produces similar goods and services, some consumers may be somewhat indifferent in their choice between one firm and another. This creates competition and keeps prices low as monopolistically competitive firms vie for customers. Of course, other consumers may be fiercely loyal to a certain firm and its products; consequently, economists cannot make sweeping generalizations about the behavior of all consumers in a monopolistically competitive environment. Question 9: What is pure competition? Answer 9: Pure competition has the following characteristics: a large number of firms, homogeneous products, and easy entry and exit into the industry. To be in perfect competition, there must be "enough competition among sellers that no one seller can raise its price without losing all its customers to the other sellers" (Wessels, 2000). Homogeneous products are exactly the same; in other words, consumers cannot distinguish between them at all. Also, it is easy to get in and out of a perfectly competitive market. The best example of a perfectly competitive market is a farmers market. There are a number of stalls, and each may be selling raspberries. If one stall tries to raise its price, then no consumers will buy from that farmer because the consumer can get it for much less at the next stall. In other words, the opportunity cost of taking a few steps to the next stall is lower than paying more to one farmer. Question 10: Does pure competition exist? Answer 10: Pure competition is a structure that is rarely seen. There are examples of purely competitive firms, like a farmers market, but it is difficult 4
to come exactly close to perfect competition for a couple of reasons. First, products are rarely homogeneous. There are little differences in one good to the next. Second, most goods can be processed and stored for sale at a later date. This means that a farmer is able to can fresh fruit and sell the fruit as jam at a later time. This is a way of adding value and differentiating the product. Even though it is rare to find perfect competition in real life, it is valuable to discuss because it provides a reference in terms of the other market structures. Reference Wessels, W. J. (2000). Economics (3rd ed.). New York, NY: Barron's Educational Series. 5