Perfect Market Structure

In the first half of this segment, learn more about perfect market structure, namely perfect competition prepared by our JC Economics Tutor Simon Ng from Economicsfocus. Generally, the study of Market Structure requires a firm understanding of the characteristics, such as the number of firms that exist in the market, existence of barriers to entry and types of profits to be attained in the short run and long run conditions. Apply economics concepts to specific industry examples that are found in real world cases.

economics tuition notes definition


What is a perfect market structure?

-In the perfect market structure, there is perfect market information and mobility of factors of production. There are many firms and the product is homogeneous. The firms are also price-takers as no firms can control the production level and thus cannot set the price level.

What is Perfect Competition?

-With perfect competition, there is perfect market information and mobility of factors of production. There are many buyers and sellers who can have information about the price and output level transacted.

What is perfect market information?

-Every seller knows the prices his rivals charge, the market costs, its cost of production and the available production technology. Buyers also have complete information about each and every seller’s price, the higher quality and availability of the products. Thus, they will not purchase at a higher price than the prevailing market equilibrium price.

What is market concentration ratio?

-Market concentration ratio is the reflection of market share a company has as compared to its rivals in the same industry.

What are the characteristics of a perfect competitive firm?

-large number of buyers and sellers

-homogenous product

-perfect knowledge

-no barriers to entry

What is subnormal profit?

-Cost is greater than profit hence the firm is making a loss.

What is normal profit?

-Cost is equal to profit hence the firm breaks even.

What is supernormal profit?

-Profit is greater than cost

What profits can be reaped in a perfect competition in the short run?

-Normal profit

What profits can be reaped in a perfect competition in the long run?

-Normal profits

How do barriers to entry affect production equilibrium?

-Barriers to entry affect market power which indirectly affects production equilibrium. The greater the barriers to entry, the greater market power a firm has and is able to produce at a higher output level.

How do barriers to entry affect profit levels?

-Usually firms in an industry with greater barriers to entry (seen in oligopoly and monopoly) earn greater profits as there are fewer firms in the industry and each firm has greater market share.

What is price discrimination?

-Price discrimination: the practice of charging different prices to different groups of customers for the exact same product. (3rd degree)

-Price discrimination occurs when a producer sells different quantities of a specific product at two or more prices, for reasons not associated with cost differences. (2nd degree)

-Price difference rest merely on different buyers’ valuation of the same product, they are discriminatory. (1st degree)

-Price discrimination, if successful, will increase the firm’s total profits.

What is contrived barrier?

-Contrived barrier is achieved when the firms or the firm in the industry creates certain professional requirement and condition of business, which will give the firm an exclusive control of the market.

What is 1st degree price discrimination?

-This happens when a firm charges each consumer the highest price he would pay for the good. The firm is able to capture all of consumer surplus. Eg auctions

What is 2nd degree price discrimination?

-The firm charges different prices for different blocks of the same good according to how much the customer purchases. Eg electricity and water

What is 3rd degree price discrimination?

-The firm sells the same product at different prices to different consumers.

What are the negative impacts of price discrimination?

-It may be a form of consumer exploitation. ( Some consumers will pay at a higher price and there is allocative inefficiency)

-It may also increase the cost of production.

(cost in engaging in the change of product imagery – inform the consumers about the change)

What are the positive impacts of price discrimination?

-Price discrimination makes it possible to supply a good which otherwise could not have been produced. For example, the services of a surgeon. (allow the surgeon to charge high price to sustain the provision of services – ensure that the loss from the lower price market is covered by the high price market)

-Price discrimination makes it possible for a greater number of consumers to benefit from the product/services.

-May be used to cultivate customer loyalty. (encourage greater consumption)

-Can allow the firm to produce above a larger quantity so as to reap EOS.

(lower AC – raise profitability)

What are the conditions for price discrimination?

-Two or more prices being charged

-The good in all situation must be exactly the same good

-Price differences must not arise out of cost differences

-The seller must be able to control the supply of the good and thus prevent the resale of the good from one market to another

-Ability of the monopolist to separate markets:

i. geographically

ii. by type of demand

iii. by time

iv. by nature of product

What is price competition?

-It occurs when firms in an industry use pricing policies to compete for market share.

What are the benefits of price competition

-It can successfully rule out competitors which lead to greater market shares for the remaining firms.

What are the limitations of price competition?

- It might take a long time for a competitor to finally give up participating in the price war. And in the meantime, huge losses are made by all the firms engaged in the price war.

What is predatory pricing?

-Predatory pricing is a deliberate act of reducing price to drive competitors out, therefore reducing competition in the market.

What is non-price price competition?

-It occurs when firms compete using strategies not involving alteration of prices.

What is anti-trust law?

-Competition law, known in the United States as antitrust law, is law that promotes or maintains market competition by regulating anti-competitive conduct by companies.

What is Free Competition Act?

-Free Competition Act is a law that promotes or maintains market competition by regulating anti-competitive conduct by companies in Singapore.

What is rival firm?

-A firm which competes with another firm in the same industry

What is a collusive activity?

-An agreement made between rival firms to lessen competitiveness between them

What is a dominant firm?

-A firm that has the greatest market share and price/output setting ability

What is a collusive oligopoly?

-Firms in the industry make agreements to set price or output at a certain level to reduce competitiveness and market uncertainty

-Firms in the industry does not make agreements on setting price or output level of the good which usually leads to greater competitiveness and market uncertainty.

What is barometric price leader?

-Barometric price leader is a firm, which makes price changes more quickly and successfully than its rivals in response to changing costs and demand conditions. The other firms watch it and emulate its decision.

-Barometric price leadership is indicated by a number of market characteristics, for example, occasional switching between firms in the role of price leader. (E.g. Computer chips/Hard disk)

What is low-cost price leader?

-Low-cost price leader is a firm with insignificant cost, which provides an advantage over its rivals by setting the price. (E.g. Seagate)

What is patent right?

-When firms have a new innovation or idea, they can gain rights to use that idea solely (preventing other firms from copying their idea). This right is named patent right and is a form of barrier to entry.

How does patent right affect market power?

-Patent rights are a form of barrier to entry. Hence this prevents new firms from entering the market. The few firms in the industry share the market, resulting in high market power.

How does patent right affect production equilibrium?

-Patent rights are a form of barrier to entry. Hence this prevents new firms from entering the market. Demand of the market is then shared between one or few firms, hence output for each firm increases. (production equilibrium increases)

What are the impacts of patent right on consumers?

-Patent rights increases firms’ ability to set price and output. Hence it usually translates to high prices for consumers.

-Patent rights are also an incentive for larger firms to do R&D as it ensures that their ideas cannot be duplicated. Hence consumers benefit from higher quality or wider variety of products due to R&D of the firms.

What are the impacts of patent right on the firm?

- Patent rights are a form of barrier to entry. Hence this prevents new firms from entering the market. The few firms in the industry share the market, resulting in high market power.

What is licensing?

-Licensing is the process of leasing a legally protected (that is, trademarked or copyrighted) entity. The entity, known as the property or intellectual property, is then used in conjunction with a product.

What are the impacts of licensing on the firm?

-Licensing serve as a form of barrier to entry. This raises cost condition of firms who wish to obtain licence to use the intellectual property. Thus, the licensor gains a competitive advantage over other firms through cost.

What is intellectual property right?

-A work or invention that is the result of creativity to which one has for a patent, copyright, or trademark

What are the impacts of intellectual property right on the firm?

-Intellectual property rights are a form of barrier to entry. Hence this prevents new firms from entering the market. The few firms in the industry share the market, resulting in high market power.

What are the necessary conditions for successful collusion?

-The price or output level initiated by any firm is reasonable and agreeable

-All the firms in the industry agree to the initiated price or output level and does not go against it by lowering price further

-No action taken by any firm in the industry to create market uncertainty (by lowering price or adjusting output level)

What is growth maximization?

-Growth depends on the volume of investment. Hence growth maximization simply refers to making the best use of the available investments (by cutting costs) to allow the firm to grow in size or expertise.

How to eradicate welfare loss?

-Welfare loss can be eradicated by a firm through policies which increase allocative and productive efficiency. Welfare loss can also be eradicated through government intervention (policies to reduce market power)

How to eradicate supernormal profit?

- Through government intervention, policies like MC and AC pricing can be implemented to reduce supernormal profits of monopolies. Taxes can also be introduced.

What is liberalization of market?

- Liberalisation of market refers to removal of laws and regulations to create a free market whereby firms have lesser restrictions when it comes to policy implementation and expansion plans. Liberalisation of market also brings about greater competition.

What is mutual interdependency?

-It is a situation (usually in oligopolies) whereby firms in the industry are affected by prices and output level of rival firms.

What is price rigidity?

-Price rigidity is a situation whereby firms follow a decrease in price and not a increase in price (of rival firms). Price rigidity happens as firms are able to match prices with rival firms and result in a kinked demand curve.

How is welfare loss incurred under imperfect market structures?

-Under imperfect market structures, the presence of market power contributes to the downward-sloping MR and AR. Thus, the production level, based on profit maximization, will not achieve allocative efficiency as the price does not equal to marginal cost. Consequently, there will be welfare loss which is also the value of deadweight loss.