2.2.3
Note

Market Structures

2.2.3 Firm strategies

Idea

A market’s structure is described by a few features that, taken together, place an industry into one of four types. The 9570 syllabus treats these structures at the level of awareness — their characteristics and the firm conduct they imply, not the cost–revenue diagrams of older syllabuses.

Mechanism

Industries are classified by five features: the number and size of firms, the nature of the product, barriers to entry, the degree of interdependence between firms, and the level of information. On these, the four structures run from most to least competitive:

  • Perfect competition (a theoretical benchmark) — a very large number of firms, each with a negligible market share, so every firm is a price-taker; an identical product (perfect substitutes); no barriers to entry; and perfect information. Because entry is free, any supernormal profit earned in the short run is competed away as new firms enter, leaving only normal profit in the long run.

  • Monopolistic competition — many small firms, each with a small market share but some price-setting power; a slightly differentiated product, which reduces substitutability; low barriers to entry; and the assumption of independence (each firm assumes its actions do not affect rivals). Low barriers again erode supernormal profit to normal profit in the long run.

  • Oligopoly — a few dominant firms, each with a significant market share (often defined as the top five firms holding over 60% of the market); products either differentiated or identical; high barriers to entry, which let firms retain supernormal profit in the long run; and mutual interdependence — each firm considers rivals’ reactions before acting.

  • Monopoly — a single firm constituting the whole industry, selling a product with no close substitutes; a price-setter; very high barriers to entry, retaining supernormal profit in the long run; and limited information available to consumers and potential rivals.

Considerations

Mutual interdependence gives oligopoly its characteristic price rigidity: a firm that raises price is not followed by rivals and loses market share, while a firm that cuts price is matched by rivals and gains little — so on either side total revenue falls, and firms prefer to leave price unchanged. (This is the kinked-demand reasoning, examined in 9570 only at this descriptive, awareness level — the diagram itself is not required.) Interdependence also opens the door to the strategies by which oligopolists compete or collude. The structures’ efficiency properties are compared in efficiency in markets.