Introduction to firms, industries

and market structures

Unit 7 - Lesson 1
Learning outcomes:
● Define all terms appearing in orange bold in section 7.1. (AO1)
● Explain the main characteristics of perfect competition - many small firms,
free entry and exit to market, and homogenous products. (AO2)
● Explain the characteristics of monopoly - single or dominant firm, high
barriers to entry, no close substitutes. (AO2)
● Explain the main characteristics of market structures in imperfect
competition. (AO2)
○ Varying degree of market power, firm is a price maker
○ Monopolistic competition - many firms, free entry and product
differentiation.
○ Oligopoly - few large firms, high barriers to entry, interdependence
● Explain the meaning of market power. (AO2)
Market Power and Market Failure

A firm is an organisation that uses the factor of production - land, labor, capital and
entrepreneurship - to produce goods and services for a market.
An industry is an individual or group of firms who produce identical or similar
goods for a market.
Industries are analysed by using market structures that describe the
characteristics of the firms within that industry that determine the behavior of firms.
The difference between various market structures is how much each individual firm
in that industry is able to control the price also known as market power.
Market power is important because it gives rise to market failure as the market fails
to achieve allocative efficiency. The greater the market power the greater the
allocative inefficiency.
Market Power and Market Failure
Market power is important because it gives rise to market failure as the market
fails to achieve allocative efficiency. The greater the market power the greater
the allocative efficiency.
We will look at four market structures each with varying degrees of market
power. Each of the four market structures are referenced below.
The illustration below shows the degree of market power each market structure
has from perfect competition (no ability to control price - no market power) to
monopoly (greatest ability to control price therefore most market power).
Market Power and Market Failure

Perfectly competitive firms do not have any market power (ability to control price)
therefore will always achieve allocative efficiency therefore the market has not failed.

Monopolistic competition, oligopoly and monopoly all have some degree of market
power (ability to control price) therefore allocatively inefficient - market failure.

Monopolistic firms have the most market power and therefore will experience the
greatest amount of allocative inefficiency and market failure.
Introduction to Market Structures
Market Power (price) is not the only defining
feature of market structures.
Market structure can be defined by three other
distinctive characteristics:
1. Number of firms within the industry
2. Product differentiation - how similar or
different the goods are.
a. Homogenous goods means the
products are not able to be
differentiated.
3. How easy or difficult it is for firms to enter
the market to begin production in a market.
a. Free entry means there are no barriers
to entry
Perfect Competition
Characteristics of Perfectly Competitive Firms
1. Large number of small firms
2. Each firm sells the same homogenous
products - no ability to differentiate
products.
3. There is free entry into the market
The perfect competition market structures is
not realistic as it is very difficult for any market
to fit the three characteristics described above.
The closest markets that fit these characteristics
are the international markets for commodities
like wheat, corn, maize and cattle.
Monopoly
Characteristics of Monopolistic Firms

1. Single seller or dominant firm.

a. Defined when one firm has 80% control of
the market
2. Firm produces a unique good or service that
does not have any close substitutes.
3. High barriers to entry
a. Since the firm has a lot of market power,
they have the ability to make it difficult for
other firms to enter the market.

Examples include companies like Monsanto,

Google, Facebook, and Amazon
Monopolistic Competition
Characteristics of Monopolistic Firms
1. Large number of small to medium size
firms in the industry.
2. No barriers to entry - free entry
3. Product differentiation
a. Quality
b. Packaging
c. Services
d. Branding
Examples include clothing, shoes, furniture,
restaurants and computers to name a few.
Oligopoly
Characteristics of Oligopolistic Firms

1. Small number of large firms

a. Firms are interdependent - actions/choices of one
firm impact the actions/choice of the other firms.
2. Products may be differentiated or not differentiated
a. Differentiated include automobiles
b. Non-differentiated include oil
3. High barriers to entry

Examples include the car industry, airline industry, and

electrical appliances.

Oligopolistic firms have significant market power - price

control