Notes
Four market structures
| Structure | Number of firms | Product | Entry | Control over price | Example |
|---|---|---|---|---|---|
| Perfect competition | many | identical | easy | none (price taker) | wheat |
| Monopolistic competition | many | differentiated | easy | a little | restaurants |
| Oligopoly | few | identical or differentiated | difficult | some, interdependent | airlines |
| Monopoly | one | unique, no close substitutes | blocked | a lot (price maker) | local water utility |
Competition and market power
- Less competition usually means higher prices and lower output than in a competitive market.
- Barriers to entry include patents, licenses, control of resources and high start-up costs. Natural monopolies are often regulated.
- Oligopolies may be tempted to collude; price fixing is illegal. A cartel such as OPEC coordinates output. The concentration ratio adds the largest firms' market shares.
- Monopolistic competitors use product differentiation and nonprice competition.
Market failures
- Public goods are nonexcludable and nonrival, which creates a free-rider problem.
- Negative externalities (pollution) lead to too much output; positive externalities (education, vaccines) lead to too little. Governments may use taxes, regulations or subsidies.
Government's role
- The Sherman Act (1890), Clayton Act (1914) and the FTC promote competition. Regulators review mergers. Deregulation removes rules to encourage competition. People disagree about how much regulation is best.
Topics in this unit
Each topic has its own short notes and practice.
Practice
One firm can serve the whole market at the lowest cost, so it naturally ends up as the only seller.
Both have many firms and low barriers; only monopolistic competition has differentiated products.
A few large firms dominate, and entry is hard because of brand loyalty and advertising costs.
People cannot easily be excluded, and one person watching does not stop another.
Subsidies encourage more of a good whose benefits spill over to others.
$35 + 25 + 12 + 8 = 80$, so a few firms control most of the market.
Free response
Write your answer first, then open the scoring guide.
Free-response question
Markets differ in how much competition they have.
(a) Identify the market structure for each: (1) thousands of farmers selling identical soybeans; (2) the only company allowed by law to sell a patented allergy medicine.
Show the answer and scoring guide
(1) Perfect competition, because there are many sellers of an identical product and each is a price taker. (2) Monopoly, because there is a single seller and the patent is a legal barrier to entry.
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(b) Explain why a monopoly usually charges a higher price and produces less than a perfectly competitive industry.
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A monopolist faces no competitors, so it is a price maker. It can earn more profit by restricting output and charging a higher price, since buyers have no close substitutes. In perfect competition, any firm charging above the market price would lose its customers to rivals, so price is pushed down and output is higher.
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(c) A coal-burning power plant produces air pollution that harms nearby residents. Identify the type of market failure and describe ONE government policy that could address it.
Show the answer and scoring guide
This is a negative externality: part of the cost of producing electricity falls on people outside the transaction, so the market produces too much. The government could tax pollution, which raises the plant's costs so it produces less or cleans up, or it could set regulations limiting emissions.
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