MARKET STRUCTURES

Market Structures

An economy of scale is the major factor which leads to imperfect competition. Under economies of scale, production is more efficient at a larger scale, possibly because there are some large fixed costs to market entry. Consider an industry that requires a large amount of research and development, such as the pharmaceutical industry. To produce a drug, a firm in this industry must invest hundreds of millions of dollars and many years of research time before the product hits the market. Once these fixed costs have been incurred, however, the marginal cost of each additional dose of the drug produced is close to zero. If the company were to charge a price equal to the marginal cost of production, it would never recover its initial investment. For this reason, we expect prices to equal average cost rather than marginal cost. If the company produced only a few doses, the average cost of production per dose would be extremely high. Yet as it produces more and more doses, the average cost per dose goes down, as does the price paid by the consumer. (Kwoka, White, 2009, p. 42)

A type of market that does not operate under the rigid rules of perfect competition is known as the imperfect competition market structure. Perfect competition implies an industry or market in which no one supplier can influence prices, barriers to entry and exit are small, all suppliers offer the same goods, there are a large number of  suppliers and buyers, and information on pricing and process is readily available. Forms of imperfect competition include monopoly, oligopoly, monopolistic competition, monopsony and oligopsony. (Kwoka, White, 2009, p. 45)

In the framework of imperfect competition, each firm produces a product that is differentiated from those of its rivals. Even if there are many firms in an industry, each firm is a monopolist in its own variety of the product. Some substitution between products is possible, but they are not perfect substitutes. Thus, each individual producer behaves as a monopolist even though there is some competition between firms. Consumers not only benefit from the lower prices that result from the concentration of production, but are also able to choose between a greater numbers of varieties in each industry. This framework allows for trade within industries as well as between them. Consider the automobile industry. The United States is both an exporter of Fords and an importer of Toyotas. Krugman's model can explain how countries that are similar in their technological development, such as the United States and Japan, can still gain from trade and can both be exporters of automobiles. (Kwoka, White, 2009, p. 49)

A monopoly is the only producer of a good for which there are no close substitutes. This puts the monopolist in a unique position: It can raise its price without losing consumers to competitors charging a lower price. Thus, the monopolist is the industry and faces the downward-sloping market demand curve for its product. The monopolist can choose any point along that demand curve; it can set a high price ...