Market structures flashcards

Market structures describe the characteristics of a market that influence how firms behave and perform. Students must understand four main structures: perfect competition, monopolistic competition, oligopoly, and monopoly. Each differs in the number of firms, the degree of product differentiation, barriers to entry, and the extent of pricing power. A key focus is how firms in each structure make decisions about price and output, and whether they earn normal or supernormal profit in the short and long run. Students should also understand the concept of contestability, which argues that the threat of entry can discipline firms even in concentrated markets. Evaluating the efficiency of each structure, including productive and allocative efficiency, is essential, as is assessing the impact on consumers and society. Game theory and interdependence in oligopoly are also important concepts.

1. Card 1

   What is meant by a market structure?

   Market structure refers to the characteristics of a market, such as the number of firms, barriers to entry, and product differentiation, that shape firm behaviour and performance.

2. Card 2

   What are the four main conditions of perfect competition?

   Many buyers and sellers, homogeneous products, perfect information, and free entry and exit. These conditions mean no single firm can influence the market price.

3. Card 3

   What profit do perfectly competitive firms earn in the long run and why?

   Only normal profit, because supernormal profit attracts new entrants who increase supply, driving price down until economic profit is eliminated.

4. Card 4

   What is a monopoly and what is the typical legal threshold in the UK?

   A monopoly exists when one firm dominates a market. In the UK, the Competition and Markets Authority considers a firm dominant if it holds 25% or more market share.

5. Card 5

   Why is a monopoly said to be allocatively inefficient?

   A monopoly sets price above marginal cost (P > MC), meaning allocative inefficiency occurs because resources are not directed to their highest-valued uses, creating a deadweight welfare loss.

6. Card 6

   What is the difference between productive and allocative efficiency?

   Productive efficiency means producing at the lowest possible average cost (AC = MC). Allocative efficiency means resources match consumer preferences, achieved when P = MC.

7. Card 7

   What distinguishes oligopoly from other market structures?

   In an oligopoly, a few large firms dominate and are interdependent, meaning each firm must consider rivals' reactions when making pricing or output decisions.

8. Card 8

   What does the kinked demand curve model explain in oligopoly?

   It explains price rigidity in oligopoly: rivals match price cuts but ignore price rises, so the demand curve has a kink, making it rational for firms to keep prices stable.

9. Card 9

   What is a Nash equilibrium in the context of game theory?

   A Nash equilibrium is a situation where each firm's strategy is the best response to the strategies of rivals, so no firm has an incentive to change its behaviour unilaterally.

10. Card 10

    What is meant by a contestable market?

    A contestable market is one where entry and exit are easy and costless, so even a monopolist may behave competitively due to the threat of hit-and-run entry by potential rivals.

11. Card 11

    How does monopolistic competition differ from perfect competition?

    In monopolistic competition, firms sell differentiated products and have some pricing power, whereas in perfect competition products are identical and firms are price takers.

12. Card 12

    What are sunk costs and why do they matter for contestability?

    Sunk costs are costs that cannot be recovered on exit, such as advertising. High sunk costs act as a barrier to entry, reducing market contestability and protecting incumbent firms.

• Many students confuse normal profit with zero profit, not realising that normal profit is the level of return needed to keep a firm in the industry and is already included in costs.
• Students often assume that a monopoly always earns supernormal profit, when in fact a monopoly can make a loss if average costs exceed average revenue at every level of output.
• A common error is to treat oligopoly and collusion as the same thing, when in reality oligopolies can be highly competitive and collusion, whilst possible, is illegal and not always present.

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