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Market Structures

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Market Structures

In this article, we will explain the market structure based on the number of suppliers and buyers for goods and services. You will learn about the different types of market structures, the important features of each structure, and the differences between them.

What is a market structure?

The market structure consists of a number of firms that supply goods and services and the consumers who buy these goods and services. This helps to determine the level of production, consumption, and also competition. Depending on this, market structures are divided into concentrated markets and competitive markets.

Market structure defines the set of characteristics that help us categorise firms depending on certain features of the market.

These features include but are not limited to: the number of buyers and sellers, the nature of the product, the level of barriers to entry and exit.

Important features of market structure

The market structure consists of several features which we explain below.

Number of buyers and sellers

The main determinant of the market structure is the number of firms in the market. The number of buyers is also very important. Collectively, the number of buyers and sellers not only determines the structure and level of competition in a market but also influences the pricing and profit levels for the firms.

Barriers to entry and exit

Another feature that helps determine the type of market structure is the level of entry and exit. The easier it is for firms to enter and exit the market, the higher the level of competition. On the other hand, if the entry and exit are difficult, competition is much lower.

Perfect or imperfect information

The amount of information the buyers and sellers have in the markets also helps to determine the market structure. Information here includes product knowledge, production knowledge, prices, substitutes available, and the number of competitors for the sellers.

Nature of the product

What is the nature of a product? Are there any or close substitutes available for the product? Are the goods and services easily available in the market and are they identical and uniform? These are a few questions that we can ask to determine the nature of a product and therefore the market structure.

Price levels

Another key to identifying the type of market structure is to observe the price levels. A firm may be a price maker in one of the markets but a price taker in another. In some forms of markets, firms may have no control over the price, though in others there might be a price war.

The market structure spectrum

We can understand the spectrum of the market structure along a horizontal line between two extremes starting with the perfectly competitive market and ending with the least competitive or concentrated market: monopoly. In between these two market structures, and along a continuum, we find Monopolistic Competition and Oligopoly. Figure 1 below shows the spectrum of market structures:

This would be the process from left to right:

1. There is a gradual increase in the market power of each firm.

2. Barriers to entry increase.

3. The number of firms in the market decreases.

4. Firms’ control over the price level increases.

5. The products become more and more differentiated.

6. The level of information available decreases.

Let’s take a closer look at each of these structures.

Perfect competition

Perfect competition assumes that there are many suppliers and buyers for goods or services, and the prices are therefore competitive. In other words, firms are ‘price-takers’.

These are the key features of perfect competition:

  • There are a large number of buyers and sellers.

  • Sellers/producers have perfect information.

  • Buyers have perfect knowledge of the goods and services and the associated prices on the market.

  • The firms have no barriers to entry and exit.

  • The goods and services are homogeneous.

  • No firm has supernormal profits due to low barriers to entry and exit.

  • The firms are price takers.

However, this is a theoretical concept and such a market structure rarely exists in the real world. It is often used as a benchmark to assess the level of competition in other market structures.

Imperfect competition

Imperfect competition means there are many suppliers and/or many buyers in the market, which influences the demand and supply of the product thereby affecting the prices. Usually, in this form of market structure, the products sold are either heterogeneous or have some dissimilarities.

The imperfectly competitive market structures consist of the following types:

Monopolistic competition

Monopolistic competition refers to many firms supplying differentiated products. Firms may have a similar range of products, though not identical as in perfect competition. The differences will help them to set different prices from each other. The competition may be limited and firms compete to get buyers via lower prices, better discounts, or differentiated advertisements. The barrier to entry and exit is relatively low.

In the UK, there are many broadband providers like Sky, BT, Virgin, TalkTalk, and others. All of these providers have a similar range of products and services. Let’s assume Virgin has an added advantage over others like a better reach, a higher consumer volume which helps them to give lower prices, and also better speed. This makes Virgin get even more consumers. However, that doesn’t mean that others like Sky, BT, and TalkTalk don’t have customers. They may get the customer with better schemes or lower prices in the future.

Oligopoly market

Why aren’t all the pharmaceutical companies researching the Covid-19 vaccines also providing medicines? Why do Astrazeneca, Moderna, and Pfizer have the right to provide vaccines in the UK? Well, this is a classic example of the oligopoly market in the UK. As we all know, only a few firms have the government and WHO approval to produce the Covid-19 vaccines.

In the oligopoly market, there are a handful of firms that are dominant and there is a high barrier to entry. This may be because of the government restrictions, the given standard of production, the capacity of production for the firm, or the level of capital required. Oligopolists may enjoy supernormal profit for quite some time.

Monopoly market

Monopoly market structure also falls under the category of imperfect competition and is the extreme form of market structure. A monopoly market structure occurs when the firm is the sole supplier of the goods and services and is leading the demand and supply game.

In a monopoly market, suppliers are the price makers and consumers are the price takers. There may be a major barrier to entry into this type of market, and a product or service may have a unique edge that allows it to enjoy a monopoly position. Monopoly firms enjoy supernormal profit for a long period due to high barriers to entry. Even though such kinds of markets are controversial, they are not illegal.

Concentration ratios and market structures

The concentration ratio helps us to distinguish the different market structures in economics. The concentration ratio is the collective market share of the major firms in the market of the industry.

The concentration ratio is the collective market share of the major firms in the market of the industry.

How to calculate and interpret a concentration ratio

If we have to find out the market share of the four largest leading individual firms in the industry, we can do so using the concentration ratio. We calculate the concentration ratio using this formula:

Where ‘n’ stands for the total number of largest individual firms in the industry and T1, T2 and T3 are their respective market shares.

Let’s find the concentration ratio of the largest providers of broadband services in the UK. Let’s assume the following:

Virgin has a market share of 40%

Sky has a market share of 25%

BT has a market share of 15%

Others have a market share of the remaining 20%

Then, the concentration ratio of the largest firms providing the broadband service in the example above would be written as:

3: (40 + 25 + 15)

3:80

Distinguishing between different market structures

As we learned above, every form of market structure has a distinguishing characteristic and each characteristic determines the level of competitiveness in the market.

Here you have a summary of the distinguishing features of each market structure:

Perfect

competition

Monopolistic

competition

Oligopoly

Monopoly

1. Number of firms

A very large number of firms.

A large number of firms.

A few firms.

One firm.

2. Product nature

Homogeneous products. Perfect substitutes.

Slightly differentiated products, but not perfect substitutes.

Homogeneous (pure oligopoly) and Differentiated (differentiated oligopoly)

Differentiated

products.

No close substitutes.

3. Entry and exit

Free entry and exit.

Relatively easy entry and exit.

More barriers of entry.

Restricted entry and exit.

4. Demand curve

Perfectly elastic demand curve.

Downward-sloping demand curve.

Kinked demand curve.

Inelastic demand curve.

5. Price

Firms are price takers

(single price).

Limited control over price.

Price rigidity due to fear of price wars.

The firm is the price maker.

6. Selling costs

No selling costs.

Some selling costs.

High selling posts.

Only information selling costs.

7. Information level

Perfect information.

Imperfect

information.

Imperfect information.

Imperfect information.

Market Structures - Key takeaways

  • Market structure defines the set of characteristics that allow the firms to be categorised depending on certain features of the market.

  • Market Structure can be classified on the basis of the following:

    Number of buyers and sellers

    Level of entry and exit

    Level of information

    Nature of Product

    Price level

  • The four types of Market structures are:

    Perfect competition

    Monopolistic competition

    Oligopoly

    Monopoly

  • Concentration ratio is the collective market share of the major firms in the market of the industry

  • The spectrum of market structures has two extreme ends ranging from competitive market on one end to fully concentrated market on the other.

Frequently Asked Questions about Market Structures

Market structure defines the set of characteristics that help us categorise firms depending on certain features of the market.

Market structures can be classified on the basis of the following:

  1. Number of buyers and sellers

  2. Level of entry and exit

  3. Level of information

  4. Nature of product

  5. Price level

The number of buyers and sellers which is the basis of market structure influences the price. The higher the number of buyers and sellers, the lower the price. The more monopoly power, the higher the price. 

The market structure in business can be any of the four major types depending on the level of competition, the number of buyers and sellers, the nature of the product, and the level of entry and exit.

The four types of market structures are:

  1. Perfect competition

  2. Monopolistic competition

  3. Oligopoly

  4. Monopoly

Final Market Structures Quiz

Question

What is a firm’s main objective?

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Answer

Profit maximisation.

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Question

Who are the customers of a firm?


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Answer

Individual customers, businesses, or governments.

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Question

What are the financial goals of a firm?


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Answer

Profit maximisation, market share expansion.

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Question

What is a firm's profit?


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Answer

The difference between the total costs and revenues.

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Question

How to maximise a firm’s profit?


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Answer

 Profit is maximised when marginal costs equal marginal revenues.

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Question

What are some non-financial objectives of a firm?


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Answer

Customer satisfaction, job satisfaction, corporate social responsibility.

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Question

How to improve employees’ job satisfaction?


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Answer

Activities to boost job satisfaction can be taking care of employees’ well-being, offering incentives for good performance, providing an opportunity to learn, and communicating.

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Question

Why is corporate social responsibility important?


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Answer

Corporate social responsibility (CSR) includes activities taken by companies to create a positive impact on the society and environment.

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Question

What is monopolistic competition?

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Answer

Monopolistic competition is the market structure in which many firms compete to sell slightly differentiated products.

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Question

What are the characteristics of monopolistic competition? 


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Answer

The characteristics are:

  • A large number of firms.
  • Slightly differentiated products.
  • No barriers to entry.
  • Firms are price makers. 

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Question

What does the demand curve for individual firms in monopolistic competition look like?


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Answer

It is more elastic than the demand curve in monopoly, though not perfectly elastic as in perfect competition.

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Question

Are firms in monopolistic competition price-takers or price-makers? 


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Answer

Price makers, though they have limited market power.

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Question

How is the barrier to entry for a new firm in a monopolistic competition market?

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Answer

Low or no barrier to entry. Firms can enter and exit the market any time.

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Question

How can firms in monopolistic competition differentiate their products? 


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Answer

Products in monopolistic competition can be differentiated with physical attributes such as taste, smell, and sizes, or intangible attributes such as brand reputation, and eco-friendly image.

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Question

When does profit optimization happen in monopolistic competition? 


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Answer

At output Q where MC = MR.

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Question

How can firms in monopolistic competition enjoy abnormal profit? 


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Answer

In the short-run, companies in a monopolistic market are able to earn abnormal profits at the output where marginal costs equal marginal revenues. 

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Question

Do the abnormal profits in monopolistic competition last in the long run? 


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Answer

In the long, due to the increase in the number of firms, the price of the product will drop. Thus, the firms will only make normal profits. 

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Question

What is a pure monopoly?

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Answer

A market that contains only one seller.

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Question

What levels of competition do pure monopolists face?

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Answer

A pure monopolist has no competitors (does not face any competition) as they represent the entire industry. There are no other firms to compete within the market.

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Question

What is a concentrated market?

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Answer

A concentrated market is one with very few firms present.

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Question

What is monopoly power?

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Answer

Monopoly power can be characterised by a market that is dominated by one firm that produces most of the output in the industry.

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Question

Where does competitive pressure come from?

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Answer

Competitive pressure can come from:

  • Competition within the market
  • Available substitutes in the market
  • Firms that are trying to enter the market and compete directly with the monopoly position of the firm

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Question

Market factors that influence monopoly power include:

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Answer

All are correct.

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Question

What are the two types of barriers to entry into a market?

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Answer

Natural and artificial.

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Question

Name an example of a natural barrier to entry.

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Answer

Economies of scale.

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Question

Name an example of an artificial barrier to entry.

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Answer

Strategic barriers.

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Question

What is product differentiation?

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Answer

Product differentiation includes making a product different from another similar product through marketing, production, or usability.

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Question

Name two sources of monopoly or monopoly power.

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Answer

Geographic disposition and the government.

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Question

What is an example of a geographic monopoly?

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Answer

When a single country or region is the only possible supplier of raw materials or commodities. Also, when a region only has one supplier due to geographical reasons.

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Question

Explain the idea of a monopoly being a 'price maker'.

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Answer

If the monopoly is the price maker, they set the price in the market and the demand curve will show the maximum quantity of the good or service that can be sold. 

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Question

How does the profit maximisation for a monopoly differ in the short and long-run?

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Answer

They do not differ.

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Question

Name two disadvantages of monopolies.

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Answer

Productive inefficiencies and the exploitation of consumers.

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Question

What is monopolistic competition inefficiency?

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Answer

In the long run, with the entry of new firms, the abnormal profit in monopolistic competition is eroded and the firms only make normal profits. Here, the profit-maximising price equals the average total cost (P = ATC). Without the economies of scale, monopolistic competition suffers from productive and allocative inefficiencies. This is because over time a firm in monopolistic competition has to produce an output (Q1) less than the output at which the average total cost is lowest (Q2). 

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Question

What is non-price competition?

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Answer

Competition in factors other than the price. 


Firms in monopolistic competition do not compete (or only compete) in terms of price. Instead, they take up non-price competition in various forms, including:

  • Marketing competition such as the use of exclusive outlets to distribute one's product. The extensive use of advertising, product differentiation, branding, packaging, fashion, style, and design. 
  • Quality competition such as providing post-sales services for customers.

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Question

What is the difference between vertical and horizontal differentiation?

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Answer

  • Vertical differentiation is the differentiation via quality and price. For example, a company can split the product portfolio among different target groups. 
  • Horizontal differentiation is the differentiation via style, type, or location. For example, Coca-Cola can sell its beverage in glass bottles, cans, and plastic bottles. While the product type is different, the quality is the same. 

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Question

When do new firms enter a monopolistic market?

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Answer

When they can make abnormal profits.

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Question

Why does the demand curve in monopolistic competition represent individual firms instead of the whole market as in perfect competition?

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Answer

In monopolistic competition, each firm produces a slightly different product, which results in different customer demands. In the case of perfect competition, the demand is the same for all firms due to identical products. Thus, only one market demand curve is shown.  

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Question

In which ways does monopolistic competition resemble perfect competition?

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Answer

  • A large number of firms in the market.
  • No barriers to entry and exit.
  • The availability of short-term abnormal profits which attract new firms to enter the market. Over time with more firms, the abnormal profits are eroded and firms only make normal profits. 

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Question

What is a firm?

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Answer

A firm is an organisation that combines and organises resources to produce goods and services for sale at profits.


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Question

What are the types of firms?

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Answer


  1. Private sector 

    1. Proprietary firms

    2. Partnerships

    3. Companies

    4. Cooperatives

  2. Public sector 

    1. Companies

    2. Corporations

    3. Departments

     3. Joint Sector

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Question

What is the profit maximsation rule?

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Answer

Profit maximisation occurs when marginal cost is equal to marginal revenue. 

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Question

State few reasons why firms should go for the sales maximization?

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Answer

Few reason why firms would go for sales maximization as their objectives are as follows:

  1. Economies of scale - When the firm increases the production levels to reduce its cost of production, it helps to create economies of scale and as the output increases, firms aim for higher sales

  2. Market flooding - This is the marketing tactic a firm uses to hammer the consumer's memory with the firm's product by seeing it everywhere possible. This kind of strategy helps the firms to gain more market share and at the same time loyal customers. 

  3. Limit Pricing - Here the firm prices its product at the break-even point where the price allows it to make an only normal profit, which results in taking away the incentive for the new firms to enter into the market. 


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Question

What does satisficing principle mean?

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Answer

The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as possible. The word satisficing comes from 'Satisfy' and 'Sacrificing'. A satisficing principle often happens when stakeholders have conflicting interests. 

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Question

What does the kinked demand curve illustrate?

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Answer

It illustrates the interdependence of firms in an oligopoly market.

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Question

Who developed the kinked demand curve theory?

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Answer

It was developed by American economist Paul Sweezy.

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Question

Why is there a kink in the demand curve?

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Answer

There are two demand curves: one that is inelastic and one that is elastic. The kink occurs when both demand curves intersect each other.

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Question

What happens when a firm increases their prices in an oligopoly market?

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Answer

An increase in price causes the quantity demanded to decrease proportionally more than the increase in price. That firm will experience a decrease in market share because of the loss in quantity demanded, and this will also decrease their total revenue.

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Question

What happens when a firm decreases its prices in an oligopoly market?

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Answer

A decrease in price causes the quantity demanded to increase proportionally less than the reduction in price. Other firms will also cut their prices, resulting in a price war. Total revenue will decrease, and over time, there will be no change in market share.


Show question

Question

What are the three main conclusions gathered from the kinked demand curve?

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Answer

Price competition: even though in theory it is not rational to increase or decrease prices in an oligopoly market, there can be price competition.

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Question

What are the characteristics of an oligopolistic market?

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Answer

High barriers to entry and exit

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