MICROECONOMICS
TOPIC 5
Economics 2013/2014
TYPES OF MARKET
2 MAIN TYPES
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Perfect markets: do not exist in the real world
Imperfect markets: do not have any of the
characteristics of a perfect market. 4 types:
 Monopoly
 Oligopoly
 Monopolistic
 Monopsony
competition
PERFECT COMPETITION (MARKET)

Characteristics:
 Large
number of firms – firms are price takers
 Large number of buyers
 Freedom of entry and exit
 Perfect knowledge
 Homogeneous products
MONOPOLY
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Only one dominant firm.
The strength of any monopoly is determined by the
barriers to entry and the availability of substitutes.
They can charge above the normal price but don’t
have a free reign on what they can charge as there
will be a limit to what consumers will pay.
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A monopoly that is too powerful may be
investigated by the government.
A monopoly is any firm that holds more than 25%
of a market.
OLIGOPOLY
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The market here is dominated by a few large firms.
Markets that have this structure are soap powder,
supermarkets and petrol.
A firm with two dominant firms are called a
DUOPOLY.

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Each firm has a branded or differentiated product.
It has a lot of influence in the market and can affect
its own and competitors’ market share.
To expand or maintain market share, firms will tend
to use non-price methods.
This can include advertising or branding.
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Competing on price can lead to costly price wars
which is not good for business.
Firms sometimes in this type of market will collude to
fix prices, limit output or share out a market.
This is called a CARTEL.
MONOPOLISTIC COMPETITION


There are a large number of firms but each firm
produces a branded or differentiated product.
Each firm has a bit of control over price and its
market share.

There are weak barriers to entry.

Examples: restaurants, taxi businesses, hairdressers.
MONOPSONY

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This is a market where there is only one buyer.
The buyer has a huge amount of power to dictate
price, product, design and delivery.
Supermarkets have a degree of monopsony power
over many of their suppliers.
PRODUCT DIFFERENTIATION

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This is when suppliers try to create differences
between their products and those of the
competition.
Real differences include: design and quality
Imaginary differences include: advertising and
brand image.
BARRIERS TO ENTRY


These prevent any potential competitors from
getting into an industry.
They can either be deliberate or natural.
DELIBERATE BARRIERS

Marketing Barriers
 High
spending on advertising can create a strong
brand image and loyalty, which new firms will find hard
to overcome.
 eg
washing powder, breakfast cereals

Restrictive Trade Practices
A
strategy that restricts competition
 Refusing
to sell to a retailer who buys from a rival
 Refusing to sell unless they buy the whole range
 Using predatory pricing to drive out competition
NATURAL BARRIERS

Capital costs
 Entry
costs to some industries are very high.
Eg car manufacturing.

Sunk costs
 These
are costs that can’t be recovered if
they firm fails. Can include advertising costs
or R&D.

Economies of Scale
 Large
firms can gain huge economies of scale that new
entrants will find hard to compete with as existing firms
will have lower average cost.

Legal barriers
 The
law can prevent new entrants to a market.
Examples include: patents and copyrights.
PRICING
PERFECT MARKETS

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The price here is determined by the interaction of
demand and supply.
Each firm has to accept the equilibrium price for
their market.
Each firm is a PRICE TAKER.
IMPERFECT MARKETS
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Firms in these markets can adopt a number of
strategies.
The decision on what to price is determined by how
much competition there is.
Fall into two groups:
COST-BASED PRICING

Cost-plus pricing
 Price
is set by working out the AC and adding a mark
up for profit.
 E.g.
AC is £1 and mark up is 10% then the price would
be £1.10.
 Firms
with little competition can use this method

Advantages to Cost-Plus Pricing
 It
is a very quick and easy method
 Ensures
sales revenue will cover TC and make the firm
profits

Disadvantages of Cost-Plus Pricing
 Fixed
mark-up could be a problem if new competition
was to enter the market

Contribution (marginal cost) Pricing
 Price
is set to cover VC.
 As
long as price more than covers VC a contribution will
be made towards FC.
 If
enough orders are received so that contribution
equals FC then the firm will break-even.
 If
contribution is greater than FC then profit is made

Advantages of Contribution Pricing
 More
flexible than cost-plus
 Pricing
of products can take into account competitors
prices and demand by customers
 Can
be used during poor trading, so long as VC are
covered and a contribution is made to FC
CUSTOMER-ORIENTATED PRICING

Competition-based Pricing
 When
there is strong competition firms may base their
price on what other firms in the market are charging.
 There
may a price leader, who sets their price and the
rest of the market follows e.g. petrol

Penetration Pricing
 New
entrants will set a price below existing suppliers to
gain a foothold in the market
 The
hope is that consumers will become loyal to the
brand and continue to buy when the price is increased.

Predatory Pricing
 Used
by existing firms to push out competition from the
market.
 The
firm will lower their prices so that new entrants will
not be able to cover its covers.
 Existing
firm covers its lost by CROSS-SUBSIDISING.
MONOPOLY PRICING

Charging what the market will bear
 Suppliers
of unique products can charge the highest
price they think consumers will pay

Psychological Pricing
 Products
may be priced above competition to create
the idea of better quality.

Price Skimming
 Suppliers
of new products may charge a high price to
begin with in order to maximise revenues before
competitors enter the market.

Price Discrimination
 Firms
over the same product but over different prices to
different types of consumers.