KRUGMAN'SMICROECONOMICS for AP*

Introduction to Market Structure

Margaret Ray and David Anderson

Micro:

Econ:

21

57

Module

What you will learnin this Module:

• The meaning and dimensions of market structure.

• The four principal types of market structure—perfect competition, monopoly, oligopoly, and monopolistic competition.

Market Structures

•The way a product is supplied depends on how the industry is structured. Economists define four different market structures; perfect competition, monopoly, oligopoly, and monopolistic competition.

Defining Market Structures

• How many Firms?

• Type of product?

Perfect Competition

• Two necessary conditions for perfect competition

• Firms are price-takers

• Free entry and exit

Monopoly

• A monopolist is a firm that is the only producer of a good that has no close substitutes. An industry controlled by a monopolist is known as a monopoly.

• A monopoly industry has barriers to entry.

• Ownership of essential resources

• Economies of scale

• Technological superiority

• Government created barriers

Oligopoly

• An oligopoly is an industry characterized by a small number of large firms with some degree of market power.

• Characteristics of an oligopoly industry include;

• a few large firms

• barriers to entry

• interdependence

Measuring Market Power

• Four-firm Concentration Ratio (CR4): Add up the market share of the four largest firms in the industry.

• Herfendahl-Hirschmann Index (HHI): The sum of the market shares, squared, for all firms in the industry.

Measuring Market Power

• Four-firm Concentration Ratio (CR4Four-firm Concentration Ratio (CR4): Add up the market share of ): Add up the market share of the four largest firms in the industry.the four largest firms in the industry.

• ExampleExample: :

• The four largest firms in industry A have market shares equal to: The four largest firms in industry A have market shares equal to: 30%, 20%, 10% and 5%.30%, 20%, 10% and 5%.

• CR4 = 65%. The four largest firms have a combined 65% of the CR4 = 65%. The four largest firms have a combined 65% of the market.market.

• Industry B has the four largest firms with market share equal to: Industry B has the four largest firms with market share equal to: 12%, 10%, 8% and 4%12%, 10%, 8% and 4%

• CR4 = 34%.CR4 = 34%.

• If we compared these two industries, we would say that industry A If we compared these two industries, we would say that industry A has more concentration and is much closer to being an oligopoly has more concentration and is much closer to being an oligopoly than industry B.than industry B.

Measuring Market Power

• Herfendahl-Hirschmann Index (HHI): The sum of the Herfendahl-Hirschmann Index (HHI): The sum of the market shares, squared, for all firms in the industry.market shares, squared, for all firms in the industry.

• Suppose a industry is perfectly competitive and has Suppose a industry is perfectly competitive and has 100s of firms with market shares each at 100s of firms with market shares each at approximately zero percent of the market.approximately zero percent of the market.

• If we square a bunch of market shares close to zero, If we square a bunch of market shares close to zero, we will get an HHI close to zero.we will get an HHI close to zero.

• What if we have a monopoly? Only one firm has What if we have a monopoly? Only one firm has market share of 100% so the HHI is 10,000.market share of 100% so the HHI is 10,000.

• So real-world industries have HHI that lie between So real-world industries have HHI that lie between zero (the most competitive) and 10,000 (the least zero (the most competitive) and 10,000 (the least competitive).competitive).

Monopolistic Competition

• Monopolistic competition is a market structure characterized by

• Many firms

• Differentiated product

• No barriers to entry/exit

Table 57.1 The HHI for Some Oligopolistic IndustriesRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers