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Module 23
Introduction to Market Structure
What’s New in the Fourth Edition?
• Handouts for use in the classroom
Module Objectives
• What is the meaning of market structure?
• What are the four principal types of market structure?
Teaching Tips
Types of Market Structure
Creating Student Interest
• Ask students if they have ever played the game Monopoly. Most of them probably have. Ask them
to tell you the object of the game and the best strategy for winning. Chances are several different
strategies will be defended as the “best” (“buy the yellow properties,” “buy the railroads or utilities”).
Use this discussion to point out that the object of the game is to become the only seller—a
Presenting the Material
• Use Handout 23-1 to help students identify different market types.
• Use the chart in text Figure 23-1 to illustrate the differences between the types of market structure.
Figure 23-1
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Perfect Competition
Creating Student Interest
• Have students imagine that they have decided to help pay for their summer school tuition by growing
tomatoes in their backyard and selling them at the nearby farmers’ market. Ask the students if they
think the venture will be successful and why. Do the students think they are capable of starting this
kind of business and what would they need to do in order to start? Will they be able to leave the
business when school starts in the fall? How much will they charge for their tomatoes? (The going
rate at the farmers’ market.) How many other producers will there be in the market? How much
market power will each have? (There will probably be many producers, each with a small share of
the market.) Will their tomatoes be different from others’ tomatoes? (Homegrown tomatoes are
Presenting the Material
• Since this is the first market structure model, start by explaining the concept of a market structure
and present market structures as a spectrum, with monopoly on one end and perfect competition on
the other end. Remind students that a model is a representation of reality. The market structures
studied in economics are representations of the way a type of industry will behave. Each market
structure assumes certain characteristics about the environment in which firms operate (for example,
the number and size of firms; firms’ ability to control price, entry, and exit). In the real world, not
all industries will fall clearly into one market structure—they lie somewhere on the spectrum. As an
example, looking at the number of firms in an industry, the smallest number is 1 (because with 0,
the industry does not exist). If you ask students to name the market structure characterized by one
firm, they usually know it is called a monopoly. They also generally figure out that an industry with
two firms is a duopoly (though they might guess it is called a biopoly). If you tell them that “oli”
means “few,” they can figure out that an industry with a few firms is an oligopoly. When there are
many firms competing in an industry, they will know it is competition (you can add the “perfect”).
And monopolistic competition becomes easy to see when it is shown as falling between monopoly
and competition. You can use the following diagram to show the spectrum and add the market
structure models as the discussion progresses.
• When considering perfect competition, some students may be skeptical that such a market structure
exists. As is generally the case with perfection, perfect competition is hard to find in the real world.
Some would argue that no industry is truly perfectly competitive. Emphasize that it is nevertheless
important to study the perfect competition model. Explain that, just as perfect competition can lead
to several beneficial and important results (which will come to light as you study the model), market
structures on the other end of the spectrum can have certain drawbacks. Therefore, we are interested
in seeing how close to perfect competition an industry can come, and in preventing movement
toward the other end of the spectrum. So economists (and economics students) study the perfect
competition model as an “ideal” to use as a benchmark for evaluating industries in the real world.
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• Introduce the characteristics of perfect competition and give a few examples of industries that fit
this structure.
Market structure:
Perfect competition
1. Many sellers, each with a small market share
2. Consumers see all the products in the market as identical
3. Easy entry and exit of firms
Examples: Agricultural markets such as dairy farming and organic tomato farming
Monopoly
Creating Student Interest
• Draw a downward-sloping demand curve on the board. Ask students if this is a market or a firm
demand curve. Students should remember that the market and firm demand curves were different in
perfect competition. You will probably get a difference of opinion, with students calling out both
“market” and “firm” as the answer. If you wait quietly for a little bit, you will likely see the class
Presenting the Material
• For a monopoly to remain a monopoly there must be something preventing firms from entering the
industry. If a monopoly were losing money in the long run, it would exit the industry (just like any
other firm). If a monopoly exits, the industry disappears (the Pet Rock industry). We have seen in
the perfect competition model that if a firm is earning profits, it will signal other firms to enter the
industry. If there is only one firm and the firm is earning a profit, then there must be something
Oligopoly
Creating Student Interest
• Ask students what they know about OPEC. Almost every student should have heard of OPEC and
should have some idea of its purpose. The current member countries are Algeria, Angola, Ecuador,
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Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela. Ask
students why they think it is in these countries’ best interest to cooperate and act together to control
The Meaning of Monopolistic Competition
Creating Student Interest
• Ask students to identify markets that might be considered monopolistic competition. For each
example considered, discuss the number of firms, the type of product, and evidence of entry and
exit. When discussing the type of product, have students think about what exactly it is about the
Presenting the Material
• Make clear that the most important feature of monopolistic competition is many sellers, which makes
it clearly different from monopoly. Give some examples of markets that fit this type of market
structure: cosmetics, fast food, retail clothing stores, restaurants, coffee houses, hair salons, and nail
salons.
Module Outline
I. Types of Market Structure
A. There are four principal models of market structure: perfect competition, monopoly, oligopoly,
and monopolistic competition.
B. Economists use these four models of market structure to develop principles and make
predictions about markets and how producers will behave in them.
C. Market structure is based on two dimensions: the number of producers in the market (one, few,
or many) and whether the goods offered are identical or differentiated.
1. In perfect competition, many producers sell an identical product.
II. Perfect Competition
A. In perfect competition, price-taking producers’ and price–taking consumers’ actions have no
effect on the market price of the goods they buy.
B. Defining perfect competition
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1. A perfectly competitive market is a market in which all market participants are price–
takers.
2. The model of a perfectly competitive market is representative of some but not all
markets.
C. Two necessary conditions for perfect competition
1. For an industry to be perfectly competitive, it must contain many producers, none of
whom has a large market share.
2. An industry can be perfectly competitive only if consumers regard the products of all
producers as equivalent, so the good must be a standardized product, also known as a
commodity.
D. Free entry and exit
1. Most perfectly competitive industries are also characterized by free entry and exit.
III. The Meaning of Monopoly
A. A monopolist is a firm that is the only producer of a good that has no close substitutes. When
an industry is controlled by a monopolist, it is known as a monopoly.
B. Monopoly: Our first departure from perfect competition
1. True monopolies are hard to find in the economy because of legal obstacles: Antitrust
laws help to prevent monopolies from emerging.
2. Monopolies play an important role in some sectors of the economy, such as
pharmaceutical markets.
C. What monopolists do
1. Monopolies raise price above the perfectly competitive price and restrict output.
2. Under perfect competition, economic profits normally vanish in the long run. This is not
the case for monopolists.
D. Why do monopolies exist?
1. To earn monopoly profits, a monopolist must be protected by a barrier to entry,
something that prevents other firms from entering the industry.
2. The five principal types of barriers to entry are:
a. Control of a scarce resource or input.
b. Increasing returns to scale: Large firms with lower unit costs drive out smaller firms,
sometimes creating a natural monopoly.
c. Technological superiority: A firm that produces a better product because it has a
technological advantage over other firms can become a monopolist, at least in the
short run.
d. Network externality: The firm with the largest network of customers using its
product can become a monopolist, even if they do not produce the highest-quality
product (e.g. Microsoft’s Windows operating system.)
e. Government-created barriers, such as patents and copyrights.
IV. Oligopoly
A. An oligopoly is an industry with only a small number of producers.
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1. The number of firms determines whether a specific market is an oligopoly, not the size
of each firm.
2. Each oligopolist has some market power.
B. When no one firm has a monopoly, but producers nonetheless realize that they can affect
market prices, an industry is characterized by imperfect competition.
C. Oligopoly and the potential for collusion
1. Sellers engage in collusion when they cooperate to raise each other’s profits.
2. When there are only a small number of firms, collusion is possible. However, it is hard
to determine whether collusion will actually materialize.
D. Is it an oligopoly or not?
V. Monopolistic Competition
A. Monopolistic competition is a market structure in which there are many competing producers
in an industry, each producer sells a differentiated product, and there is free entry into and exit
from the industry in the long run.
Case Studies in the Text
Economics in Action
The Monopoly That Wasn’t: China and the Market for Rare Earths—This EIA discussed the effects of an
export quota by China for rare earths and the subsequent, though short-lived, spike in prices.
Ask the students the following questions:
Web Resources
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Handout 23-1
Date_________ Name____________________________ Class________ Professor________________
Classifying Markets
Classify the following products as being in monopoly, oligopoly, monopolistically competitive, or
perfectly competitive industries. What is the source of their market power?
Microsoft’s Windows operating system
Kodak’s 35-mm film
Burroughs Wellcome’s drug for AIDS patients
McDonald’s Big Mac
A regional electric company
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Answers