Market Structures

and Market Failures

Perfect (or pure) competition

Perfect competition is a

market structure in which

many producers supply an

identical product and no

single producer can

influence its price; in such a

perfectly competitive

market, prices are set by

supply and demand

Monopoly Monopoly is a market

structure in which a single producer supplies a unique product that has no close substitutes. This producer is a price-setter; it alone determines the price.

Oligopoly Oligopoly is a

market structure in

which a few firms

dominate the

market and

produce similar or

identical goods.

Monopolistic competition

Monopolistic competition refers to

a market structure in which many

producers supply similar but varied

products. It typically has many

sellers, low barriers to entry, and

non-price competition. Examples:

restaurants and hotels.

Monopsony A monopsony is a market in which

there is only one buyer of a good, service, or factor of production but many sellers. Examples of monopsony include the defense industry or the space industry.

Some economists argue that Amazon (or, in the past, Walmart) so dominate the market that they operate as monopsonies also. A town in which there is only one employer is another example. Like a monopoly, a monopsony is a form of imperfect competition.

Comparison

Summary of market structures

Positive and negative externalities

One of the reasons why economists

value competitive markets is because

they seem to lead to an efficient use of

resources. All the costs and benefits of

a good or service are thought to be

reflected in the price of that good or

service.

With imperfect competition, though,

certain costs or benefits may escape

the buyer or seller.

These unaccounted costs or benefits

are called externalities or spillovers.

They are evidence of market failures.

Positive externality

A positive externality is a benefit

of production or consumption

that falls on someone other

than the producer or consumer.

It is a positive side-effect of an

economic activity that benefits a third party (for instance,

society). Education and R & D

are typical examples.

Negative externality

A negative externality is a

cost of production or

consumption that falls on

someone other than the

producer or consumer. It

is a negative side-effect

of an economic activity.

Air or water pollution are

examples of a negative

externality.

A negative externality is a form of market inefficiency. We see

this in the case of pollution in an unregulated market, where

the cost of the pollution is not born by the producer and leads

to overproduction.

Public goods Public goods are goods and

services that are used

collectively and that no one

can be excluded from using.

Public goods are not

provided by markets. Fresh

air, national defense, street

lights, and lighthouses are all

examples of public goods.

The Free-rider problem

A free rider is someone who enjoys the benefit of a good or service, such as roads or public schools, without paying for it. Free riding becomes a problem when it leads to the underproduction of that good or service.

An example of a free rider is a worker who does not belong to a union and thus does not have to pay union dues but who would benefit if that union should negotiate a wage increase for all those doing the worker’s job.

Tragedy of the commons

Tragedy of the commons is

a circumstance in which a

shared resource is overused

or destroyed because users

take no responsibility for its

preservation. Overfishing

and habitat destruction are

examples.

Coase theorem (first suggested by

Ronald Coase in the early 1960s)

This theorem states that where externalities are a problem, often a negotiated solution can be found in the market. This is true even in the case of a dispute over who has the right to do something, such as a factory polluting the air.

The key is that the responsibility for these externalities can be identified as well as bought and sold. Transaction costs would also have to be low. If these two conditions can be met, there should be a market solution that can help mitigate the negative effects of externalities.

An example of such

a market-based

approach to

correcting negative

externalities is the so-

called cap-and-

trade program. In

this program,

pollution rights are

bought and sold.

Asymmetric information

This occurs when information is held by

one but not all parties to a transaction.

This difference in information gives the one party an advantage over the other

parties to that transaction.

An example of asymmetric information

may be getting knowledge about two companies’ plans to merge before the

general public does. Such information

could help one party benefit in the stock

market, for example.

The moral hazard problem This kind of problem could result from situations in which

people have placed their trust in someone else by

asking him or her to act as their agent in the market

(e.g., a financial company could be entrusted with

looking after the assets of another party). A moral

hazard occurs if the agent is not held fully responsible

for managing these assets and acts in a way that

benefits himself or herself first rather than the other

party.

An example would be the bailout of some financial

companies during the Financial Crisis in 2008 (these

were the companies that were deemed “too big to

fail”). Instead of being allowed to go bankrupt, these

companies were rescued by the taxpayer.

Summary of the different types of markets