Market Structures
In economics, market structure is the number of firms producing identical products
which are homogeneous. The types of market structures include the following:
Monopolistic competition, also called competitive market, where there is a
large number of firms, each having a small proportion of the market share and
slightly differentiated products.
Oligopoly, in which a market is by a small number of firms that together control
the majority of the market share.
Duopoly, a special case of an oligopoly with two firms.
Monopsony, when there is only one buyer in a market.
Oligopsony, a market in which many sellers can be present but meet only a
few buyers.
Monopoly, in which there is only one provider of a product or service.
Natural monopoly, a monopoly in which economies of scale cause efficiency
to increase continuously with the size of the firm. A firm is a natural monopoly
if it is able to serve the entire market demand at a lower cost than any
combination of two or more smaller, more specialized firms.
Perfect competition, a theoretical market structure that features no barriers to
entry, an unlimited number of producers and consumers, and a perfectly
elastic demand curve.
The imperfectly competitive structure is quite identical to the realistic market conditions
where some monopolistic competitors, monopolists, oligopolists and duopolists exist
and dominate the market conditions. The elements of Market Structure include the
number and size distribution of firms, entry conditions, and the extent of differentiation.
These somewhat abstract concerns tend to determine some but not all details of a
specific concrete market system where buyers and sellers actually meet and commit to
trade. Competition is useful because it reveals actual customer demand and induces
the seller (operator) to provide service quality levels and price levels that buyers
(customers) want, typically subject to the seller’s financial need to cover its costs. In
other words, competition can align the seller’s interests with the buyer’s interests and
can cause the seller to reveal his true costs and other private information. In the
absence of perfect competition, three basic approaches can be adopted to deal with
problems related to the control of market power and an asymmetry between the
government and the operator with respect to objectives and information: (a) subjecting
the operator to competitive pressures, (b) gathering information on the operator and the
market, and (c) applying incentive regulation.
Monopolistically competitive markets have the following characteristics:
There are many producers and many consumers in the market, and no
business has total control over the market price.
Consumers perceive that there are non-price differences among the
competitors' products.
There are few barriers to entry and exit.
Producers have a degree of control over price.
The long-run characteristics of a monopolistically competitive market are almost the
same as a perfectly competitive market. Two differences between the two are that
monopolistic competition produces heterogeneous products and that monopolistic
competition involves a great deal of non-price competition, which is based on subtle
product differentiation. A firm making profits in the short run will nonetheless only break
even in the long run because demand will decrease and average total cost will increase.
This means in the long run, a monopolistically competitive firm will make zero economic
profit. This illustrates the amount of influence the firm has over the market; because of
brand loyalty, it can raise its prices without losing all of its customers. This means that
an individual firm's demand curve is downward sloping, in contrast to perfect
competition, which has a perfectly elastic demand schedule.
Oligoply characteristics:
Profit maximization conditions: An oligopoly maximizes profits by producing where
marginal revenue equals marginal costs.
Ability to set price: Oligopolies are price setters rather than price takers.
Entry and exit: Barriers to entry are high. The most important barriers are economies of
scale, patents, access to expensive and complex technology, and strategic actions by
incumbent firms designed to discourage or destroy nascent firms. Additional sources of
barriers to entry often result from government regulation favoring existing firms making it
difficult for new firms to enter the market.
Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions
of one firm can influence the actions of the other firms.
Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry
prevent sideline firms from entering market to capture excess profits.
Product differentiation: Product may be homogeneous (steel) or differentiated
(automobiles).
Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of
various economic factors can be generally described as selective. Oligopolies have
perfect knowledge of their own cost and demand functions but their inter-firm
information may be incomplete. Buyers have only imperfect knowledge as to price, cost
and product quality.
Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies
are typically composed of a few large firms. Each firm is so large that its actions affect
market conditions. Therefore the competing firms will be aware of a firm's market
actions and will respond appropriately. This means that in contemplating a market
action, a firm must take into consideration the possible reactions of all competing firms
and the firm's countermoves. It is very much like a game of chess or pool in which a
player must anticipate a whole sequence of moves and countermoves in determining
how to achieve his or her objectives. For example, an oligopoly considering a price
reduction may wish to estimate the likelihood that competing firms would also lower
their prices and possibly trigger a ruinous price war. Or if the firm is considering a price
increase, it may want to know whether other firms will also increase prices or hold
existing prices constant. This high degree of interdependence and need to be aware of
what other firms are doing or might do is to be contrasted with lack of interdependence
in other market structures. In a perfectly competitive (PC) market there is zero
interdependence because no firm is large enough to affect market price. All firms in
a PC market are price takers, as current market selling price can be followed predictably
to maximize short-term profits. In a monopoly, there are no competitors to be concerned
about. In a monopolistically-competitive market, each firm's effects on market conditions
is so negligible as to be safely ignored by competitors.
Non-Price Competition: Oligopolies tend to compete on terms other than price. Loyalty
schemes, advertisement, and product differentiation are all examples of non-price
competition
Perfectly Competitive Market Characteristics
Infinite buyers and sellers – An infinite number of consumers with the
willingness and ability to buy the product at a certain price, and infinite
producers with the willingness and ability to supply the product at a certain
price.
Zero entry and exit barriers – A lack of entry and exit barriers makes it
extremely easy to enter or exit a perfectly competitive market.
Perfect factor mobility – In the long run factors of production are perfectly
mobile, allowing free long term adjustments to changing market conditions.
Perfect information - All consumers and producers are assumed to have
perfect knowledge of price, utility, quality and production methods of products.
Zero transaction costs - Buyers and sellers do not incur costs in making an
exchange of goods in a perfectly competitive market.
Profit maximization - Firms are assumed to sell where marginal costs meet
marginal revenue, where the most profit is generated.
Homogenous products - The qualities and characteristics of a market good or
service do not vary between different suppliers.
Non-increasing returns to scale - The lack of increasing returns to scale (or
economies of scale) ensures that there will always be a sufficient number of
firms in the industry.
Property rights - Well defined property rights determine what may be sold, as
well as what rights are conferred on the buyer.
The correct sequence of the market structure from most to least competitive is perfect
competition, imperfect competition, oligopoly and pure monopoly. The main criteria by
which one can distinguish between different market structures are: the number and size
of producers and consumers in the market, the type of goods and services being traded
and the degree to which information can flow freely.
