The Different Market Structures

Created by: S.Graham

May 5, 2020
The Concept of Market Structure
To explain the concept of market structure, an analogy which can be used
is a jelly fish in the ocean. The main aim of jellyfish is to eat plankton. If
there is only one jelly fish in a feeding area, it can have all the plankton
for itself. If more jellyfish join in, then the plankton which they feed on
would now have to be shared up. If more and more jelly fish keep joining
in, then there would soon be a large school of jellyfish and there would be
a lot of competition for plankton.
If new jellyfish were somehow prevented from entering the feeding area,
then only one jelly fish would have access to the feeding area. This means
that there would be no competition for plankton and the jellyfish would
have all the plankton for itself.
Justlike jelly fish compete for a share of plankton, firms or suppliers
compete for market share. If there is only one firm, then it would supply
the whole market and a lot of profit would be earned. If there are many
firms, then the market would have to be shared up. Each firm would
supply only a portion of the market as they compete with each other for
customers.
Market structure refers to the type of competition which exists among
firms in a particular industry. In one extreme, there can be immense
competition which is a state of perfect competition. At the other extreme,
there can be no competition at all which occurs under monopoly. In
between these two extremes are oligopoly and monopolistic competitions
which refers to imperfect competition.
Perfect Competition

The firm refers to a single entity or producer that engages in the

production of a specific commodity or service. An industry refers to a
group of firms that produce identical goods and/ or services.
Perfect competition refers to a market structure that is characterized by the
absence of rivalry. In its purest sense, the term ‘rivalry’ is associated with
competition and as such firms in this market structure do not compete
against each other for market share or customer loyalty as in other market
structures.
 Perfect Competition
A market is said to be perfectly competitive only if the following
conditions are fulfilled:
1. The market is large, meaning that there are a large number of
consumers.
2. There are a large number of suppliers where each individual firm
contributes a small proportion of the overall market supply.
3. The market is liberal in the sense that any buyer and seller could freely
conduct business in the market without any barriers to entry and exit.
 Perfect Competition

4. The output supplied by each firm in the market is identical. That is,
there is product homogeneity throughout the market.
5. Buyers and sellers have perfect knowledge of all market variables. As
such, market participants are able to make well informed decisions and
take full advantage of all opportunities in the market.
Perfect Competition

In reality, no market would simultaneously fulfil all these conditions,

which therefore make perfect competition only a hypothetical situation.
Economists, however, have developed the theory of perfect competition
purely to demonstrate the conditions necessary for the optimal
performance of the free market system.
Perfect Competition

Under perfect competition, suppliers or firms are said to be price takers, as

they simply adopt the price which prevails in the market. This is because ,
if any firm attempts to set its own price above the existing market price,
then no output would be sold since consumers would simply switch to
other suppliers on the market. Thus, the only price consumers would be
willing to pay to any individual supplier is the market price.
Monopoly
The monopolistic market structure is a market structure with absolutely no
competition. This occurs whenever there is a sole, usually large producer
of a particular good or service which does not have a close substitute
available. In this case, the industry is comprised one supplier or one firm.
The main reason that there is only one firm in the industry is that there are
barriers which prevent new firms from entering the market. As such,
monopoly firms are usually large-scale producers as they supply the entire
market.
 Monopoly
A monopoly is a market structure that is characterized by only one seller
who produce a commodity (service) for which there are no close
substitutes.
A monopoly exists if an industry has the following features:
1. One supplier in the entire industry. The implication of this is that the
monopolist has significant control over the market price of the commodity
it sells. Monopolists are known as ‘price makers.’
2. There are no close substitutes to the firm's output.
3. There are barriers to entry and exit to the industry. A monopoly has
very strong market barriers and these barriers are strong enough to ensure
that there is no market penetration so that a monopolist’s short-run
position can extend into the long run.
4. The monopoly market structure is characterized by imperfect knowledge
and as such sometime price discrimination occurs.
Price Discrimination
Price discrimination occurs when a monopolist (or any firm with market
power) charges a different price to different groups of consumers for an
identical goods or service, for reasons not associated with the cost of
production. The goal of price discrimination by monopoly suppliers is to
capture some of the consumer surplus for themselves in the form of
producer surplus. Evidently this leads to an increase in the firm’s revenue
and enables it to earn even higher abnormal profits.
 Price Discrimination
There are basically two main conditions required for price discrimination
to take place. These are:
1. Market/Monopoly power: The firm must have some price setting
power in order to charge different prices for the same commodity.
2. Separation of the market: The firm must be able to separate the market
into different subgroups of consumers.
Degrees of Price Discrimination
There are three different forms or degrees of price discrimination based
upon the firm’s ability to extract consumer surplus and turn it into
producer surplus. These are:
1. First degree price discrimination
2. Second degree price discrimination
3. Third degree price discrimination
 First Degree Price Discrimination
The price charged for each unit sold is based on the consumers’
willingness to pay. Different consumers have different preferences which
are reflected in varying levels of willingness to pay for a good or service.
Quite often there is a difference between the maximum price consumers
are willing to pay for a good and the actual market price for it. This
maximum price is also referred to as the reservation price.
 First Degree Price Discrimination

Under first degree price discrimination, it is assumed that the firm

charges each customer a price which is exactly equal to how much he or
she is willing to pay for each unit of the good or service consumed.
In its purest form, first degree price discrimination is called perfect
discrimination. Perfect price discrimination is hinged on businesses
having perfect knowledge about their customers and using that
information to extract the highest payment possible.
 First Degree Price Discrimination

Skilled salespersons may attempt to practice first degree price

discrimination when they take time to bargain or “haggle” with the
customer about the price that he or she is willing to pay. For instance, the
salesperson at a jewelry store may directly ask the consumer ‘How much
are you willing to spend?’ which indicates to the seller right away the
consumer’s reservation price.
Second Degree Price Discrimination

This involves offering discounts to consumers who purchase different

quantities. Second degree price discrimination involves charging
different prices for different quantities. This is usually in the form of
quantity discounts where a pricing structure for a particular good is
established based on the number of units which a consumer purchase.
Second Degree Price Discrimination

The firm would therefore sell larger bundles of the good lower than the
regular price. The aim here is to encourage larger sales volume in order
for the firm to utilize its full production capacity. In so doing, the seller
is also able to extract some of the consumers’ surplus.
Third Degree Price Discrimination

The firm separates the market into segments and charges a different
price to each. This is the most frequently found form of price
discrimination; the market is usually segmented through:
a) Time
b) Geographic location
c) Income level
 Third Degree Price Discrimination

Third degree price discrimination can be achieved when the market can be
segmented and when the segments have different elasticities of demand. A
higher price is charged to the segment of consumers who have a relatively
more elastic demand, whilst a lower price is charged to the segment with
the relatively lower price elasticity of demand. In so doing, the firm will
be able to extract some but not the entire consumers’ surplus in the form
of additional revenue. For instance, airlines may charge more to
passengers who book flights late than those who book flights much
earlier. This is because those who book flights late may have a much more
inelastic demand than those who book flights early.
 Monopolistic Competition

A monopolistically competitive market structure applies to an industry

with the following characteristics:
1. Many suppliers where each individual firm is small relative to the
industry as a whole.
2. Product differentiation- there are real differences in the output
produced by firms across the industry.
3. There are no barriers to entry and exit to the industry.
Monopolistic Competition
Monopolistic competition is a common market form. Many markets can
be considered monopolistically competitive, often including the markets
for restaurants, clothing and shoes. The characteristics of a
monopolistically competitive market are almost the same as in perfect
competition, with one exception; that is, instead of homogenous products
there are heterogeneous products as the output of each firm can be
distinguished from that of rival firms.
Monopolistic Competition
This is because in order to gain an edge on the market, firms tend to
engage in some actual product differentiation apart from just branding and
advertising. These real difference in products offered usually include
features or designs which help to distinguish each firm’s output from its
rival’s. As a result, the outputs of different firms in the industry are not
easily substitutable for consumers. The large number of firms operating in
the market also makes competition on the basis of price, quite intense.
 Oligopoly

An oligopoly applies to an industry if the following features are present:

1. Few large suppliers and a large number of buyers make up the industry.
2. Product differentiation – there are perceived difference in the output
produced by firms, achieved through branding.
3. There are barriers to entry and exit to the industry.
4. For simplicity we assume perfect knowledge exists.
Oligopoly
An oligopoly exists when there are a few, usually large producers which
supply a particular market. Oligopolies tend to be real world market
structure as a result of a range of barriers to entry and exit which present
themselves in reality. In addition to this supply constraint, oligopolies may
be encouraged as a sheer result of consumers’ preference to purchase
goods and services from larger firms. These preferences arise from the
potential higher quality products and lower prices offered by such firms
through economies of scale.
Oligopoly
Firms in this market structure usually devote considerable resources
towards brand images building through advertising. This means the
products of each firm are essentially identical. Given that oligopolies do
not compete through prices but instead focus on product differentiation to
gain customer loyalty, there may be greater innovation and product
development in such markets.
Oligopoly
Thus, given the high level of profitability, such firms may reinvest their
earnings in research and development projects with the aim of gaining
enhanced customer loyalty, which ultimately results in the development of
more sophisticated goods and services and hence improved consumer
welfare. In addition to these benefits, consumers also prefer larger firms
since such firms often offer superior customer support services such as
warranties, guarantees, after-sale services and customer relations help
desks.
Cartels and Collusion

Collusion exists when the firms agree on prices and other factors, such as
output levels and market share. A cartel is a formal collusive agreement
between firms in an industry. A cartel occurs when competing firms team
up or collude to make decisions about prices and output as a group. Such
actions create a non-competitive environment, and this typically applies
under an oligopolistic market structure, where there are few suppliers who
sell virtually the same product under different brand names. The aim of
such collusion is to increase the profits of members since, as they team up
and work together, they effectively operate as a monopoly.
Cartels and Collusion

In the U.S.A competition laws forbid the formation of cartels.

Internationally, however, there are no restrictions on establishment of
cartels. The Organization of the Petroleum Exporting Countries (OPEC)
is a prime example of an international cartel. The members of this cartel
meet regularly to decide how much oil each member country will be
allowed to produce as they seek to manipulate the supply and hence price
of crude oil in international markets.
The characteristics of the different market structures

Market structure is determined by many factors that create competitiveness among the
firms in an industry.

Factors/Characteristics that determine market structure are:

(a) barriers to entry

(b) control over market and price

(c) nature of the good

(d) numbers of buyers and sellers

(e) competitive behavior and performance.

Barriers to entry or exit

These are the difficulties or invisible barriers that new firms face trying to
enter or leave an industry. Firms enter an industry easily or can make it
difficult for new entrants. Some barriers are:
Patents, licenses, and copyright – Legal barriers to entry. A patent is a
right granted by the government which allows only the inventor of a
product to produce and sell the invention.
Barriers to entry or exit

Production secrets – If the production of a good involves a secret

ingredient or a secret recipe, then this would effectively prevent other
firms from producing this good.
control of raw materials- The exclusive ownership or control of a
substantial amount of an essential raw material would considerably limit
attempts by other firms to enter an industry.
Barriers to entry or exit

Others include: brand name or trade logos, high advertising costs of

existing firms, extremely high set up costs (as found in the oil industry),
extremely high costs of land, economies of scale of existing firms and
raising large sums of financial capital.
Control over market and price – This depends on whether the firm is a
price taker or price maker. If prices are raised or lowered it may cause a
loss or gain in sales. In order words, the ability to influence price is
determined by how price elastic the good is and how dominant the firm is
to set price.
Nature of the good – If the good has very few good substitutes then
demand will be inelastic and there will be little or no competition, for
example, gasoline or electricity or telecommunications.
Numbers of buyers and sellers – If there are few sellers, they may enjoy
monopoly power, while many buyers provide them the opportunity to
achieve market power.
Competitive behavior and performance – A few firms in an industry
may record high profit levels. While few firms do earn high profit, the
price elasticity of demand of the products that they trade in plays a major
role in the profit earned. Profit may not be evenly shared among the firms
in the industry.