Market structure

Market structure, in economics, depicts how firms are

differentiated and categorised based on the types of goods they sell
(homogeneous/heterogeneous) and how their operations are
affected by external factors and elements. Market structure makes it
easier to understand the characteristics of diverse markets.

The main body of the market is composed of suppliers and

demanders. Both parties are equal and indispensable. The market
structure determines the price formation method of the market.
Suppliers and Demanders (sellers and buyers) will aim to find a
price that both parties can accept creating a equilibrium quantity.

Market definition is an important issue for regulators facing changes

in market structure, which needs to be determined.[1] The
relationship between buyers and sellers as the main body of the
market includes three situations: the relationship between sellers Adam Smith
(enterprises and enterprises), the relationship between buyers
(enterprises or consumers) and the relationship between buyers and
sellers. The relationship between the buyer and seller of the market and the buyer and seller entering the
market. These relationships are the market competition and monopoly relationships reflected in economics.

History
Market structure has been a topic of discussion for many economists like Adam Smith and Karl Marx who
have strong conflicting viewpoints on how the market operates in presence of political influence. Adam
Smith in his writing on economics stressed the importance of laissez-faire principles outlining the operation
of the market in the absence of dominant political mechanisms of control, while Karl Marx discussed the
working of the market in the presence of a controlled economy[2] sometimes referred to as a command
economy in the literature. Both types of market structure have been in historical evidence throughout the
twentieth century and twenty-first century.

Market structure has been apparent throughout history due to its natural influence it has on markets, this can
be based on the different contributing factors that market up each type of market structure.

Types
Based on the factors that decide the structure of the market, the main forms of market structure are as
follows:

Perfect competition, refers to a type of market where there are many buyers and seller that
feature free barriers to entry, dealing with homogeneous products with no differentiation,
where the price is fixed by the market. Individual firms are price taker[3] as the price is set by
the industry as a whole. Example: Agricultural products which have many buyers and
sellers, selling homogeneous goods where the price is determined by the demand and
supply of the market and not individual firms. In the short run, a firm in a perfectly competitive
market may gain profits or loss, but in the long run, due to the entry and exit of new firms,
price will equal ATC in the long run, which is the lowest point of average total cost.[4]
Imperfect Competition refers to markets where standards for perfect competition are not
fulfilled (such as no barriers for entry and exit, homogeneous products and many buyers
and sellers). All other types of competition come under imperfect competition.
Monopolistic competition, a type of imperfect competition where there are many sellers,
selling products that are closely related but differentiated from one another (e.g. quality of
products may differentiate) and hence they are not perfect substitutes. This market structure
exists when there are multiple sellers who attempt to seem different from one another.
Examples: toothpaste, soft drinks, clothing as they all are homogeneous products with many
buyers and sellers, no to low entry barriers but are different from each other due to quality,
taste, branding. Firms have partial control over the price as they are not price takers (due to
differentiated products) or Price Maker (as there are many buyers and sellers).[5]
Oligopoly, refers to market structure where only small number of firms operate together
control the majority of the market share. Firms are neither price takers or makers. Firms tend
to avoid price war by following price rigidity. They closely monitor the prices of their
competitors and change prices accordingly. Oligopoly firms focus on quality and efficiency of
their products to compete with other firms. Example: Network providers[6] ( Entry barriers,
Small number of sellers, many buyers, products can be homogeneous or differentiated).
Three types of oligopoly.Due to he hallmark of oligopoly is the presence of strategic
interactions among rival firms, the optimal business strategy of an enterprise can be studied
through the thought of game theory. Under the logic of game theory, enterprises in oligopoly
market have interdependent behavior. These actions are non-cooperative, each company is
making decisions that maximize its own profits, and equilibrium is reached when all
businesses are doing their best, taking into account the actions of their competitors.[7]
Duopoly, a case of an oligopoly where two firms operate and have power over the
market.[8] Example: Aircraft manufactures: Boeing and Airbus. A duopoly in theory could
have the same effect as a monopoly on pricing within a market if they were to collude on
prices and or output of goods.
Oligopsony, a market where many sellers can be present but meet only a few buyers.
Example: Cocoa producers
Cournot quantity competition, one of the first models of oligopoly markets was developed
by Augustin Cournot in 1835. In Cournot’s model, there are two firms and each firm
selects a quantity to produce, and the resulting total output determines the market
price.[9]
Bertrand Price Competition, Joseph Bertrand was the first to analyze this model in 1883.
In Bertrand’s model, there are two firms and each firm selects a price to maximize its own
profits, given the price that it believes the other firm will select.[9]
Monopoly, where there is only one seller of a product or service which has no substitute. The
firm is the price maker as they have control over the industry. There are high barriers to entry,
which an incumbent would conduct entry-deterring strategies if keeping out entrants reaping
additional profits for the company.[9] Frank Fisher, a noticed antitrust economist has
described monopoly power as “the ability to act in an unconstrained way,” such as
increasing price or reducing quality.[10] Example: Standard Oil (1870–1911)Under
monopoly, monopoly firms can obtain excess profits through differential prices. According to
the degree of price difference, price discrimination can be divided into three levels.[11]
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.
 Or natural obstacles, such as the sole ownership of natural resources, De beers was a
monopoly in the diamond industry for years.
Monopsony, when there is only a single buyer in a market. Discussion of monopsony
power in the labor literature largely focused on the pure monopsony model in which a
single firm comprised the entirety of demand for labor in a market (e.g., company
town).[12]

Features of market structures

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 of sellers, entry and exit barriers,
nature of product, price, selling costs. Market structure can alter based on the new external factors, such as
technology, consumer preferences and new entrants. Therefore, elements of Market Structure always stay
the same but the importance of a single element may change making it more influential on the current
structure.

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.[13]
 Quick Reference to Basic Market Structures
Seller
Number Number
Market Entry & Nature of
of of Price
Structure Exit product
sellers buyers
Barriers

Uniform
Perfect price as
No Homogeneous Many Many
Competition their price
takers

Closely related Partial

Monopolistic
No but Many Many control
competition
differentiated over price
Differentiated Price
Monopoly Yes One Many
(No Substitute) Maker

Price
Homogeneous rigidity
Duopoly Yes Two Many
or Differentiated due to
price war

Price
Homogeneous rigidity
Oligopoly Yes Few Many
or Differentiated due to
price war
Price
taker (as
Homogeneous
Monopsony No Many One there is
or Differentiated
only one
buyer)

Homogeneous Price
Oligopsony No Many Few
or Differentiated Taker

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 firms and consumers
in the market, the type of goods and services being traded, and the
degree to which information can flow freely. In today's time, Karl
Marx's theory about political influence on market makes sense as
firms and industry are affected strongly by the regulation, taxes,
tariffs, patents imposed by the government. These affect the barriers
to entry and exit for the firms in the market.

Perfect competition:

1. There are many buyers and sellers in the market, and there is no
Karl Marx
fixed buying and selling relationship between them.

2. The products or services traded in the market are all the same
without any difference.

3. There are no barriers to entry and exit from the market.

4. There are no trade secrets.

5. Capital resources and labour are easily transferable.

Monopolistic Competition:

There are a large number of enterprises, there are no restrictions on entering and exiting the market, and
they sell different products of the same kind, and enterprises have a certain ability to control prices.[14]
Monopolies have complete market control as the barriers to entry are high and the threat of new entrants is
low; therefore they can price set to their preference.

Oligopoly:

The number of enterprises is small, entry and exit from the market are restricted, product attributes are
different, and the demand curve is downward sloping and relatively inelastic. Oligopolies are usually found
in industries in which initial capital requirements are high and existing companies have strong foothold in
market share.

Monopoly:

The number of enterprises is only one, access is restricted or completely blocked, and the products
produced and sold are unique and cannot be replaced by other products. The company has strong control
and influence over the price of the entire market.

Different market structures will also lead to different levels of social welfare. Generally speaking, as the
degree of competition increases, the total social welfare measured by producer surplus plus consumer
surplus will rise. The total surplus of perfect competition market is the highest. And the total surplus of
imperfect competition market is lower. In the monopoly market, if the monopoly firm can adopt first-level
price discrimination, the consumer surplus is zero and the monopoly firm obtains all the benefits in the
market.[15]

Importance of Market Structure

Market structure is important for a firms use as it motivations, decision making, opportunities. This will
incur changes to current market standings affecting: market outcomes, price, availability and variety.[16]

Market structure provides indication on potential opportunities and threats which can influence business to
adapt there processes and operations in order to meet market structure requirements in order to stay
competitive. For example being able to understand market structure will help to identify any product
substitutability a foundation element of market structure analysis to then determine the best course of action.

Measure of market structure

N-firm concentration ratio, N-firm concentration ratio is a common measure of market
structure. This gives the combined market share of the N largest firms in the market.[9] For
example, if the 5-firm concentration ratio in the United States smart phone industry is about
.8, which indicates that the combined market share of the five largest smart phone sellers in
the United states is about 80 percent.
Herfindahl index, The Herfindahl index defined as the sum of the squared market shares of
all the firms in the market. Increases in the Herfindahl index generally indicate a decrease in
competition and an increase of market power, vice versal. Generally, the Herfindahl index
conveys more information than the N-firm concentration ratio.In general, this index can also
measure the market concentration of the top n companies, and the impact of corporate
mergers and acquisitions on the market structure. And although any relationship between
 Herfindahl index and concentration ratio can only provide a rough approximation, the
estimation (prediction) of Herfindahl index becomes rapidly more accurate when given some
of the largest market shares.[17]

Besides market structure, many factors contribute to conduct and market performance. Market pressures are
similarly evolving therefore when decision making based on market performance it is essential to assess all
the circumstances affecting competition rather than rely solely on measures of market structure. Using a
single measurement of market share can be misleading or inconclusive as only indicators are taken into
account.[18]

Different aspects that have been taken into account to measures the innovative advantage within particular
market structures are: the size distribution of firms, the existence of certain barriers to entry, and the stage of
industry in the product lifecycle.[19] Creating another measure to determine the current market structure that
can be used as evidence or to evaluate current market performance thus it can be used to forecast and
determine future trends.

See also
Industrial organization
Microeconomics Herfindahls index and types of
Economics market structure
Structure-conduct-performance paradigm
Business economics
Stackelberg competition
Competition (economics)
Porter's five forces analysis

References
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11. Armstrong, M. (2008). Price discrimination. MIT Press.
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16. "Market Structure" (https://www.westga.edu/~bquest/1997/ecnmkt.html#:~:text=Market%20str
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17. Kvålseth, T. O. (2018). Relationship between concentration ratio and Herfindahl-Hirschman
index: A re-examination based on majorization theory. Heliyon, 4(10), e00846.
18. Khan, Habib Hussain; Ahmad, Rubi Binit; Gee, Chan Sok (2016-08-04). Hernandez
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External links
Media related to Market structure at Wikimedia Commons
Microeconomics (http://www.egwald.ca/economics/index.php) by Elmer G. Wiens: Online
Interactive Models of Oligopoly, Differentiated Oligopoly, and Monopolistic Competition

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