Market Structure

Study Notes:

Market structure attempts to make it easier to understand the characteristics of diverse markets. It also attempts to explain how firms are differentiated and categorized by the types of goods they sell and the impact on their operations coming from outside factors.

Microeconomic theory looks at the way businesses run under differing types of industry and various levels of competition. The cornerstone of microeconomic market structure is Perfect Competition.

If you think of an agricultural commodity such as wheat, you’ll have a better sense of the game rules. Perfect competition assumes that no single firm has an advantage over the next and that there are no barriers to entry. Anyone can form a business and sell this product. Producers are price-takers and that price is set by the market as a whole. Everyone’s product is so-called homogeneous, which essentially means it’s identical to anyone else’s product and a customer is not better off buying from one seller over the next.

Imperfect Competition exists when firms do face barriers to entry, where products are differentiated and one producer may have a price advantage over another. There are different degrees of imperfect competition.

Monopolistic Competition is assumed to exist when there are still many sellers, but each has differentiated its product. This could be due to differences in quality and so consumers do not have a perfect substitute. In this case, imagine how two cans of soft drinks are different, although quite similar to one another. Therefore, under monopolistic competition, due to branding, better quality products or simply consumers’ tastes and preferences, there are so-called barriers to entry facing new firms wanting to take part in this industry. And because of product differentiation, producers have at least partial control over the price of their products.

Oligopoly – When only a few firms exist within an industry controlling the majority of market share, an oligopoly is said to exist. Here, firms are neither price takers nor makers. They tend to be rigid in setting prices and avoid niggling with other producers. Each firm carefully watches the price setting patterns of its neighbor and tends to be respectful for fear of setting prices too low and potentially harming the profitability of the few producers. There are barriers to entry, such as high technology costs.

A Monopoly exists when a single seller produces products or services for which there is no substitute. As such the firm can dictate the price and is said to be a price maker. There are high barriers to entry, and it remains in the monopolist’s interest to deter competition from setting up an alternative product. The monopolist can control price and output. Some natural monopolies occur, whereby economies of scale exist. That means that a single producer can do something effectively while two or more entrants would still not be able to produce and compete effectively with the monopolistic producer.  , such as major diamond mine. A monopsony occurs when there is a single buyer of a product in the market. This could be the state or government who is the only consumer of a product.

Market Structure is therefore a function of the number and size of sellers of a particular good, barriers to entry and barriers to exiting the market, the nature of the product, its price and the cost of selling.

Competition serves to induce producers to create and maintain products of satisfactory quality at an affordable price to the consumer. Monopolies are least competitive and perfect competition represents the most competitive situation. Somewhere in between in the real world represents competitive forces working in the mutual interests of both consumers and producers.