Market structure

Adam Smith

Market Structure in economics, depicts how firms are differentiated and categorised based on 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.

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 ^[1]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.

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^[2] 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.
  • 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). ^[3]

• 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^[4] ( Entry barriers, Small number of sellers, many buyers, products can be homogeneous or differentiated). Three types of oligopoly.
  • Duopoly, a special case of an oligopoly where two firms operate and have power over the market.^[5] Example: Aircraft manufactures: Boeing and Airbus.
  • 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.^[6]
  • 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.^[6]
• 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.^[6] 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.^[7] Example: Google
  • 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).^[8]

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.

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.^[9]

Karl Marx

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.

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.^[6] 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 maket power, vice versal. Generally, the Herfindahl index conveys more information than the N-firm concentration ratio.

Besides market structure, many factors contribute to conduct and market performance. Thus, it is essential to assess all the circumstances affecting competition rather than rely solely on measures of market structure.

Herfindahls index and types of market structure

See also[]

• Industrial organization
• Microeconomics
• Economics
• Structure-conduct-performance paradigm
• Business economics
• Stackelberg competition
• Competition (economics)
• Porter's five forces analysis

References[]

External links[]

• Media related to Markets at Wikimedia Commons
• Microeconomics by Elmer G. Wiens: Online Interactive Models of Oligopoly, Differentiated Oligopoly, and Monopolistic Competition