What is Market Structure?
Market structure, in economics, refers to how different industries are classified and differentiated based on their degree and nature of competition for goods and services. It is based on the characteristics that influence the behavior and outcomes of companies working in a specific market.
Some of the factors that determine a market structure include the number of buyers and sellers, ability to negotiate, degree of concentration, degree of differentiation of products, and the ease or difficulty of entering and exiting the market.
- Market structure refers to how different industries are classified and differentiated based on their degree and nature of competition for services and goods.
- The four popular types of market structures include perfect competition, oligopoly market, monopoly market, and monopolistic competition.
- Market structures show the relations between sellers and other sellers, sellers to buyers, or more.
Understanding Market Structures
In economics, market structures can be understood well by closely examining an array of factors or features exhibited by different players. It is common to differentiate these markets across the following seven distinct features.
- The industry’s buyer structure
- The turnover of customers
- The extent of product differentiation
- The nature of costs of inputs
- The number of players in the market
- Vertical integration extent in the same industry
- The largest player’s market share
By cross-examining the above features against each other, similar traits can be established. Therefore, it becomes easier to categorize and differentiate companies across related industries. Based on the above features, economists have used this information to describe four distinct types of market structures. They include perfect competition, oligopoly market, monopoly market, and monopolistic competition.
Types of Market Structures
1. Perfect Competition
Perfect competition occurs when there is a large number of small companies competing against each other. They sell similar products (homogeneous), lack price influence over the commodities, and are free to enter or exit the market.
Consumers in this type of market have full knowledge of the goods being sold. They are aware of the prices charged on them and the product branding. In the real world, the pure form of this type of market structure rarely exists. However, it is useful when comparing companies with similar features. This market is unrealistic as it faces some significant criticisms described below.
- No incentive for innovation: In the real world, if competition exists and a company holds a dominant market share, there is a tendency to increase innovation to beat the competitors and maintain the status quo. However, in a perfectly competitive market, the profit margin is fixed, and sellers cannot increase prices, or they will lose their customers.
- There are very few barriers to entry: Any company can enter the market and start selling the product. Therefore, incumbents must stay proactive to maintain market share.
2. Monopolistic Competition
Monopolistic competition refers to an imperfectly competitive market with the traits of both the monopoly and competitive market. Sellers compete among themselves and can differentiate their goods in terms of quality and branding to look different. In this type of competition, sellers consider the price charged by their competitors and ignore the impact of their own prices on their competition.
When comparing monopolistic competition in the short term and long term, there are two distinct aspects that are observed. In the short term, the monopolistic company maximizes its profits and enjoys all the benefits as a monopoly.
The company initially produces many products as the demand is high. Therefore, its Marginal Revenue (MR) corresponds to its Marginal Cost (MC). However, MR diminishes over time as new companies enter the market with differentiated products affecting demand, leading to less profit.
An oligopoly market consists of a small number of large companies that sell differentiated or identical products. Since there are few players in the market, their competitive strategies are dependent on each other.
For example, if one of the actors decides to reduce the price of its products, the action will trigger other actors to lower their prices, too. On the other hand, a price increase may influence others not to take any action in the anticipation consumers will opt for their products. Therefore, strategic planning by these types of players is a must.
In a situation where companies mutually compete, they may create agreements to share the market by restricting production, leading to supernormal profits. This holds if either party honors the Nash equilibrium state and neither is tempted to engage in the prisoner’s dilemma. In such an agreement, they work like monopolies. The collusion is referred to as cartels.
In a monopoly market, a single company represents the whole industry. It has no competitor, and it is the sole seller of products in the entire market. This type of market is characterized by factors such as the sole claim to ownership of resources, patent and copyright, licenses issued by the government, or high initial setup costs.
All the above characteristics associated with monopoly restrict other companies from entering the market. The company, therefore, remains a single seller because it has the power to control the market and set prices for its goods.
Thank you for reading CFI’s guide on Market Structure. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: