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Market Structure

Sep 14, 2017 in Marketing

A market structure refers to the total number of firms that are producing indistinguishable goods and services which are homogenous in nature and are targeting the same consumers in a particular region or location. The most common types of market structures described by economists include perfect competition, monopolistic competition, oligopoly and monopoly (Etro, 2009). Each market structure has specific characteristics or attributes which distinguish it from other types of market structures. Some of the major factors that determine the type of market structure include the number of buyers and sellers operating in the market, pricing strategies adopted by the sellers or the ability of producers to set prices for their products, the influence of government and forces of demand and supply in the market.

Descriptions of Market Structures and Their Major Characteristics

a)      Perfect Competition

A perfect competition is a free market structure, in which no particular seller or producer is large enough to gain control of the market or power to set prices for products in the market. In a perfect competition market, the producers compete freely with one another in the market. Two major characteristics of a perfect competition market include the presence of an infinite number of buyers and sellers in the market and free entry into and exit from the market by buyers and sellers. In a perfect competition market, the buyers and sellers are too many such that the actions of any particular seller or buyer do not result into considerable effects in the market. On the other hand, free entry and exit from the market implies that consumers and producers can enter or leave the market at will and easily without causing any considerable impact in the market. Other characteristics of a perfect competition market include perfect mobility or movement of factors of production in the market, the buyers and sellers have perfect knowledge about the market and profit maximization goals by buyers and sellers. A perfect competition market is also called pure competition.

b)      Monopolistic Competition

A monopolistic competition refers to a type of imperfect competition market in which there are many or numerous producers selling goods and services that are differentiated from the products of other producers but cannot be substituted perfectly. Two major characteristics of monopolistic competition are high levels of product differentiation and a large number of firms in the market. According to Keppler (2007), producers in a monopolistic competition market produce and sell goods that are relatively distinguishable but can be substituted easily by products of the rival firms. The firms often differentiate their products from those of competitors through branding strategies, achieving high quality standards and selling products in different locations within the same market. Secondly, the number of firms selling their products in a monopolistic competition is usually high. Others characteristic of a monopolistic competition market include free entry into and exit from the market in the long run, independency of firms and lack of perfect information among sellers and buyers.

c)      Oligopoly

An oligopoly refers to a market structure in which there are a small number of sellers who can collude with one another and determine the supply of products as well as the level of competition in the market. In an oligopolistic market, the firms can set the prices of their products by controlling the supply of the products in the market. Two major characteristics of oligopoly market structures include a small number of firms in the industry and ability to set prices. An oligopoly has a small number of firms operating in the market. Similarly, the firms in the market are able to set the prices of goods and services sold to consumers through collusions. Other characteristics of oligopolistic market structures include the existence of barriers to entry and exit, which prevent new firms from entering the market or industry, selling of products that are either homogenous or differentiated, and ability of firms to retain abnormal profits in the long run. According to Leahy and Neary (2010), the most common methods of product differentiation used in an oligopolistic market are heavy advertising and promotional expenditures. The firms in an oligopoly are also able to anticipate the actions of rival firms in the market. McEachern (2013) also asserts that firms in an oligopoly are highly interdependent.

d)     Monopoly

A monopoly refers to a market situation in which there is only one seller or producer operating in the market. A single firm in the market is able to control the supply of goods and services. In a monopoly, the entry of new firms is prevented through strict laws and regulations. According to Lynn (2010), monopolistic firms usually restrict the output of products in the market in order to facilitate the control of supply so that they can maximize profits by charging higher prices. Monopolistic firms often show little or no concern to the needs, wants and preferences of consumers. Most monopolies are usually created and regulated by the government. Two major characteristics of monopoly market structures are single seller and price setting. In a monopoly, there is only one seller or producer who supplies a particular commodity to the entire market. Secondly, the monopolistic firm sets the prices of its goods and services; thus, it is usually referred to as the price maker. Other common characteristics of monopoly markets include the existence of high barriers to entry into the market, profit maximization goal of the monopolistic firm and high levels of price discrimination in the market depending on the level of elasticity of demand (SelectSoft Publishers, 2009). Goods and services offered in a monopoly market usually lack substitutes.

Real-Life Examples of the Market Structures

A real-life example of a perfect competition market is the stock exchange markets such as New York Stock Exchange, which has numerous listed companies and numerous investors. Similarly, the public transport industry is a perfect competition market because there are large numbers of owners of public service vehicles which offer transportation services to thousands of passengers. A real-life example of monopolistic competition market is the toothpaste industry which is characterized by numerous producers selling homogenous toothpastes to consumers. Most firms in the toothpaste industry conduct massive promotions and advertising in order to persuade consumers to purchase their products. The toothpastes are also differentiated through packaging and branding. Similarly, a good example of oligopoly is the cellular phone market in the United States of America which is controlled by a small number of firms namely T-Mobile, Verizon, Sprint and American Telephone and Telegraph (AT & T). The banking industry is also an example of oligopoly. Lastly, an example of a monopoly is the Comcast Corporation which enjoys monopoly in Boston, Philadelphia and Chicago for the provision of entertainment, information and communication products and services.

How High Entry Barriers into a Market Would Influence the Long-Run Profitability of the Firms

Barriers to entry refer to various factors or obstacles that inhibit the entry of new firms into a particular market. According to Carlton and the National Bureau of Economic Research (2005), barriers to entry are those factors that hinder or make it difficult for new firms to enter a given market. Examples of barriers to entry include strict rules and regulations set by the government or regulatory authorities, the ability of existing firms to enjoy economies of scale, high costs of entry into market, high levels of customer loyalty and control over resources by the existing firms.

In relation to the above market structures, perfect competition markets are characterized by the lack of barriers to entry. Thus, barriers to entry do not influence the profitability of the firms in the long-run. On the other hand, oligopoly markets are characterized by high barriers to entry. Similarly, monopoly markets are also characterized by very high barriers to entry. Firms in oligopoly and monopoly markets are likely to enjoy excess profits in the short-run. However, the high profits earned by the firms will attract new entrants and lead to increase in competition. As a consequence, the profitability of the firms will reduce because of the increase in competition among firms operating in the market. According to Rosado (2010), the profitability of the firms is likely to reduce to zero in the long-run as competition increases in the industry.

Competitive Pressures Present In Markets with High Barriers to Entry

The competitive pressure in market structures such as oligopoly and monopolistic is relatively low. Theoretically, firms in a monopoly market do not experience any competitive pressures. This is because of the existence of barriers to entry, which bar or deter new entrants into the industry. As a consequence, the level of competition is relatively low or may not exist at all as in the case of monopoly markets.

Price Elasticity of Demand in Each Market Structure and Its Effect on the Pricing of Its Products in Each Market

Price elasticity of demand refers to the percentage of change in demand that is caused by  one percent increase or decrease in the price of the products. Landsburg (2010) defines elasticity of demand as the responsiveness of the quantity demanded of a good or service to a change in the price of the good or service when all other factors of demand and supply are held constant.

a)      Perfect Competition Market

In a perfect competition market, the demand curve of the firms is perfectly elastic. This forces firms in the market to take prices as set by forces of demand and supply; thus, the firms are commonly referred to as price takers. According to Etro (2009), elasticity of demand is perfectly elastic in a perfect competition market because of the large number of sellers or producers; hence, a price change by one firm does not influence prices charged by other firms. All firms in a perfect competition do not have control over prices of their products in the market.

b)      Monopolistic Competition

In a monopolistic competition market, the elasticity of demand is relatively elastic. Thus, firms are able to set prices for their products. However, the firms can only sell the products within a relatively narrow range of prices (Chamberlin, 2006). The firms are able to control the prices of their products because they are relatively few in the market. Price control is usually derived from collusions among the firms. Relative elasticity of demand is also caused by the existence of close substitutes in the market or industry.

c)      Oligopoly

In an oligopoly market, the elasticity of demand is relatively elastic in the short-run because all firms in the industry do not change their prices. However, in the long-run, the elasticity of demand becomes inelastic because all firms will reduce their prices in attempts to attract more customers and to increase sales. As a result, a price war emerges between the firms. The point of equilibrium for firms in an oligopoly is reached when the marginal revenue curve equals demand.

d)     Monopoly

A monopoly market is characterized by an inelastic demand. Therefore, the monopolist has adequate control over the market and can easily set prices for its goods and services.

How the Role of the Government Affects Each Market Structure’s Ability to Price Its Products

The ability of firms, operating within a given market, to set prices for their products is a key component and characteristic of market structures. In some market structures, firms have the exclusive ability to set prices for their products. However, in some markets, the firms may lack the ability to set prices for the products. Moreover, firms, which have the exclusive ability to set prices, may also have this ability thwarted by the government or a regulatory authority.

In my view, the government has little or no effect on the ability of firms in a perfect competition market to set prices. In this type of market structures, the prices of goods and services offered by producers to consumers are determined freely by the forces of demand and supply. Similarly, the government has minimal effect on the control of prices in a monopolistic competition and oligopoly markets. However, the government may intervene in extreme situations where firms in a monopolistic competition and oligopoly markets collude or come together to form a monopoly, usually called trade cartels, in order to exploit consumers. In such cases, the government would intervene and set maximum prices for goods and services offered to consumers in the markets, hence, reducing the power of producers to charge higher prices.

In a monopolistic market, the government affects the ability of firms to set prices by imposing price controls. The most common type of price controls is the ceiling price, which refers to the highest price that can be charged by a monopoly or any other trader for a particular good or service. The government usually sets ceiling prices in order to prevent excessive exploitation of consumers by the monopolist. In addition, the government may also nationalize the monopolistic firm in order to affect its ability to price goods and services in the market. Nationalization is the process, in which a privately owned firm becomes a state corporation or parastatal. The government may also use nationalization strategy to improve efficiency in the provision and supply of goods and services previously offered by a monopolist.

Effects of International Trade On the Market Structures

International trade has adverse effects on a perfect competition market because of the free entry and exit of firms. Firstly, the number of firms operating in a perfect competition market is likely to increase because of easy entry into the market. This would lead to increase in supply of goods and services. International trade would also lead to stiff competition among the firms. As a consequence, the firms would reduce the prices of their products as competition increases in attempts to attract more customers and to make more profits through increased sales. Decrease in prices would also be facilitated by an increase in supply, which is not accompanied by a corresponding increase in demand. The forces of demand and supply would play until it reaches a point at which the firms would not make more profits, hence, forcing some firms to exit the market. Similarly, international trade would also lead to increase in the number of firms operating in a monopolistic competition market because of existence of few barriers to entry. The supply of goods and services is also likely to increase. Prices would reduce as demand remains constant.

In an oligopoly market, international trade would lead also to the entrance of more firms as the market opens up to foreign producers. Supply of goods is expected to increase followed by a decline in prices and profitability of the firms.

On the other hand, international trade would not have a considerable effect on a monopolistic market because monopolistic markets are usually guarded by the barriers to entry. This would prevent new firms from entering the market. However, international trade would lead to the introduction of substitute products, which may rival products of the monopolist. As a consequence, consumers may switch brands, thus, leading to reduced demand for the products of the monopolist. But the impact of international trade in a monopolistic market would be controlled by the government, which may impose trade quotas and tariffs to regulate and control the importation of goods and services from foreign countries, thus, providing further protection or guard to the monopolist.

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