Market structure


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Market structure

  1. 1. Market structure<br />Market Structure is defined as Interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market. Basic types of market structure are<br />Monopolistic competition, also called competitive market, where there are a large number of firms, each having a small proportion of the market share and slightly differentiated products.<br />Oligopoly, in which a market is dominated by a small number of firms that together control the majority of the market share.<br />Duopoly, a special case of an oligopoly with two firms.<br />Oligopsony, a market, where many sellers can be present but meet only a few buyers.<br />Monopoly, where there is only one provider of a product or service.<br />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.<br />Monopsony, when there is only one buyer in a market.<br />Perfect competition is a theoretical market structure that features unlimited contestability (or no barriers to entry), an unlimited number of producers and consumers, and a perfectly elastic demand curve.<br />Quick Reference to Basic Market StructuresMarket StructureSeller Entry BarriersSeller NumberBuyer Entry BarriersBuyer NumberPerfect CompetitionNoManyNoManyMonopolistic competitionNoManyNoManyOligopolyYesFewNoManyOligopsonyNoManyYesFewMonopolyYesOneNoManyMonopsonyNoManyYesOne<br />Monopolistic competition<br />Monopolistic competition is a form of imperfect competition where many competing producers sell products that are differentiated from one another (that is, the products are substitutes, but, with differences such as branding, are not exactly alike). In monopolistic competition firms can behave like monopolies in the short-run, including using market power to generate profit. In the long-run, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like perfect competition where firms cannot gain economic profit. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries.<br />Characteristics<br />Monopolistically competitive markets have the following characteristics:<br />There are many producers and many consumers in a given market, and no business has total control over the market price.<br />Consumers perceive that there are non-price differences among the competitors' products.<br />There are few barriers to entry and exit. <br />Producers have a degree of control over price.<br />The long-run characteristics of a monopolistically competitive market are almost the same as in perfect competition, with the exception of monopolistic competition having heterogeneous products, and that monopolistic competition involves a great deal of non-price competition (based on subtle product differentiation). A firm making profits in the short run will break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This gives the amount of influence over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.<br />Examples<br />In many U.S. markets, producers practice product differentiation by altering the physical composition, using special packaging, or simply claiming to have superior products based on brand images and/or advertising. Toothpastes and toilet papers are examples of differentiated products.<br />Oligopoly<br />An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants.<br />Characteristics<br /><ul><li>Profit maximization conditions: An oligopoly maximizes profits by producing where marginal revenue equals marginal costs.
  2. 2. Ability to set price: Oligopolies are price setters rather than price takers.
  3. 3. Entry and exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms.
  4. 4. Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms.
  5. 5. Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.
  6. 6. Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles).
  7. 7. Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic actors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price, cost and product quality.
  8. 8. Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately</li></ul>Examples<br />In industrialized economies, barriers to entry have resulted in oligopolies forming in many sectors, with unprecedented levels of competition fueled by increasing globalization. Market shares in an oligopoly are typically determined by product development and advertising. For example, there are now only a small number of manufacturers of civil passenger aircraft, though Brazil (Embraer) and Canada (Bombardier) have participated in the small passenger aircraft market sector. Oligopolies have also arisen in heavily-regulated markets such as wireless communications: in some areas only two or three providers are licensed to operate.<br />Duopoly<br />A true duopoly is a specific type of oligopoly where only two producers exist in one market. In reality, this definition is generally used where only two firms have dominant control over a market. In the field of industrial organization, it is the most commonly studied form of oligopoly due to its simplicity.<br />Duopoly models in economics<br />There are two principal duopoly models, Cournot duopoly and Bertrand duopoly:<br />The Cournot model, which shows that two firms assume each other’s output and treats this as a fixed amount, and produce in their own firm according to this.<br />The Bertrand model, in which, in a game of two firms, each one of them will assume that the other will not change prices in response to its price cuts. When both firms use this logic, they will reach a Nash Equilibrium.<br />Examples <br />The most commonly cited duopoly is that between Visa and MasterCard, who between them control a large proportion of the electronic payment processing market. In 2000 they were the defendants in a US Department of Justice antitrust lawsuit. An appeal was upheld in 2004. <br />Oligopsony<br />An oligopsony is a market form in which the number of buyers is small while the number of sellers in theory could be large. This typically happens in a market for inputs where numerous suppliers are competing to sell their product to a small number of (often large and powerful) buyers. It contrasts with an oligopoly, where there are many buyers but few sellers. An oligopsony is a form of imperfect competition.<br />Example<br />One example of an oligopsony in the world economy is cocoa, where three firms (Cargill, Archer Daniels Midland, and Callebaut) buy the vast majority of world cocoa bean production, mostly from small farmers in third-world countries. Likewise, American tobacco growers face an oligopsony of cigarette makers, where three companies (Altria, Brown & Williamson, and Lorillard Tobacco Company) buy almost 90% of all tobacco grown in the US.<br />In each of these cases, the buyers have a major advantage over the sellers. They can play off one supplier against another, thus lowering their costs. They can also dictate exact specifications to suppliers, for delivery schedules, quality, and (in the case of agricultural products) crop varieties. They also pass off much of the risks of overproduction, natural losses, and variations in cyclical demand to the suppliers.<br />Monopoly<br />In economics, a monopoly exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it.<br />Monopolies are thus characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. The verb "monopolise" refers to the process by which a firm gains persistently greater market share than what is expected under perfect competition.<br />Characteristics<br />Single seller: In a monopoly there is one seller of the good who produces all the output. Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry.<br />Market power: Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition). Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers.<br />Firm and industry: In a monopoly, market, a firm is itself an industry. Therefore, there is no distinction between a firm and an industry in such a market.<br />Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging fewer prices against the product in a highly elastic market and sells less quantities charging high price in a less elastic market.<br />Example<br />Assume that under a uniform pricing system the monopolist would sell five units at a price of $10 per unit. Assume that his marginal cost is 5 per unit. Total revenue would be $50, total costs would be $25 and profits would be $25. If the monopolist practiced price discrimination he would sell the first unit for $50 the second unit for $40 and so on. Total revenue would be $150, his total cost would be $25 and his profit would be $125.00. Several things are worth noting. The monopolist captures the entire consumer surplus and eliminates practically all the deadweight loss because he is willing to sell to anyone who is willing to pay at least the marginal cost. Thus the price discrimination promotes efficiency. Secondly, under the pricing scheme price = average revenue and equals marginal revenue. That is the monopolist is behaving like a perfectly competitive firm. Thirdly, the discriminating monopolist produces a larger quantity than the monopolist operating under a uniform pricing scheme. <br />Qd12345Price5040302010<br />Natural monopoly<br />A natural monopoly arises where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual and potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market, and hence high barriers to entry; examples include public utilities such as water services and electricity. It is very expensive to build transmission networks (water/gas pipelines, electricity and telephone lines); therefore, it is unlikely that a potential competitor would be willing to make the capital investment needed to even enter the monopolist's market.<br />Some free-market-oriented economists argue that natural monopolies exist only in theory, and not in practice, or that they exist only as transient states. <br />Example<br />Utilities are often natural monopolies. In industries with a standardized product and economies of scale, a natural monopoly often arises. In the case of electricity, all companies provide the same product, the infrastructure required is immense, and the cost of adding one more customer is negligible, up to a point. Adding one more customer may increase the company's revenue and lowers the average cost of providing for the company's customer base. So long as the average cost of serving customers is decreasing, the larger firm more efficiently serves the entire customer base. Of course, this might be circumvented by differentiating the product, making it no longer a pure commodity. For example, firms may gain customers who pay more by selling "green" power, or non-polluting power, or locally-produced power.<br />Monopsony<br />In economics, a monopsony is a market form in which only one buyer faces many sellers. It is an example of imperfect competition, similar to a monopoly, in which only one seller faces many buyers. As the only purchaser of a good or service, the "monopsonist" may dictate terms to its suppliers in the same manner that a monopolist controls the market for its buyers.<br />Example<br />A single-payer universal health care system, in which the government is the only "buyer" of health care services, is an example of a monopsony. It has also been argued that Wal-Mart, in the United States, functions as a monopsony in certain market segments, as its buying power for a given item may dwarf the remaining market. Another possible monopsony could develop in the exchange between the food industry and farmers.<br />Perfect Competition<br />In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets say for commodities or some financial assets may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets.<br />Structural Characteristics<br />Generally, a perfectly competitive market exists when every participant is a "price taker", and no participant influences the price of the product it buys or sells. Specific characteristics may include:<br />Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price.<br />Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a perfectly competitive market.<br />Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions.<br />Perfect information - Prices and quality of products are assumed to be known to all consumers and producers. <br />Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility). <br />Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.<br />Homogeneous products – The characteristics of any given market good or service do not vary across suppliers.<br />Constant returns to scale - Constant returns to scale ensure that there are sufficient firms in the industry. <br />In the short term, perfectly-competitive markets are not productively efficient as output will not occur where marginal cost is equal to average cost, but allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue, and therefore where marginal cost equals average revenue. In the long term, such markets are both allocatively and productively efficient. <br />Examples<br />The closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. By design, a stock exchange resembles this, not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e.g. investment banks) may solely influence the market price. This, of course, violates the condition that "no one seller can influence market price".<br />Some believe that one of the prime examples of a perfectly competitive market anywhere in the world is street food in developing countries. This is so since relatively few barriers to entry/exit exist for street vendors. Furthermore, there are often numerous buyers and sellers of a given street food, in addition to consumers/sellers possessing perfect information of the product in question. It is often the case that street vendors may serve a homogenous product, in which little to no variations in the product's nature exist.<br />Another very near example of perfect competition would be the fish market and the vegetable or fruit vendors who sell at the same place.<br />There are large number of buyers and sellers.<br />There are no entry or exit barriers.<br />There is perfect mobility of the factors, i.e. buyers can easily switch from one seller to the other.<br />The products are homogenous.<br />REFERENCES<br /><ul><li>
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