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Market Structure

There are four main types of market structures: 1) Perfect competition, where many small firms sell identical goods and no single firm can influence prices. 2) Monopolistic competition, where many small firms sell differentiated goods, giving them some power over prices. 3) Oligopoly, dominated by a small number, usually 3-5, large firms that can collaborate to influence prices. 4) Monopoly, where a single firm controls the entire market and can set prices and restrict output to maximize profits.

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286 views3 pages

Market Structure

There are four main types of market structures: 1) Perfect competition, where many small firms sell identical goods and no single firm can influence prices. 2) Monopolistic competition, where many small firms sell differentiated goods, giving them some power over prices. 3) Oligopoly, dominated by a small number, usually 3-5, large firms that can collaborate to influence prices. 4) Monopoly, where a single firm controls the entire market and can set prices and restrict output to maximize profits.

Uploaded by

jane
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Market Structure

A market is a set of buyers and sellers, commonly referred to as agents, who through
their interaction, both real and potential, determine the price of a good, or a set of
goods. The concept of a market structure is therefore understood as those
characteristics of a market that influence the behaviour and results of the firms working
in that market.

The main aspects that determine market structures are: the number of agents in the
market, both sellers and buyers; their relative negotiation strength, in terms of ability to
set prices; the degree of concentration among them; the degree of differentiation and
uniqueness of products; and the ease, or not, of entering and exiting the market.

The Four Types of Market Structures


There are quite a few different market structures that can characterize an economy. However, if you are
just getting started with this topic, you may want to look at the four basic types of market structures
first: perfect competition, monopolistic competition, oligopoly, and monopoly. Each of them has its own
set of characteristics and assumptions, which in turn affect the decision making of firms and the profits
they can make.

Perfect Competition

Perfect competition describes a market structure, where a large number of small firms compete against
each other. In this scenario, a single firm does not have any significant market power. As a result, the
industry as a whole produces the socially optimal level of output, because none of the firms can
influence market prices.

The idea of perfect competition builds on several assumptions: (1) all firms maximize profits (2) there is
free entry and exit to the market, (3) all firms sell completely identical (i.e., homogenous) goods, (4)
there are no consumer preferences. By looking at those assumptions, it becomes quite obvious that we
will hardly ever find perfect competition in reality. That is an essential aspect because it is the only
market structure that can (theoretically) result in a socially optimal level of output.

Monopolistic Competition

Monopolistic competition also refers to a market structure, where a large number of small firms
compete against each other. However, unlike in perfect competition, the firms in monopolistic
competition sell similar, but slightly differentiated products. That gives them a certain degree of market
power, which allows them to charge higher prices within a certain range.
Monopolistic competition builds on the following assumptions: (1) all firms maximize profits (2) there is
free entry, and exit to the market, (3) firms sell differentiated products (4) consumers may prefer one
product over the other. Now, those assumptions are a bit closer to reality than the ones we looked at in
perfect competition. However, this market structure no longer results in a socially optimal level of
output because the firms have more power and can influence market prices to a certain degree.

An example of monopolistic competition is the market for cereals. There is a huge number of different
brands (e.g., Cap’n Crunch, Lucky Charms, Froot Loops, Apple Jacks). Most of them probably taste
slightly different, but at the end of the day, they are all breakfast cereals.

Oligopoly

An oligopoly describes a market structure which is dominated by only a small number of firms. That
results in a state of limited competition. The firms can either compete against each other or collaborate
(see also Cournot vs. Bertrand Competition). By doing so, they can use their collective market power to
drive up prices and earn more profit.

The oligopolistic market structure builds on the following assumptions: (1) all firms maximize profits, (2)
oligopolies can set prices, (3) there are barriers to entry and exit in the market, (4) products may be
homogenous or differentiated, and (5) there is only a few firms that dominate the market.
Unfortunately, it is not clearly defined what a «few firms» means precisely. As a rule of thumb, we say
that an oligopoly typically consists of about 3-5 dominant firms.

To give an example of an oligopoly, let’s look at the market for gaming consoles. This market is
dominated by three powerful companies: Microsoft, Sony, and Nintendo. That leaves all of them with a
significant amount of market power.

Monopoly

A monopoly refers to a market structure where a single firm controls the entire market. In this scenario,
the firm has the highest level of market power, as consumers do not have any alternatives. As a result,
monopolies often reduce output to increase prices and earn more profit.

The following assumptions are made when we talk about monopolies: (1) the monopolist maximizes
profit, (2) it can set the price, (3) there are high barriers to entry and exit, (4) there is only one firm that
dominates the entire market.

From the perspective of society, most monopolies are usually not desirable, because they result in lower
outputs and higher prices compared to competitive markets. Therefore, they are often regulated by the
government. An example of a real-life monopoly could be Monsanto. This company trademarks about
80% of all corn harvested in the US, which gives it a high level of market power. You can find additional
information about monopolies our post on monopoly power.
In a Nutshell

There are four basic types of market structures: perfect competition, imperfect competition, oligopoly,
and monopoly. Perfect competition describes a market structure, where a large number of small firms
compete against each other with homogenous products. Meanwhile, monopolistic competition refers
to a market structure, where a large number of small firms compete against each other with
differentiated products. An Oligopoly describes a market structure where a small number of firms
compete against each other. And last but not least, a monopoly refers to a market structure where a
single firm controls the entire market.

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