UNIT 4- MARKET STRUCTURES

What Is a Market?

A market is any place or venue where buyers and sellers can exchange goods and services. A market
may be physical, like a retail outlet, or virtual, like an online brokerage with no physical contact
between buyers and sellers.

Some key characteristics of a market are the availability of an arena, buyers and sellers, and a
commodity or other asset that can be bought and sold. A market transaction may include goods,
services, information, currency, or any combination that passes from one party to another. In short,
markets are any setting where buyers and sellers can gather and interact. Every trade needs at least
two parties, a buyer and a seller. In some cases, a third party is required to introduce competition
and balance the market. As such, a market in a state of perfect competition, among other things, is
characterized by a high number of active buyers and sellers. Certain decisions that help shape the
market are determined by an economic system known as the market economy. In this system,
factors like investments and the production, distribution, and pricing of goods and services are led by
supply and demand from businesses and individuals. As such, a market economy is unplanned and is
not part of a planned or command economy where the government dictates all these factors.
Examples of market economies include the United States, Canada, the United Kingdom, and Japan.
Markets try to find some balance in price when supply and demand are in balance. But that balance
can be disrupted by factors other than price, including incomes, expectations, technology, the cost of
production, and the number of buyers and sellers participating.

Simply, the number of goods and services available is determined by what people want and how
eager they are to buy. Sellers increase production when buyers demand more goods and services.
Producers tend to raise their prices when demand increases. When buyer demand decreases, they
drop their prices and, therefore, the number of goods and services they bring to market.

Factors Influencing Market Structure

Several factors influence market structure. These include:

1. Number of Firms: The number of firms operating within a market plays a significant role in
determining its structure. Markets can range from having just a few dominant
firms (oligopoly) to many small firms (perfect competition).

2. Entry Barriers: Entry barriers refer to obstacles that make it difficult for new firms to enter a
particular market. High entry barriers, such as high capital requirements or strict regulations,
tend to result in fewer competitors and more concentrated markets.

3. Product Differentiation: The extent to which products are differentiated or similar within a
market also impacts its structure. Markets with highly differentiated products (such as luxury
goods) often have fewer competitors compared to markets with homogeneous products
(such as basic commodities).

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.

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Economic market structures can be grouped into four categories: perfect competition, monopolistic
competition, oligopoly, and monopoly.

It is common to differentiate these markets across the following seven distinct features.

1. The industry’s buyer structure

2. The turnover of customers

3. The extent of product differentiation

4. The nature of costs of inputs

5. The number of players in the market

6. The largest player’s market share

1. Perfect Competition
A competitive market is defined as a market where market operators cannot take advantage
of demand fluctuations, and regulators monitor prices to prevent high prices, ensuring fair
pricing for all products offered by suppliers. Market conditions including the
number of sellers, type of product sold, barriers to entry, and
consumer information determine the level of competition in a
market. This level of competition can range from perfectly
competitive to purely monopolistic. The highest degree of competition
occurs in a perfectly competitive market. A perfectly competitive market
assumes there are many individual suppliers of identical products, there
are no barriers to entry or exit from the market and the availability of
perfect information allows consumers to accurately determine which firm
offers the best value.
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.

Conversely, the least competitive market structure is a

pure monopoly where there is one seller of a unique product in a market
with high barriers to entry, allowing the firm to be a price-setter. A less
extreme version of a pure monopoly is an oligopoly. An oligopoly is

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 characterized by a few dominant firms in a market with substantial barriers
to entry. The small number of firms causes the behavior of any one firm to
significantly influence that of another. Collusive oligopolies are
characterized by cooperation among the few firms in a market to inflate
prices and maximize profits by acting together as a monopoly. In practice,
firms are deterred from collusion due to anti-trust regulations. Monopolistic
competition describes a market with many sellers selling a product that is
differentiated across all firms. In this case, a firm with a highly
differentiated product can gain significant pricing power in a particular
market segment.
In health care, suppliers of goods and services include physicians,
hospitals, pharmaceutical manufacturers, and private health
insurance companies.

 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.
 Many firms, freedom of entry, homogeneous product, normal profit.
 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.
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.
 One firm dominates the market, barriers to entry, possibly supernormal profit.
 What is a Natural Monopoly?
 A natural monopoly is a situation where one firm can efficiently provide a good or service at
a lower cost than multiple firms due to economies of scale. A classic example of a natural
monopoly is the provision of electricity. In many countries, there is often only one major
electricity provider that serves the entire population. This is because the infrastructure
required to generate and distribute electricity is extremely expensive and complex. Building
multiple competing electricity grids would be inefficient and costly. Therefore, it makes
more sense to have a single firm that can take advantage of economies of scale and provide
electricity at a lower cost to consumers. This natural monopoly ensures that electricity is
widely accessible and affordable for the general population.

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 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.

 3. Oligopoly
 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. 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.


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 

COMPETITIVE MARKETS AND PERFECT COMPETITION

Perfect competition or pure competition is an idealized market condition where many sellers
compete to offer the best prices and large sellers have no advantages over smaller ones.
Perfect competition rarely occurs in real-world markets but it provides a useful model for
explaining how supply and demand affect prices and behavior in a market economy.

There are many buyers and sellers in perfect competition and prices are determined purely
by supply and demand. Companies earn just enough profit to stay in business and no more.
Other companies would enter the market and drive profits down if they were to earn excess
profits.

The Revenue of a Competitive Firm

1. Total revenue from the sale of output is equal to price times quantity.

1. Definition of Marginal Revenue: the change in total revenue from an additional unit
sold.

3. The profit-maximizing quantity can also be found by comparing marginal revenue and
marginal cost.

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 a. As long as marginal revenue exceeds marginal cost, increasing output will raise profit.

PERFECT COMPETITION

 Perfect competition is an ideal type of market structure where all producers and consumers
have full and symmetric information and no transaction costs.

 There are a large number of producers and consumers competing with each other in this kind
of environment.

 Perfect competition is theoretically the opposite of a monopolistic market.

 All real markets exist outside of the plane of the perfect competition model so each can be
classified as imperfect.

 The opposite of perfect competition is imperfect competition which exists when a market
violates the abstract tenets of neoclassical pure or perfect competition.

Characteristics of Perfect Competition

A perfectly-competitive market is defined by several factors.

A Large and Homogeneous Market

A large number of buyers and sellers exist in a perfectly competitive market. The sellers are small
firms rather than large corporations that are capable of controlling prices through supply
adjustments. They sell products with minimal differences in capabilities, features, and pricing. This
ensures that buyers can't distinguish between products based on physical attributes such as size or
color or intangible values such as branding.

A large population of both buyers and sellers ensures that supply and demand remain constant in
this market. Buyers can easily substitute products made by one firm for others.

Perfect Information Availability

Information about an industry's ecosystem and competition constitutes a significant advantage.
Knowledge about component sourcing and supplier pricing can make or break the market for
certain companies.

Information about patents and competitors' research initiatives can help companies develop
competitive strategies and build a moat around their products in certain knowledge and research-
intensive industries such as pharmaceuticals and technology,

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The availability of free and perfect information in a perfectly competitive market ensures that each
firm can produce its goods or services at the same rate and with the same production techniques as
another in the market.
Absence of Controls
Governments play a vital role in market formation for products by imposing regulations and price
controls. They can control the entry and exit of firms into a market by setting up rules to function in
it. The pharmaceutical industry must contend with a roster of rules governing the development,
production, and sale of drugs.

These rules require big capital investments in the form of employees such as lawyers and quality
assurance personnel as well as infrastructure such as machinery to manufacture medicines. The
cumulative costs add up and make it extremely expensive for companies to bring a drug to the
market.The technology industry functions with relatively less oversight as compared
to its pharma counterpart. Entrepreneurs in this industry can start firms with
less capital , making it easy for individuals to start a company in the industry.

Such controls don't exist in a perfectly competitive market . The entry and exit of
firms are unregulated and this frees them up to spend on labor and capital assets
without restrictions and adjust their output in relation to market demands.

Cheap and Efficient Transportation

Cheap and efficient transportation is another characteristic of perfect competition. Companies don't
incur significant costs to transport goods in this type of market. This helps reduce the product’s
price and cuts back on delays in transporting goods.

Firms are in perfect competition when the following conditions occur: (1) many firms produce
identical products; (2) many buyers are available to buy the product, and many sellers are available
to sell the product; (3) sellers and buyers have all relevant information to make rational decisions
about the product that they are buying and selling; and (4) firms can enter and leave the market
without any restrictions—in other words, there is free entry and exit into and out of the market.

A perfectly competitive firm is known as a price taker, because the pressure of competing firms
forces it to accept the prevailing equilibrium price in the market. If a firm in a perfectly competitive
market raises the price of its product by so much as a penny, it will lose all of its sales to
competitors. When a wheat grower wants to know the going price of wheat, they have to check on
the computer or listen to the radio. Supply and demand in the entire market solely determine the
market price, not the individual farmer. A perfectly competitive firm must be a very small player in
the overall market, so that it can increase or decrease output without noticeably affecting the
overall quantity supplied and price in the market.

Theory vs. Reality of Perfect Competition

Real-world competition differs from this ideal primarily because of differentiation in production,
marketing, and selling . The owner of a small organic products shop can advertise extensively about
the grain fed to the cows that made the manure that fertilized the non-GMO soybeans, thereby
setting their product apart from competitors. This is referred to as differentiation.

Homogeneous products and price takers are far from realistic but the global tech and trade
transformation is improving information and resource flexibility. The reality is far from this

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theoretical model but the model is still helpful because of its ability to explain many real-life
behaviors.

Advantages and Disadvantages of Perfect Competition

Perfect competition is an idealized framework for a market economy. It provides a convenient

model for how an economy works but it's not always accurate and has significant departures from
the real-world economy. The value of a perfect competition framework is only accurate to the
extent that it reflects actual conditions.

One notable feature of perfect competition is low profit margins. All consumers have access to the
same products so they naturally gravitate toward the lowest prices. Firms can't set themselves apart
by charging a premium for higher-quality products and services. It would be impossible for a
company like Apple (AAPL) to exist in a perfectly competitive market because its phones are more
expensive than those of its competitors.

Another issue is the absence of innovation. The prospect of greater market share and setting
themselves apart from the competition is an incentive for firms to innovate and make better
products. No firm possesses a dominant market share in perfect competition.

What Is Competitive Equilibrium?

Competitive equilibrium is a condition in which profit-maximizing producers and utility-maximizing

consumers in competitive markets with freely determined prices arrive at an equilibrium price. At
this equilibrium price, the quantity supplied is equal to the quantity demanded. In other words, all
parties—buyers and sellers—are satisfied that they're getting a fair deal.

Key Takeaways

 Competitive equilibrium is achieved when profit-maximizing producers and utility-

maximizing consumers settle on a price that suits all parties.

 At this equilibrium price, the quantity supplied by producers is equal to the quantity
demanded by consumers.

 The theory serves many purposes, including as an analytical tool and a benchmark for
efficiency in economics.

 Perfect Competition vs. Monopoly

 The opposite of perfect competition is a monopoly in which a single company controls the
supply of a certain product. Consumers can't go elsewhere if the price is too high in
monopoly conditions. They can only decide not to buy the product.
 The monopolistic firm can simply set a price point that maximizes its profits rather than
setting prices by supply and demand. Some types of firms are considered natural
monopolies because there's a significant first-mover advantage that discourages
competitors from entering the market. Other monopolies may be established through
government actions or by cartels such as OPEC.

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 KEY POINTS:

 A monopoly is a firm that is the sole seller in its market. A monopoly arises when a single
firm owns a key resource, when the government gives a firm the exclusive right to produce
a good, or when a single firm can supply the entire market at a lower cost than many firms
could.

 Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at
which marginal revenue equals marginal cost. The monopoly then chooses the price at
which that quantity is demanded. Unlike a competitive firm, a monopoly firm’s price
exceeds its marginal revenue, so its price exceeds marginal cost.

 A monopolist’s profit-maximizing level of output is below the level that maximizes the sum
of consumer and producer surplus. That is, when the monopoly charges a price above
marginal cost, some consumers who value the good more than its cost of production do not
buy it. As a result, monopoly causes deadweight losses.

 Policymakers can respond to the inefficiency of monopoly behavior in four ways. They can
use the antitrust laws to try to make the industry more competitive. They can regulate the
prices that the monopoly charges. They can turn the monopolist into a government-run
enterprise. Or, if the market failure is deemed small compared to the inevitable
imperfections of policies, they can do nothing at all.

 Monopolists often can raise their profits by charging different prices for the same good
based on the buyer’s willingness to pay. This practice of price discrimination can raise
economic welfare by getting the good to some consumers who otherwise would not buy it.
In the extreme case of perfect price discrimination, the deadweight losses of monopoly are
completely eliminated. More generally, when price discrimination is imperfect, it can either
raise or lower welfare compared to the outcome with a single monopoly price.

 QUESTIONS

 what characteristics make a market competitive.

 how competitive firms decide how much output to produce.

 how competitive firms decide whether to exit or enter a market.