Explained: What is a market structure and its significance?
Market structure describes the features of a market that influence how businesses operate in its function.
Market structure describes the features of a market that influence how businesses operate in its function. These characteristics include the number and size of companies operating in the market, the degree of product differentiation, entry and exit barriers, and the level of market dominance possessed by specific companies.
Both policymakers and business owners must understand the market structure to make decisions about pricing policies, competition policies, and investment decisions. The sort of market structure in a sector has a big impact on how businesses function, how markets work, and how consumers are regarded.
There are four main types of market structures:
- Perfect competition
- Monopolistic competition
Let’s understand each of them in detail:
Perfect competition is a market structure in which many small firms are selling identical products and there are no barriers to entry or exit from the market. Firms in a perfectly competitive market are price takers, which means they have no control over the market price of their products.
Characteristics of Perfect Competition:
- Homogeneous Products: In a perfectly competitive market, all firms create identical products, and consumers believe them to be the same. This ensures that buyers have complete knowledge about the products and can simply move between providers based on price or quality.
- Large Number of Buyers and Sellers: There are many buyers and sellers in a perfectly competitive market, and no single buyer or seller can affect the market price. This ensures that market prices are controlled by supply and demand dynamics rather than by the actions of specific enterprises.
- Perfect Information: All buyers and sellers in a perfectly competitive market have perfect information about the market, including prices, quality, and availability of products. This guarantees that pricing are transparent and that customers can make informed purchasing decisions.
- Free Entry and Exit: There are no entry or exit barriers in a perfectly competitive market. This means that if new firms see a profit opportunity, they can easily enter the market, and existing firms can exit if they are unable to compete.
- No Non-Price Competition: Firms only compete on price in a perfectly competitive market. There is no advertising, branding, or other non-price competition. This guarantees that resources are distributed properly and that enterprises cannot use advertising or branding to create artificial barriers to entry.
Let's have a look at an example:
There may be several small farms selling the same sort of product, such as tomatoes or apples, at a local farmer's market. Consumers can readily switch farms based on price or quality because the goods are identical. Because there are so many local farms, none has market power, and they must accept the market price for their produce. Furthermore, there are no barriers to entry or exit from the market, making it relatively easy for new farmers to participate or existing farmers to exit the market.
To summarize, perfect competition is a market structure in which numerous small enterprises compete with one another and no single firm has the market power to influence prices. The agricultural industry is an example of a market that exhibits several characteristics of perfect competition.
Monopolistic competition is a market structure in which many small firms are selling differentiated products, with some barriers to entry and exit from the market.
Characteristics of Monopolistic Competition:
- Differentiated Products: Firms sell products that are distinct from those of their competitors in a monopolistic competitive market. This permits enterprises to charge slightly varying prices while maintaining some market share.
- Large Number of Buyers and Sellers: In a monopolistic competitive market, there are numerous buyers and sellers, but no single buyer or seller can affect the market price. This ensures that the market price is set by supply and demand dynamics rather than by the actions of particular enterprises.
- Some Barriers to Entry and Exit: There are several hurdles to entry and exit in a monopolistic competitive market, such as brand loyalty, advertising, and economies of scale. This means that while new firms can enter the market, they may find it more difficult to compete with existing firms.
- Non-Price Competition: Firms can compete on non-price criteria such as advertising, branding, and customer service in a monopolistic competitive market. This enables businesses to differentiate their offerings and gain market share.
- Imperfect Information: Buyers and sellers in a monopolistic competitive market do not have perfect information about the market, including prices, quality, and availability of products. This may result in some market inefficiencies.
Here’s an example:
The smartphone industry is an example of a monopolistic competitive market. Several companies compete in this market, including Samsung, Xiaomi, Apple, Vivo, Oppo, and others. Each company offers a slightly different product, and they adopt numerous marketing methods to set themselves apart from their competition. For example, Samsung provides premium phones with high-end features, whereas Xiaomi provides budget-friendly phones with comparable features at lower prices.
Monopolistic competition, in summary, is a market structure that allows enterprises to differentiate their products and gain some market share while still competing with other firms. The smartphone business is an example of a market with many monopolistic competition features.
Oligopoly is a market structure in which a few large firms dominate the market and have significant market power, with high barriers to entry and exit.
Characteristics of Oligopoly:
- Few Large Firms: In an oligopolistic market, a few large enterprises dominate the market and control a considerable share of the total output.
- Interdependence: The actions of one firm in an oligopolistic market can have a major impact on the market share and profitability of the other competitors. As a result, when making strategic decisions, each corporation must consider the actions of its competitors.
- Barriers to Entry and Exit: There are substantial barriers to entry and exit in an oligopolistic market. Among these barriers include economies of scale, patents, government regulations, and hefty entry costs. This makes it difficult for new enterprises to enter the market and compete with established firms.
- Product Differentiation: To gain market share and boost profits in an oligopolistic market, enterprises may differentiate their products from those of their competitors.
- Non-Price Competition: To differentiate their products and acquire market share in an oligopolistic market, firms may compete on non-price variables such as advertising, branding, and customer service.
Here is an example:
The automobile industry is an example of an oligopolistic market. Only a few huge corporations, such as Maruti Suzuki, Tata Motors, and Hyundai, dominate the market and control a sizable portion of the overall output. These companies make strategic decisions, taking into account their competitors' actions when deciding on price, production, and advertising methods. Due to the requirement for substantial quantities of capital, advanced technology, and strong brand awareness, the market has high entrance and exit barriers. Furthermore, companies differentiate their products through branding, design, and features, and compete for market share through non-price rivalry.
In summary, an oligopoly is a market structure in which a few large firms dominate the market, and have significant market power. The automobile industry is an example of a market that exhibits many of the characteristics of an oligopoly.
Monopoly is a market structure in which there is only one firm that controls the entire market for a particular product or service.
Characteristics of Monopoly:
- Single Firm: In a monopoly, there is only one firm that controls the entire market for a particular product or service.
- No Close Substitutes: There are no close substitutes for the firm's product or service under a monopoly. This provides the corporation with enormous market power, allowing it to set prices and manage output levels.
- High Barriers to Entry: A monopoly has high entry barriers, making it difficult for new enterprises to enter the market and compete with the existing firm. Patents, hefty entry costs, economies of scale, and government regulations are examples of these barriers.
- Price Maker: The enterprise has considerable market power in a monopoly, allowing it to operate as a price maker rather than a price taker. Rather than accepting the market price, the corporation can determine its prices to maximise profits.
- No Competition: In a monopoly, there is no competition from other firms in the market.
Let’s have a look at an example:
An example of a monopoly is the Power Grid Corporation of India Limited (PGCIL). PGCIL is a government enterprise that manages India's power transmission network. It has a monopoly on energy transmission in India, and there are no other major competitors in this market. Because of its large market share, PGCIL can oversee the transmission network, set pricing, and control the flow of electricity without experiencing considerable competition from other companies. However, other types of electricity generation, such as coal-fired power plants, hydroelectric power plants, and solar power plants, compete with PGCIL.
In summary, a monopoly is a market structure in which there is only one firm that controls the entire market for a particular product or service. PGCIL is an example of a market that exhibits many of the characteristics of a monopoly.
To summarize the market structure with the context of investment decisions, in the environment of perfect competition, it is difficult to generate a return on the invested capital as the barriers to entry and exit are minimal and the product sold is also identical resulting in low margin businesses. On the other hand, investing in companies in monopolistic competition can generate a higher yield if the investor can identify the different dynamics such as prices, quality, and availability of products that the company is offering. However, finding the right investment can be difficult because there are a large number of players in this structure.
Investors have a better chance of generating a higher return in the Oligopolistic companies given that they can find a company with a strong outlook with increasing market share. Investing in a monopoly can also benefit investors, however, should look for any regulatory concerns about the company as the government does not promote the monopoly of private companies.