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Market Structure

The analysis of market structures is of great importance when studying


microeconomics. How the market will behave, depending on the number of buyers or
sellers, its dimensions, the existence of entry and exit barriers, etc. will determine how
an equilibrium is reached. Even though market structures were thoroughly analysed by
economists from the early 20th century on, its study can be traced back to economists
such as Antoine Cournot, Alfred Marshall or even Adam Smith.

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
interaction and differences between these aspects allow for the existence of several
market structures, from which we can highlight the following:

a. Perfect competition: the efficient market where goods are produced using the most
efficient techniques and the least amount of factors. This market is considered to be
unrealistic but it is nevertheless of special interest for hypothetical and theoretical
reasons.

Perfect competition or competitive markets -also referred to as pure, or free


competition-, expresses the idea of the combination of a wide range of firms, which
freely enter or leave the market and which considers prices as information, since each
bidder only provides a relative small share of the good to the market and thus do not
exert a noticeable influence on it. Therefore, perfect competitors cannot influence the
levels of market clearing prices. Also, buyers are numerous and disperse, which also
means that they cannot influence prices.

This market model is based on a set of assumptions, each of them representing a


necessary but insufficient condition to ensure perfect competition. These assumptions
are:

-Homogeneous product: all firms offer the same goods, with the same characteristics
and quality as the others, without any variations.

-Large number of agents: there should be a sufficient quantity of buyers and sellers, so
that no action from a single agent will affect the market structure or its prices.
-No entry or exit barriers: there has to be free entry and exit of agents in the market.
This assumption is of special interest for firms, which must be able to enter or leave the
market freely.

-Price flexibility: price adjustments to changes happen as fast as possible. Usually, price
changes are assumed instantaneous.

-Free and perfect information: all agents have perfect knowledge of products and their
prices, and everything else related to them, as well as free access to this information.

-Perfect factor mobility: all factors should be able to change so adjustments processes
can be carried out with the greatest efficiency.

-No government intervention: markets should be left alone as government intervention


would only lead to imbalances in perfectly competitive markets.

Perfect competition markets are almost impossible to find in the real word as all markets
have some type of imperfection. This is the reason they are mostly considered only
theoretically. However, its study helps understand real world markets and their
phenomena.

It must be noted that the theory of contestable markets, developed by William J. Baumol
in his “Contestable Markets: An Uprising in the Theory of Industry Structure”, 1982, that
perfect competition prices and output can be reached with just a few of these
assumptions. Furthermore, Bertrand’s duopoly model determines
that oligopolistic markets can reach the same prices as in perfect competition as long as
oligopolists compete by changing their prices, instead of the quantity offered.

b. Imperfect competition or imperfectly competitive markets is one in which some of


the rules of perfect competition are not followed. Virtually, all real world markets follow
this model, as in practice, all markets have some form of imperfection. When dealing
with imperfect competition the equilibrium price can be influenced by the actions of
agents. In imperfect competition the price of goods can increase above their marginal
cost and thus have customers decrease their level of purchase, and so reach inefficient
levels of production. Governments try to avoid these situations and take measures to
stop imperfect competition.

The most common forms of imperfect competition


include: monopolies, oligopolies, duopolies, monopolistic competition and monopsony.

Roy Harrod was the first economist to develop the theory of imperfect competition and,
other authors, such as Edward Chamberlin and Joan Robinson renewed its interest and
made major contributions. Nevertheless, it is important to point out that Cournot, in his
“Researches into the Mathematical Principles of the Theory of Wealth”, 1838, was the
first to model this kind of markets.

b.1. Monopoly (from the greek «mónos», single, and «polein», to sell) is a form
of market structure of imperfect competition, mainly characterized by the existence of a
sole seller and many buyers. This kind of market is normally associated
with entry and exit barriers.

Types of monopolies:

Multiplant monopoly: firms which have many production plants and hence different
marginal cost functions will have to choose the individual output level for each plant.

Bilateral monopoly: this market structure consists of a single buyer (monopsony) and
a single seller (monopoly). Depending on who has greater negotiation power there can
be different outcomes. Two possible scenarios may be in either one of them having all
of the power, an intermediate solution may be found or a vertical integration may occur.

Multiproduct monopoly: instead of selling one product, the monopoly sells several.
The firm will have to take into account how the changes in the price of one affect the
rest of its products.

Discriminating monopoly: firms may want to charge different prices to different


consumers, depending on their willingness to pay. Depending on the level of
discrimination we have different degrees. The first degree or perfect discrimination is
given when the monopolist sets the highest price that each consumer is willing to be
pay. The second degree or nonlinear price fixing is given when price depends on the
amount bought by the consumer. And finally, the third degree or market segmentation of
price discrimination occurs when there are several differentiated consumers segments
to which the firm will apply different prices, e.g. student or third age discounts.

Natural monopoly: this kind of monopoly occurs in industries in which, due to cost-
technological factors, it is more efficient to have a single firm dealing with all of the
production, as average costs are lower in the long run; a phenomenon known
as subadditivity.

b.2.Oligopoly (from the Greek «oligos», few, and «polein», to sell) is a form of market
structure that is considered as half way between two extremes: perfect
competition and monopolies. This kind of imperfect competition is characterized by
having a relatively scarce amount of firms, but always more than one, which produce a
homogeneous good. Due to the small number of firms in the market, the strategies
between firms will be interdependent, thus implying that the profits of an oligopolistic
firm will highly depend on their competitors’ actions.
Firms in oligopolistic market can have a wide range of behaviour patterns making it
difficult to have a single model. Static models are used as they present a simple way of
analysing equilibriums in this market. However, the maximisation problem faced by the
firm will be marked by the different strategic interdependence context in which that
market works. Therefore, the firm must estimate and collect the reactions of its
competitors in its optimisation problem to choose the best strategy to follow. As a result
we must propose a conjectural variation on how competitors modify their behaviour as
the firm varies strategies.

For simplicity purposes, oligopolies are specially studied in cases in which there are
only two competitors in the market. These are known as duopolies and its analysis and
conclusions can be extrapolated for oligopolies.

b.2.1Duopoly (from the Greek «duo», two, and «polein», to sell) is a type of oligopoly.
This kind of imperfect competition is characterized by having only two firms in the
market producing a homogeneous good. For simplicity purposes, oligopolies are
normally studied by analysing duopolies. What strategies firms follow and their
interactions are a key feature of this market structure.

In duopolies there are two variables of interest: the prices set by each firm and
the quantity produced by each firm. Several models have been developed through time,
from which we must highlight the Cournot, Stackelberg, Bertrand and
the Edgeworth solution. The first two models seek the optimum quantity a firm should
produce. Both have different conclusions as they have a different initial assumption.
With time, and as the next two models proved, the focus changed to target the optimum
price a firm should set in order to maximise profits.

b.3. Monopolistic competition is a market structure defined by four main


characteristics: large numbers of buyers and sellers; perfect information;
low entry and exit barriers; similar but differentiated goods. This last one is key to
distinguish monopolistic competition from perfect competition since in the latter all
products are homogenous. This product differentiation leads consumers to perceive
products in this market as unique, providing firms with a monopolistic-like property that
enables them having price-making power. There is a distinction to be made between
horizontally and vertically differentiated products in order to be able to understand
different strategies that monopolistic firms might adopt. The former is given when
consumers base their purchasing decision on subjective preferences when comparing
products, e.g. colours or flavours. The latter occurs when the product can be evaluated
with another one in terms of measurable and qualitative factors, e.g. technological
differences or technical properties in engines.

BUYERS CONTROL
b.4. Monopsony (from the greek «mónos», single, and «opsõnía», purchase) is
a market structure form of imperfect competition characterized by the existence of a
unique buyer and many sellers. It is a similar case to monopoly but were the
monopolistic powers come from the demand side and not from the supply one. Joan
Robinson first coined this term in her book “The Economics of Imperfect Competition”
1933.

There are not many cases of real monopsonies in the world, however the many occur in
any input market. Examples of this include the one of the United States over defence
and security assets in the economy, which started during the cold war. Nevertheless,
the most significant case analysed is monoposony in the labour market. Frictions
between the job searching progress and joining to it, causes employees to be
uncomfortable about leaving their workplace.

This position gives the employer monopsonist powers and allows them to push wages
down to the marginal revenue product providing them with higher
profits. Governments have the possibility to set a minimum wage to prevent wages
dropping to very low levels.

Markets with the same features as monopsonies but where there are more than one
buyer, being the number of buyers still small enough, are known as oligopsonies.

b.5. Oligopsony (from the greek «oligoi», few, and «opsõnía», purchase) is a market
structure form of imperfect competitioncharacterized by the existence of a relative small
number of buyers, and many sellers. It is a similar case to oligopoly but were the
oligopolistic powers come from the demand side.

In this Learning Path we’ve learned the basics about the main market structures.
Starting with perfect competition, and imperfect competition, which includes monopolies,
oligopolies and monopolistic competition. We’ve learned also about market structures
where it’s the buyers who have price-setting power, such as monopsonies and
oligopsonies.
Republic of the Philippines
Province of Sorsogon
Sorsogon State College
Engineering-Architecture Department
A.Y. 2017-2018

Market Structure

Submitted by:

RACHEL L. DOLLISON

BS Architecture 5A

Submitted to:

Instructor