REPORT TOPIC:

Market Structure

BA 203
MACROECONOMICS & MICROECONIMICS

Submitted to:
PROF. SHERYLL MARIE B. ARUTA, MBM

Submitted by:
CHELSEA IRISH M. OGA
Report Outline:

 Definition of Market Structure

Market structure is best defined as the organizational and other
characteristics of a market. We focus on those characteristics which affect the
nature of competition and pricing – but it is important not to place too much
emphasis simply on the market share of the existing firms in an industry.

 Important features of market structure are:

1. The number of firms (including the scale and extent of foreign

competition)
2. The market share of the largest firms (measured by the concentration
ratio – see below)
3. The nature of costs (including the potential for firms to exploit economies
of scale and also the presence of sunk costs which affects market
contestability in the long term)
4. The degree to which the industry is vertically integrated - vertical
integration explains the process by which different stages in production
and distribution of a product are under the ownership and control of a
single enterprise. A good example of vertical integration is the oil
industry, where the major oil companies own the rights to extract from
oilfields, they run a fleet of tankers, operate refineries and have control of
sales at their own filling stations.
5. The extent of product differentiation (which affects cross-price elasticity
of demand)
6. The structure of buyers in the industry (including the possibility of
monopsony power)
7. The turnover of customers (sometimes known as "market churn") – i.e.
how many customers are prepared to switch their supplier over a given
time period when market conditions change. The rate of customer churn
is affected by the degree of consumer or brand loyalty and the influence
of persuasive advertising and marketing

 The Four Types of Market Structures

It is important to note that not all of these market structures exist in

reality; some of them are just theoretical constructs. Nevertheless, they are of
critical importance because they can illustrate relevant aspects of competing
firms’ decision making. Hence, they will help you to understand the underlying
economic principles. With that being said, let’s look at them in more detail.
1. 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. Probably the best example of a market with
almost perfect competition we can find in reality is the stock market. If you
are looking for more information on perfect competition, you can also
check our post on perfect competition vs. imperfect competition.

2. 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.

3. 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.

4. 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.

Perfect Contestable
Character Oligopoly Monopoly
Competition Market
One w/ pure
monopoly
No. of firms Many Few dominant Many
Effective duopoly
in many cases
Type of
Homogenous Differentiated Limited Differentiated
production
Low entry & exit
Barriers to entry None High High
cost
Price maker- Price maker – but
Price maker but constraint by actual and
Price taker
Pricing power interdependent demand curve potential
(passive)
behavior and possible competition limits
regulation pricing power