In this article, we will explain the market structure based on the number of suppliers and buyers for goods and services. You will learn about the different types of market structures, the important features of each structure, and the differences between them.
What is a market structure?
The market structure consists of a number of firms that supply goods and services and the consumers who buy these goods and services. This helps to determine the level of production, consumption, and also competition. Depending on this, market structures are divided into concentrated markets and competitive markets.
Market structure defines the set of characteristics that help us categorise firms depending on certain features of the market.
These features include but are not limited to: the number of buyers and sellers, the nature of the product, the level of barriers to entry and exit.
Important features of market structure
The market structure consists of several features which we explain below.
Number of buyers and sellers
The main determinant of the market structure is the number of firms in the market. The number of buyers is also very important. Collectively, the number of buyers and sellers not only determines the structure and level of competition in a market but also influences the pricing and profit levels for the firms.
Barriers to entry and exit
Another feature that helps determine the type of market structure is the level of entry and exit. The easier it is for firms to enter and exit the market, the higher the level of competition. On the other hand, if the entry and exit are difficult, competition is much lower.
Perfect or imperfect information
The amount of information the buyers and sellers have in the markets also helps to determine the market structure. Information here includes product knowledge, production knowledge, prices, substitutes available, and the number of competitors for the sellers.
Nature of the product
What is the nature of a product? Are there any or close substitutes available for the product? Are the goods and services easily available in the market and are they identical and uniform? These are a few questions that we can ask to determine the nature of a product and therefore the market structure.
Price levels
Another key to identifying the type of market structure is to observe the price levels. A firm may be a price maker in one of the markets but a price taker in another. In some forms of markets, firms may have no control over the price, though in others there might be a price war.
The market structure spectrum
We can understand the spectrum of the market structure along a horizontal line between two extremes starting with the perfectly competitive market and ending with the least competitive or concentrated market: monopoly. In between these two market structures, and along a continuum, we find Monopolistic Competition and Oligopoly. Figure 1 below shows the spectrum of market structures:
This would be the process from left to right:
1. There is a gradual increase in the market power of each firm.
2. Barriers to entry increase.
3. The number of firms in the market decreases.
4. Firms’ control over the price level increases.
5. The products become more and more differentiated.
6. The level of information available decreases.
Let’s take a closer look at each of these structures.
Perfect competition
Perfect competition assumes that there are many suppliers and buyers for goods or services, and the prices are therefore competitive. In other words, firms are ‘price-takers’.
These are the key features of perfect competition:
There are a large number of buyers and sellers.
Sellers/producers have perfect information.
Buyers have perfect knowledge of the goods and services and the associated prices on the market.
The firms have no barriers to entry and exit.
The goods and services are homogeneous.
No firm has supernormal profits due to low barriers to entry and exit.
The firms are price takers.
However, this is a theoretical concept and such a market structure rarely exists in the real world. It is often used as a benchmark to assess the level of competition in other market structures.
Imperfect competition
Imperfect competition means there are many suppliers and/or many buyers in the market, which influences the demand and supply of the product thereby affecting the prices. Usually, in this form of market structure, the products sold are either heterogeneous or have some dissimilarities.
The imperfectly competitive market structures consist of the following types:
Monopolistic competition
Monopolistic competition refers to many firms supplying differentiated products. Firms may have a similar range of products, though not identical as in perfect competition. The differences will help them to set different prices from each other. The competition may be limited and firms compete to get buyers via lower prices, better discounts, or differentiated advertisements. The barrier to entry and exit is relatively low.
In the UK, there are many broadband providers like Sky, BT, Virgin, TalkTalk, and others. All of these providers have a similar range of products and services. Let’s assume Virgin has an added advantage over others like a better reach, a higher consumer volume which helps them to give lower prices, and also better speed. This makes Virgin get even more consumers. However, that doesn’t mean that others like Sky, BT, and TalkTalk don’t have customers. They may get the customer with better schemes or lower prices in the future.
Oligopoly market
Why aren’t all the pharmaceutical companies researching the Covid-19 vaccines also providing medicines? Why do Astrazeneca, Moderna, and Pfizer have the right to provide vaccines in the UK? Well, this is a classic example of the oligopoly market in the UK. As we all know, only a few firms have the government and WHO approval to produce the Covid-19 vaccines.
In the oligopoly market, there are a handful of firms that are dominant and there is a high barrier to entry. This may be because of the government restrictions, the given standard of production, the capacity of production for the firm, or the level of capital required. Oligopolists may enjoy supernormal profit for quite some time.
Monopoly market
Monopoly market structure also falls under the category of imperfect competition and is the extreme form of market structure. A monopoly market structure occurs when the firm is the sole supplier of the goods and services and is leading the demand and supply game.
In a monopoly market, suppliers are the price makers and consumers are the price takers. There may be a major barrier to entry into this type of market, and a product or service may have a unique edge that allows it to enjoy a monopoly position. Monopoly firms enjoy supernormal profit for a long period due to high barriers to entry. Even though such kinds of markets are controversial, they are not illegal.
Concentration ratios and market structures
The concentration ratio helps us to distinguish the different market structures in economics. The concentration ratio is the collective market share of the major firms in the market of the industry.
The concentration ratio is the collective market share of the major firms in the market of the industry.
How to calculate and interpret a concentration ratio
If we have to find out the market share of the four largest leading individual firms in the industry, we can do so using the concentration ratio. We calculate the concentration ratio using this formula:
Where ‘n’ stands for the total number of largest individual firms in the industry and T1, T2 and T3 are their respective market shares.
Let’s find the concentration ratio of the largest providers of broadband services in the UK. Let’s assume the following:
Virgin has a market share of 40%
Sky has a market share of 25%
BT has a market share of 15%
Others have a market share of the remaining 20%
Then, the concentration ratio of the largest firms providing the broadband service in the example above would be written as:
3: (40 + 25 + 15)
3:80
Distinguishing between different market structures
As we learned above, every form of market structure has a distinguishing characteristic and each characteristic determines the level of competitiveness in the market.
Here you have a summary of the distinguishing features of each market structure:
| Perfect competition | Monopolistic competition | Oligopoly | Monopoly |
1. Number of firms | A very large number of firms. | A large number of firms. | A few firms. | One firm. |
2. Product nature | Homogeneous products. Perfect substitutes. | Slightly differentiated products, but not perfect substitutes. | Homogeneous (pure oligopoly) and Differentiated (differentiated oligopoly) | Differentiated products. No close substitutes. |
3. Entry and exit | Free entry and exit. | Relatively easy entry and exit. | More barriers of entry. | Restricted entry and exit. |
4. Demand curve | Perfectly elastic demand curve. | Downward-sloping demand curve. | Kinked demand curve. | Inelastic demand curve. |
5. Price | Firms are price takers (single price). | Limited control over price. | Price rigidity due to fear of price wars. | The firm is the price maker. |
6. Selling costs | No selling costs. | Some selling costs. | High selling posts. | Only information selling costs. |
7. Information level | Perfect information. | Imperfect information. | Imperfect information. | Imperfect information. |
Market Structures - Key takeaways
Market structure defines the set of characteristics that allow the firms to be categorised depending on certain features of the market.
Market Structure can be classified on the basis of the following:
Number of buyers and sellers
Level of entry and exit
Level of information
Nature of Product
Price level
The four types of Market structures are:
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Concentration ratio is the collective market share of the major firms in the market of the industry
The spectrum of market structures has two extreme ends ranging from competitive market on one end to fully concentrated market on the other.
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