Four Types of Market Structures

 

            There are four types of market structures: perfect completion, monopolistic competition,
oligopoly, and monopoly. Each city is made up of a variety of each of these structures. In order to better understand how the city’s economy works, it is important to have a working knowledge of each of these market structures. Each structure has differing characteristics which will be analyzed in detail along with a look at how price elasticity, barriers to entry, the role of government, and international trade are affected in each structure. As the mayor of Example City, the more you know about each market structure, the better you can understand how your city runs and make better economical choices for it.

A Detailed Look at Each Market Structure

            In this section we will look at each of the four market structures and discuss the differing
market characteristic of each.

Perfect Competition

            A perfect competition is a market structure in which there are many buyers and sellers of products that are equal in quality and value. There are no barriers of entry or exit of the industry. All products in this structure are homogeneous, meaning they are created equally and demanded equally, which means no one firm can have more market power.  Since there is no market power no single product will have any effect on market price, consequently all firms will sell at an equal price and can sell as much as they desire.

 

            “As in the name ‘perfect’ competition, this type of market structure would be ideal, yet it is only theoretical” (VanAssen, 2013). There are no examples of this type of structure in your city, although this structure is very useful to look at as a point of reference.

Monopolistic Competition

            Similar to perfect competition, there are many buyers and sellers in the monopolistic competition structure; the difference is the products that are being produced are differentiated, meaning they are not equal in quality and value. Also, like the perfect competition, there are no barriers to entry or exit of the industry in this structure. In this type of structure there will be firms that hold more market power than others. One way for firms to increase their market power is through brand loyalty, they can also do this through creating higher quality products or setting more competitive prices. There are many examples of monopolistic competition throughout Example City.

Oligopoly

            “An oligopoly is a market structure where there are only a few firms in the market or the market is dominated by only a few firms” (VanAssen, 2013). Unlike perfect competition and monopolistic competition, there are barriers of entry into the industry under this structure. Oligopoly can be separated into two categories: pure oligopoly and differentiated oligopoly. A pure oligopoly is more like the perfect competition in which all products being produced are equal; a differentiated oligopoly is like the monopolistic competition where the products are differentiated by quality, value or demand.

What is this a picture of? Did you say a Band-Aid? Actually it is an adhesive bandage and Band-Aid is the leading brand that markets them.

            As this type of market structure may be a little more difficult to comprehend, we will look at a short example of a differentiated oligopoly. Think facial tissue . . . chances are one word popped into your head . . . Kleenex. There are many producers of facial tissue, every grocery store carries their own brand of tissue: Meijer brand, Spartan brand, Great Value (Walmart), yet Kleenex is such a dominate brand of facial tissue that even if a consumer buys another brand of tissue, they generally call the product a Kleenex. Yet this is not a monopoly, which we will discuss next, because there are two majorly competitive brands in facial tissue, Kleenex and Puffs. In this market structure the dominant competitors have market power and can raise market price to increase profit. Brand loyalty will keep consumers purchasing their products even if the prices are raised.

Monopoly

            The last market structure we will look at is a monopoly. A monopoly is a structure in which there is only one seller of a specific product and there are no other competitors that offer a close substitution. In this structure the seller has very high market power and can set prices as high as they desire. There are many barriers in this structure making it difficult for other firms to enter the industry.

            A real-life example of a monopoly in Lowell, Michigan is Meijer. Before Meijer was built in Lowell, there was a Family Fare store; the size, variety of products, and low prices of Meijer drove Family Fare out of business. After Family Fare closed, Meijer was the only grocery/department store in town and quickly raised its prices. Residents of Lowell are forced to pay the ever increasing prices because Meijer has no competition in town. There are many other clothing stores, convenience stores, and a few dollar stores in town, yet nothing compares to the convenience of having everything located in this ‘One Stop Shop’.

How Do High Entry Barriers Influence Long Run Profitability

            High entry barriers come with the oligopoly structure and the monopoly structure; the barriers of entry are increased because products are differentiated and considered to be better than other products on the market. Once a company has increased market power due to their differentiated products, they have to power to keep other businesses out of the market. “If a firm is able to successfully differentiate its product so that consumers don’t consider the products of other firms close substitutes, the firm will be able to earn a long-run economic profit because it can keep would-be competitors out of its segment of the market” (Amacher & Pate, 2013). The less competition a firm has higher its long run profit will be because more consumers are purchasing their products.

Competitive Pressures of Markets with High Barriers to Entry

            There are many types of barriers to entry in an industry; there are natural barriers, artificial barriers, government barriers, social barriers, and institutional barriers. Some of the most common natural barriers would be costs, the size of the firm and the size of the market. Some artificial barriers could be violence, patents, or other legal barriers. Government regulations can cause some very difficult barriers to entry (such as liquor licensing for bars or restaurants).

            When looking at terms of barriers of entry in the industry in your city, you may also want to look at social and institutional barriers such as “networks or resources, access to an appropriate workforce, political stability, culture, norms, and values” (Robinson, 2005). There also becomes a higher barrier when you are looking at the inner city area; “The persistent drain of resources from the ghetto prevents the inner city from accumulating significant amounts of capital [. . .] The lack of capital is the most important barrier to inner city economic development” (Robinson, 2005).

            These barriers to entry create high competitive pressures within the market. The firms that are on top of the market need to work tirelessly to remain on top and keep their competitive edge while enforcing the barriers to keep other competition out. At the same time new firms that desire to enter the industry have a great competitive pressure to try and wedge through the barriers and begin to climb the ladder of the market.

The Effects of Price Elasticity of Demand on Each Market Structure

            In a perfect competition price elasticity is perfectly elastic; prices do not very with product output. Since all products are considered equal in a perfect competition a firm that raises prices will sell less products because consumers can purchase equal substitutions at a lower cost; at the same time if these firms lower their prices, they are lowering their profit because they would sell just as many products at a higher cost. A monopoly produces more products when demand is elastic and raises prices when demand is inelastic. In a monopoly structure there is no competition and no equal substitutions, therefore when demand is inelastic consumers will pay any cost that is set for the product.

            In a monopolistic competition products are differentiated; demand elasticity depends on the amount of differentiation between products. When the differentiation is slight, the demand is very elastic, when products are highly differentiated demand is less elastic. The less elastic the demand is, the higher the firm can set its prices and the more likely consumers will be to pay those higher prices. “A monopolistically competitive firm’s pricing decisions depend on the elasticity of demand which is in turn determined by the number of close substitutes to the good in the market. Therefore, product differentiation can be a sign of market power” (Inanc, 2007). In an oligopoly market structure demand “becomes more inelastic by developing customer loyalty” (Amacher & Pate, 2013). “Given an oligopolistic market structure, a firm specific shock does not only influence that firm’s prices but all other firm’s prices as well” (De Stefano, 2005).

The Role of Government in Market Structures

            Again, a perfect competition is only a theoretical structure and generally considered to be free of government regulation. The government would have no effect on the pricing of products in this market. Government regulations are also slight in a monopolistic competition. The product differentiation in this structure is the cause of the price difference, not government regulation. On the other hand government regulations can be high in monopoly and oligopoly structures. Both of these structure are more likely to be government supported and welcome the aid of the government in creating barriers to entry into the industry. As discussed earlier, the more barriers to entry into the market, the higher these firms can set their prices because of the lack of competition. Yet, there can be problems with government regulations as well; Mr. Richard Epstein, a professor at the University of Chicago Law School, states “Whenever the government intervenes in the economy, there is a chasm between high purpose and overzealous application” (1998). He argues that “with interconnectivity, monopoly pricing could at worst result in 15% to 20% increase in total consumer cost” (Epstein, 1998).

International Trade and Market Structures

            Trade costs can be “imposed by policy [in way of] tariffs and quotas, or imposed by environment [such as] transportation costs, insurance costs, and time” (Inanc, 2007). In a perfect competition, international trade, again, does not affect the pricing of products as all products are created equally. Yet, in the remaining markets, “market structure has an important impact on international price dispersion” (Inanc, 2007). “Bigger markets [such as monopolistic competition markets] exhibit higher levels of product variety and host more productive firms that set lower markups and lower prices” (Inanc, 2007).

            In a monopolistic or oligopolistic market structure there may be much higher trade costs associated with international products. Government regulations are highly utilized in these structures and can be used to limit the amount of products that are imported with tariffs and quotas. “Price dispertion [,in these market structures, are] determined by trade cost, good specific characteristics, taxes, and markup differences” (Inanc, 2007).

Summary

Having a wider knowledge of the market structures that make up your city will give you, as mayor, a much better understanding of how your city works and what economic impact these structures have. You will not see a perfect competition market structure in your city, but it gives you a good point of reference when looking at the other structures around. Monopolistic competition will be very common around the city as many firms may offer similar products, yet these products are differentiated by customer loyalty and some firms will fare better than others.

Oligopolies will also be a large part of your city, waste management, telephone companies, and cable companies are good examples of these structures. Oligopolies have strict government regulations on rates and product pricing that will help to keep these structures running smoothly. There will also likely be a few monopoly structures throughout the city as well. These markets will also need to support of the government in order to create barriers of entry into their industry and maintain their monopolistic control.

In conclusion, “you can succeed in any market where there is high demand and complexity, where there are significant barriers to entry and where you have sustainable competitive advantages, as long as you are running the business efficiently” (Waidmann, 2001). Please use your new found knowledge to aid in the economic and market growth of your city.

 

Amacher, R., & Pate, J. (2013). Microeconomics Principles and Policies. San Diego, CA: Bridgepoint Education, Inc.

De Stefano, M. (2005). Essays on the Impact of Oligopoly on International Trade. Boston University, UMI Dissertation Publishing. Retrieved from Proquest database. Document ID: 305033087.

Epstein, R. (1998, July 06). Monopoly is Bad. Trustbusting Can be Worse. Wall Street Journal, p. A14. Retrieved from Proquest database. Document ID: 398702474.

Inanc, O. (2007). The Microeconomics of International Price Dispersion. Louisiana State University and Agricultural & Mechanical College; UMI Dissertation Publishing. Retrieved from Proquest database. Document ID: 304845486.

Robinson, J.A. (2005). An Economic Sociology of Entry Barriers: Business Entry and the Inner City Market. Retrieved from Proquest database. Document ID: 305016025.

VanAssen, K. (2013, November 16). Re: Market Structure: KV-DQ1 [Online forum comment]. Retrieved from http://classroom.ashford.edu.

Waidmann, R.S. (2001, April 16). Service Providers Profiles – Insider Information. VARbusiness 17(08), p. 83. Retrieved from Proquest database. Document ID: 194198532