Economics 5A

Market Structures

A market structure is defined as the features that determine the performance and behaviour of firms in
the market. There are four main market structures: monopoly, oligopoly, monopolistic competition and
perfect competition.

Market Structures in the Economy

Monopoly Oligopoly Monopolistic Perfect competition

competition

The firm is the industry Competition amongst Competition among Many buyers and many
the few many firms sellers

In the economy there are four main market structures, at one extreme there is the monopoly, where
there is no competition as the firm is the industry. At the other extreme, there is perfect competition,
where there is total competition in the market. In between these extremes, there is the oligopoly,
where there is some competition amongst firms, and monopolistic competition, where there is even
more competition than in oligopoly. As we move from left to right on the spectrum of markets, the level
of competition amongst the firms increases. Monopoly, oligopoly and monopolistic competition are
considered imperfect competition.

Perfect competition

Perfect competition is a market structure in which there are many sellers in the industry and many
buyers, producing a homogeneous product. Because the product is identical buyers will buy from any
seller. There is perfect knowledge in this market, as all buyers and sellers are aware of the product, its
features, its price and other buyers and sellers. There is one price prevailing in the market and whatever
quantity of the product that firms produce in the market will be sold at that prevailing price. In this
market structure, no firm can influence price, as a firm’s output is only a small part of the total output of
the industry. The firm is therefore a price taker. The individual firm has no market power. There is
freedom of entry and exit. A new firm can enter the industry and start producing at any time. An existing
firm is free to leave the industry. Gas stations and the stock exchange are two of the best real world
examples of firms that fall under the perfectly competitive market structure.
Monopoly

A monopoly is a market in which there is only one seller and there are many buyers. In a monopoly the
firm is the industry. There is no competition, as the firm has no other firm to compete with. There are
many buyers of the product. The product is unique and has no close substitutes. There is imperfect
knowledge in this market as the buyers and sellers are not aware of all the information in the market.
The monopolist can only sell more at a lower price and, if price increases, less will be sold. The firm
produces the given quantity and sells it at the price the market is willing to pay. Or the firm might
choose a particular price and sell whatever it can at that price. The firm is therefore, a price maker.
Cement Company, National Water Commission and the Jamaica Public Service Company are all
monopolies.

Barriers to entry are anything that prevents new firms from entering and competing in an industry.
There is no free entry into the industry. Barriers to entry enable the firm to remain a monopolist, as no
new firms can enter and compete with the monopolist. Some barriers to entry are:

 Government regulations – these are the laws that prevent new firms from entering an industry,
for example, in Caribbean economies there is only one firm providing water, due to government
regulations.
 Patents – a patent grants the inventor exclusive rights to the patented product or process.
 Large capital outlay – that prevents smaller forms from entering an industry : for example oil
refining
 Ownership by the firm of a scarce factor of production – for example a firm that possesses the
knowledge of the secret ingredient of the recipe or factor capital.

Oligopoly

An oligopoly is a market structure in which there are few firms competing in the market. Examples of an
oligopoly in the region include: commercial banks and telecommunication companies.

In an oligopoly, there are few sellers and many buyers. The product might be homogeneous or
differentiated. There is imperfect knowledge in this market, as firms and buyers might not know all
sellers, buyers, prices and products available. Firms tend to avoid price competition and so prices remain
rigid or there is price stickiness. Price rigidity means that prices remain at a certain level over a long
period.

If firms increase prices, competition will not follow, and so the given firm will lose customers to its rivals
(market share and revenue will also decline). If the firm lowers prices, its competitors will also follow
and so the firm will not gain additional customers, market share or revenue. In fact, revenue will fall.
Cutting of prices will lead to price wars, which benefits none of the firms, only the customers. A price
war occurs when rival firms continuously reduce prices to undercut each other.
Oligopolies might choose to enter into agreement with, or collude with other firms to maximize profits.
Collusion occurs when there are price and quantity agreements with other firms.

A group of sellers colluding in this way is called a cartel. In many countries cartels are illegal. There are
high barriers to entry in this market, usually due to high set up costs. A private individual cannot simply
take a loan from a bank and set up a bank or oil refining company, as he does not have the knowledge or
the large capital outlay. The oligopoly is also a typical market structure in the real world, unlike perfect
competition and monopoly.

Monopolistic Competition

Monopolistic competition is a market structure in which there is competition amongst many firms. In
this market structure there are features of both perfect competition and monopoly. In this market
structure there are many buyers and many sellers, just as in perfect competition. The product is similar
yet differentiated through branding. This is product differentiation, which means, the product is made
to look different in the eyes of the consumer. This is usually achieved through packaging or even slight
differences in product features and, giving the products a brand name. The products are still close
substitutes. Product differentiation gives the individual firm some degree of market power. Example,
Grace Jerk seasoning, there is no substitute for Grace Jerk seasoning, even though other firms produce
jerk seasoning. (This is especially true for the loyal customers).

In monopolistic competition, there is imperfect knowledge in this market, as the buyers and sellers do
not have all the information on the product, its features, its price and the other buyers and sellers. As
with the monopolist, more can only be sold at a lower price and less is sold if the price increases. The
firm is therefore a price maker and can choose a given quantity to produce, and sell this at the price the
market is willing to pay. Alternatively, it can choose a price and sell whatever quantity it can at that
price. There might be some barriers to entry in this market, though they are not difficult to break
through. While pure monopoly and perfect competition are rare, monopolistic competition is more
common in the region and throughout the world. Some examples are restaurants, hair and beauty
salons, and supermarkets.

Monopolistic competition is therefore a combination of the monopoly market structure and perfect
competition.
 Monopoly Oligopoly Monopolistic Perfect
Competition Competition

Number of sellers One Few Many Many

Number of buyers Many Many Many

Many
Product Unique Homogeneous/ Differentiated Homogeneous
Differentiated

Knowledge of Imperfect imperfect Imperfect Perfect

market
Price Price makers Price makers with Price makers Price takers
price rigidity

Entry No free entry High barriers to Low barriers to Freedom of entry

entry entry

Example of Cement company Commercial Banks Auto/ auto parts Gas stations
market structure eg. NCB dealers