Understanding Different Market Structures and Their Impact

Posted on Dec 12, 2024 in Economy

Market Structures and Their Characteristics

Market Performance and Market Classes

  • Perfect Competition
  • Imperfect Competition:
    • Monopoly
    • Oligopoly
    • Monopolistic Competition

To understand these structures, the following characteristics are studied:

  • The degree of concentration: This is the number of bidders in a market. The greater the number of bidders, the lower the concentration. (Example: mobile phone companies. The more concentrated the market, the fewer phone companies there will be, possibly only one or two.)
  • The degree of product homogeneity: This refers to the differences in quality or design. If a good is perfectly consistent, it can be a substitute for other similar assets from other companies.
  • Barriers to entry: These are elements that hinder the entry of new firms into a market.
  • The existence of perfect information: This refers to the ability of consumers to find out about the products on the market at no cost.
  • Freedom of consumers and producers to enter and exit a market.

Monopoly

A monopoly is an imperfectly competitive market with a single bidder that caters to the entire demand. (Example: Iberdrola a few years ago)

There are root causes for the emergence of monopolies, including: ownership of patents, exclusive control of some kind of action, exclusive administrative concessions, etc.

In a monopoly, there would be no supply curve because there is only one bidder. To determine the balance, only the demand curve should be considered.

In perfect competition, the company is a price taker. In a monopoly, the firm is a price bidder as it sets the price to provide the greatest benefit. It can also determine the amount of product it wants to offer, always according to the price to be set, which will be determined by the demand curve.

Monopolistic Market Characteristics

Monopolies occur due to the high infrastructure costs needed to start certain businesses. The characteristics of a monopoly market are:

  • One supplier of a good: Due to the absence of other companies that manufacture substitutes for the product of the monopoly firm, it has the domain and can dictate prices that interest it and how much it will sell, but always taking into account demand.
  • Homogeneous product: Having a single bidder, there is no replacement for the product, as it only produces one.
  • Existence of entry barriers: These make it difficult for other companies to enter the market. Therefore, when there are excess profits, although other companies try to enter, attracted by them, they may not be able to. In these markets, it is possible to have sustained extraordinary profits.

The monopoly firm will also seek to obtain the maximum benefit, which will occur when MR = MC.

Oligopoly

An oligopoly is an imperfectly competitive market where a few firms control the supply without reaching agreements among themselves.

This is the most common type of market today. It has the following characteristics:

  • There are few bidders: The size of each firm is relatively large, and they are also closely interrelated with each other since variations in prices or quantities offered affect each other. As in the monopoly, the Qd is decreasing.
  • Homogeneous product: Oligopolistic firms compete with each other because there are few sellers, and the products they offer are substitutes for each other.
  • Existence of entry barriers: The companies in these markets are quite large and therefore require very high investment and high technology, so it is not easy for other companies to enter their markets.

The Cartel

If a company cuts its prices and other oligopolistic companies keep theirs, the demand for its products, and thus its income, will increase. This means that there is stiff competition among companies, and there are price wars. To avoid this, companies in an oligopoly may form a cartel, which involves agreements between them to avoid excessive competition.

These agreements are often based on two fundamental aspects:

  • Agreement on quantities: This determines the level of product that each company can produce.
  • Agreement on prices: This sets the selling price.

Although collaboration between these companies benefits all of them, it is not always the case, as each of them individually could improve its position by breaching the agreement. The paradox is that it benefits them individually to cheat, but if all do, the end result for them is worse than if they kept their agreements.

It can be difficult for members of an oligopoly to collaborate. However, in some cases, collaboration does occur. The deal usually works when:

  • It is possible to detect who fails and penalize them.

The lower the number of firms in the market, the easier the collaboration between them. The higher the number, the more difficult it will be. With few companies, the oligopoly will approach a monopoly, while a high number will be closer to the competitive model.

There is also the possibility of creating a company that acts as an innovator. If it raises prices, other companies may follow.

Barriers to Entry

Barriers to entry are features that prevent companies from entering certain markets or sectors. These barriers may be due to:

  • Absolute cost advantages: This occurs when firms already in the sector use better technologies that make their production costs lower than those of companies trying to enter.
  • Advantages in product differentiation: This feature refers to companies that are already in the sector having the advantage of consumer loyalty over companies that want to enter. Those who wish to enter will have to invest heavily in advertising, for example, to attract customers.
  • High capital requirements: New companies will need outside resources and may have trouble getting the necessary funding.
  • Economies of scale: Firms can obtain economies of scale if they use new technologies, improve their organization, or diversify their product. There are two types of economies of scale:
    • Internal economies of scale: These are within the company. They are the result of increased efficiency because labor is specialized or production techniques are improved.
    • External economies of scale: These affect the sector as a whole. Access may be due to an industrial area, the training of the workforce, etc.
Externalities

In a perfectly competitive market, companies meet a set of rules. When any of the companies in the market does not, it tends to lead to inefficient resource allocation. When this happens, the State should intervene to protect primarily the final consumer.

All acts of production and consumption have an impact on citizens and therefore on society. This means that production and consumption have some side effects called externalities. These can be positive (Example: installing solar panels on households to reduce pollution or a fruit tree farm next to a honey bee farm. The bees need the nectar of the flowers, and the trees need pollination from the bees. Both businesses benefit from each other without paying for it.) or negative (Example: a trout farm that needs clean water. Pollution would negatively impact the farm.)

Although there are positive externalities