In this post and the following posts we will learn about the types of market structure with examples. There are four basic market types, perfect competition, monopolistic competition, oligopoly and pure monopoly. For today let’s look at each one in brief….
‘Perfect competition’ market structure:
We have come across perfect competition in the earlier posts too. Here we will review it in detail.
A market structure is said to be perfectly competitive if all the firms in the market produce identical products (which are not differentiated on the basis of quality or features) and only the forces of demand and supply determine the market price. That is, no single firm is large enough to move the price. Such a market structure has perfectly elastic demand and therefore its demand curve is horizontal. As the products are identical they compete only on the basis of price so people are more likely to switch products easily if the price of one goes up. The barriers to entry in such a market are low. Any firm can enter the market and compete on the basis of price.
‘Monopolistic competition’ market structure:
Monopolistic competition differs from perfect competition in the sense that the products of the different firms in the market are not identical. The firms differentiate their products from those of the other firms in terms of quality, features or marketing. For example, the market for lipsticks. Some lipsticks are low end while others are considered high end depending upon the materials that go into making the lipstick. Some lipsticks claim to have vitamin e, jojoba butter and so on and therefore are priced higher than the other lipsticks available in the market. Again some claim to have features like extra creamy or highly glossy etc.
The firms in monopolistic competition market structure have elastic demand (but not perfectly elastic) and therefore have downward sloping demand curves. You are not likely to switch so easily if the price of your favorite lipstick goes up over a certain range. Barriers to entry in a monopolistic competition are low.
Oligopoly market structure:
In an oligopoly market structure there are only few firms competing in the market. The actions of each firm affect the others significantly. For example, the automobile industry. The pricing decision of Maruti is certainly going to affect the pricing decision of Hyundai. The demand in Oligopoly market structure may be more or less elastic than monopolistic competition. Barriers to entry are high because economies of scale lead to large firm sizes.
Monopoly market structure:
In a monopoly market structure there is only a single seller of a product that has no close substitutes. In a monopoly the seller has the choice to choose its selling price and therefore it has a downward sloping demand curve as it can sell higher quantities by lowering the price. The barriers to entry in a monopoly are high in the form of copyrights and patents and control over the source of raw material. For example, electricity. The nature of monopoly market structure is such that the average cost of production goes on decreasing as demand and therefore output increases. If another player enters the monopoly it would lead to higher costs than what was with a single player to the detriment of the consumers. Therefore monopolies are largely controlled and regulated by governments.
That’s all in this post …..Thanks for reading….over the next three posts we will study each market structure i.e perfect and monopolistic competition, oligopoly and monopoly in detail …look out for them….
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For solved examples please refer to the CFA Institute Books or any other study notes that provide them and you may want to use. The problems can be easily solved using the CFA institute approved financial calculators. Please refer to the CFA exam policy and CFA calculator guide.