Market Structures: Perfect and Imperfect Market Structures

Market Structure
Market structure is best defined as the organizational and other characteristics of a market. We
focus on those characteristics which affect the nature of competition and pricing - but it is
important not to place too much emphasis simply on the market share of the existing firms in
an industry.

Traditionally, the most important features of market structure are:

1. The number of firms (including the scale and extent of foreign competition)

2. The market share of the largest firms (measured by concentration ratio see below) the

3. The nature of costs (including the potential for firms to exploit economies of scale and also
the presence of sunk costs which affects market contestability in the long term)

4. The degree to which the industry is vertically integrated vertical integration explains the
process by which different stages in production and distribution of a product are under the
ownership and control of a single enterprise. A good example of vertical integration is the oil
industry, where the major oil companies own the rights to extract from oilfields, they run a fleet
of tankers, operate refineries and have control of sales at their own filling stations.

5. The extent differentiation of product (which affects cross-price elasticity of demand)

6. The structure of buyers in the industry (including the possibility of monopsony power).

7. The turnover of customers (sometimes known as "market churn") - i.e. how many customers
are prepared to switch their supplier over a given time period when market conditions change.
The rate of customer churn is affected by the degree of consumer or brand loyalty and the
influence of persuasive advertising and marketing.
Perfect Market Structure
The Perfect Competition is a market structure where a large number of buyers and sellers are
present, and all are engaged in the buying and selling of the homogeneous products at a single
price prevailing in the market.

In other words, perfect competition also referred to as a pure competition, exists when there is
no direct competition between the rivals and all sell identically the same products at a single
price.

1. Large number of buyers and sellers

In perfect competition, the buyers and sellers are large enough, that no individual can influence
the price and the output of the industry. An individual customer cannot influence the price of the
product, as he is too small in relation to the whole market. Similarly, a single seller cannot
influence the levels of output, which is too small in relation to the gamut of sellers operating in
the market.

2. Homogeneous Product

Each competing firm offers the homogeneous product, such that no individual has a preference
for a particular seller over the others. Salt, wheat, coal, etc. are some of the homogeneous
products for which customers are indifferent and buy these from the one who charges a less
price. Thus, an increase in the price would let the customer go to some other supplier.

3. Free Entry and Exit

Under the perfect competition, the firms are free to enter or exit the industry. This implies, If a
firm suffers from a huge loss due to the intense competition in the industry, then it is free to
leave that industry and begin its business operations in any of the industry, it wants. Thus, there
is no restriction on the mobility of sellers.

4. Perfect knowledge of prices and technology

This implies that both the buyers and sellers have complete knowledge of the market conditions
such as the prices of products and the latest technology being used to produce it. Hence, they
can buy or sell the products anywhere and anytime they want.

5. No transportation cost

There is an absence of transportation cost, i.e. incurred in carrying the goods from one market
to another. This is an essential condition of the perfect competition since the homogeneous
product should have the same price across the market and if the transportation cost is added to
it, then the prices may differ.

6. Absence of Government and Artificial Restrictions

Under the perfect competition, both the buyers and sellers are free to buy and sell the goods
and services. This means any customer can buy from any seller and any seller can sell to any
buyer. Thus, no restriction is imposed on either party. Also, the prices are liable to change freely
as per the demand-supply conditions.

IMPERFECT STRUCTURE
 An imperfect market refers to any economic market that does not meet the rigorous
standards of a hypothetical perfectly or purely competitive market, as established by
Marshallian partial equilibrium models.

 An imperfect market is one in which individual buyers and sellers can influence prices
and production, where there is no full disclosure of information about products and
prices, and where there are high barriers to entry or exit in the market. It's the opposite of
a perfect market, which is characterized by perfect competition, market equilibrium, and
an unlimited number of buyers and sellers.
  Imperfect markets are found in the real world and are used by businesses and other
sellers to earn profits.

Understanding Imperfect Markets

All real-world markets are theoretically imperfect, and the study of real markets is always
complicated by various imperfections. They include the following:

• Competition for market share

• High barriers to entry and exit

• Different products and services

• Prices set by price makers rather than by supply and demand

• Imperfect or incomplete information about products and prices

• A small number of buyers and sellers

Monopoly: Feature, Pricing under Monopoly

The word monopoly has been derived from the combination of two words i.e., 'Mono' and 'Poly'.
Mono refers to a single and poly to control.

In this way, monopoly refers to a market situation in which there is only one seller of a
commodity.

"Pure monopoly is represented by a market situation in which there is a single seller of a

product for which there are no substitutes; this single seller is unaffected by and does not affect
the prices and outputs of other products sold in the economy." Bilas

"Monopoly is a market situation in which there is a single seller. There are no close substitutes
of the commodity it produces, there are barriers to entry". -Koutsoyiannis

"Under pure monopoly there is a single seller in the market. The monopolist demand is market
demand. The monopolist is a price- maker. Pure monopoly suggests substitute situation". -A. J.
Braff

"A pure monopoly exists when there is only one producer in the market. There are no dire
competitions." -Ferguson

"Pure or absolute monopoly exists when a single firm is the sole producer for a product for
which there are no close substitutes." – McConnel

Features of Monopoly
We may state the features of monopoly as:

1. One Seller and Large Number of Buyers

The monopolist's firm is the only firm; it is an industry. But the number of buyers is assumed to
be large.

2. No Close Substitutes
There shall not be any close substitutes for the product sold by the monopolist. The cross
elasticity of demand between the product of the monopolist and others must be negligible or
zero.

3. Difficulty of Entry of New Firms

There are either natural or artificial restrictions on the entry of firms into the industry, even when
the firm is making abnormal profits.

4. Monopoly is also an Industry

Under monopoly there is only one firm which constitutes the industry. Difference between firm
and industry comes to an end.

5. Price Maker
Under monopoly, monopolist has full control over the supply of the commodity. But due to large
number of buyers, demand of any one buyer constitutes an infinitely small part of the total
demand. Therefore, buyers have to pay the price fixed by the monopolist.

Price Determination under Monopoly Market

A monopolist is the sole seller of a commodity. The aim of a monopolist is to get maximum
profits. Of course, everyone who enters business aims at getting maximum profit. But there is
no scope for getting abnormal profit under competition for there are several number of sellers.
But the monopolist is the sole seller of a commodity. So he will take advantage of the situation
and try to get maximum profits. For, all those who want the good should buy it only from him.
They have no other way. So in determining the price of a commodity, he will be guided by only
one motive, that is, to maximize his profits.

We know in a market, price is determined by the interaction of supply and demand. Under
monopoly too, the price of a good is determined by the interaction of supply and demand, but in
a different way. Under perfect competition, there will be several number of sellers. But under
monopoly, the monopolist is the sole seller of a commodity. So he can control the supply of his
good. But he cannot control demand for there are several number of buyers as in the case of
competition.

The aim of a monopolist is to maximize his profits. For that, he can do one of the following two
things. He can fix the price for his good and leave the market to decide what output will be
required. Or he can fix the output and leave the price to be determined by the interaction of
supply and demand. In other words, he can fix the price or the output; he cannot do both. The
amounts he can sell at any given price depend upon the conditions of demand for his good.
The monopolist will get maximum profit at the output at which his marginal cost and marginal
revenue are equal to one another.

Under monopoly, marginal cost = marginal revenue; but marginal revenue is less than price,
therefore marginal cost is less than price. In other words, price is greater than marginal cost.

Product Differentiation
Product differentiation is a marketing strategy that strives to distinguish a company's products
or services from the competition. Successful product differentiation involves identifying and
communicating the unique qualities of a company's offerings while highlighting the distinct
differences between those offerings and others on the market. Product differentiation goes
hand-in-hand with developing a strong value proposition to make a product or service attractive
to a target market or audience.

If successful, product differentiation can create a competitive advantage for the product's seller
and ultimately build brand awareness. Examples of differentiated products might include the
fastest high-speed internet service or the most gas-efficient electric vehicle on the market today.

Product differentiation can be achieved through:

• Distinctive design- e.g. Dyson; Apple iPod

• Branding - e.g. Nike, Reebok

• Performance - e.g. Mercedes, BMW

A key term to remember is USP, which is the acronym for Unique Selling Point.

A Unique Selling Point is a feature or benefit that separates a product competitor. from its

A USP could be a lower price, a smaller version of the product, offering extra functions, or even
simply producing a standard product in a range of colors or designs.

The Advantages of Differentiation Strategy a Product

Product differentiation is a marketing strategy that businesses use to distinguish a product
from similar offerings on the market. For small businesses, a product differentiation strategy
may provide a competitive advantage in a market dominated by larger companies. The
differentiation strategy the business uses must target a segment of the market and deliver the
message that the product is positively different from all other similar products available.

Creates Value
When a company uses a differentiation strategy that focuses on the cost value of the product
versus other similar products on the market, it creates a perceived value among consumers and
potential customers A strategy that focuses on value highlights the cost savings or durability of
a product in comparison to other products.

Non-Price Competition
The product differentiation strategy also allows business to compete in areas other than price.
For example, a candy business may differentiate its candy from other brands in terms of taste
and quality. A car manufacturer may differentiate its line of cars as an image enhancer or status
symbol while other companies focus on cost savings. Small businesses can focus the
differentiation strategy on the quality and design of their products and gain a competitive
advantage in the market without decreasing their price.

Brand Loyalty
A successful product differentiation strategy creates brand loyalty among customers. The same
strategy that gains market share through perceived quality or cost savings may create loyalty
from consumers. The company must continue to deliver quality or value to consumers to
maintain customer loyalty. In a competitive market, when a product doesn't maintain quality,
customers may turn to a competitor.

No Perceived Substitute
A product differentiation strategy that focuses on the quality and design of the product may
create the perception that there's no substitute available on the market. Although competitors
may have a similar product, the differentiation strategy focuses on the quality or design
differences that other products don't have. The business gains an advantage in the market, as
customers view the product as unique.

Oligopoly Features
The Oligopoly Market characterized by few sellers, selling the homogeneous or differentiated
products. In other words, the Oligopoly market structure lies between the pure monopoly and
monopolistic competition, where few sellers dominate the market and have control over the
price of the product.

Under the market, a produces Oligopoly firm either produces

1. Homogeneous Product
The firms producing the homogeneous products are called as Pure or Perfect Oligopoly. It is
found in the producers of industrial products such as aluminum, copper, steel, zinc, iron, etc.

2. Heterogeneous Product
The firms producing the heterogeneous products are called as Imperfect or Differentiated
Oligopoly. Such type of Oligopoly is found in the producers of consumer goods such as
automobiles, soaps, detergents, television, refrigerators, etc.
(i) Few Sellers
 Under the Oligopoly market, the sellers are few, and the customers are many. Few firms
dominating the market enjoys a considerable control over the price of the product.

(ii) Interdependence
 It is one of the most important features of an Oligopoly market, wherein, the seller has to
be cautious with respect to any action taken by the competing firms. Since there are few
sellers in the market, if any firm makes the change in the price or promotional scheme,
all other firms in the industry have to comply with it, to remain in the competition. Thus,
every firm remains alert to the actions of others and plan their counterattack beforehand,
to escape the turmoil. Hence, there is a complete interdependence among the sellers
with respect to their price-output policies.

(iii) Advertising
 Under Oligopoly market, every firm advertises their products on a frequent basis, with
the intention to reach more and more customers and increase their customer base. This
is due to the advertising that makes the competition intense.

(iv) Competition
 It is genuine that with a few players in the market, there will be an intense competition
among the sellers. Any move taken by the firm will have a considerable impact on its
rivals. Thus, every seller keeps an eye over its rival and be ready with the counterattack.

(v) Entry and Exit Barriers

 The firms can easily exit the industry whenever it wants, but has to face certain barriers
 to entering into it. These barriers could be Government license, Patent, large firm's
economies of scale, high capital requirement, complex technology, etc. Also, sometimes
the government regulations favor the existing large firms, thereby acting as a barrier for
the new entrants.

(vi) Lack of Uniformity

 There is a lack of uniformity among the firms in terms of their size, some are big, and
some are small.

 Since there are less number of firms, any action taken by one firm has a considerable
effect on the other. Thus, every firm must keep a close eye on its counterpart and plan
the promotional activities accordingly.

kinked demand Curve

In an oligopolistic market, firms cannot have a fixed demand curve since it keeps changing as
competitors change the prices/quantity of output. Since an oligopolist is not aware of the
demand curve, economists have designed various price-output models based on the behavior
pattern of other firms in the industry.

In many oligopolist markets, it has been observed that prices tend to remain inflexible for a very
long time. Even in the face of declining costs, they tend to change infrequently. American
economist Sweezy came up with the kinked demand curve hypothesis to explain the reason
behind this price rigidity under oligopoly.

According to the kinked demand curve hypothesis, the demand curve facing an oligopolist has a
kink at the level of the prevailing price. This kink exists because of two reasons:

1. The segment above the prevailing price level is highly elastic.

2. The segment below the prevailing price level is inelastic.

The following figure shows a kinked demand curve dD with a kink at point P.

 The prevailing price level = P

  The firm produces and sells output = O

 Also, the upper segment (dP) of demand curve (dD) is elastic.

 The lower segment (PD) of the demand curve (dD) is relatively inelastic.

This difference in elasticities is due to assumption of the kinked demand cu hypothesis.

Cartels
A cartel is a grouping of producers that work together to protect their interests. Cartels are
created when a few large producers decide to co-operate with respect to aspects of their
market. Once formed, cartels can fix prices for members, so that competition on price is
avoided. In this case cartels are also called price rings. They can also restrict output released
onto the market, such as with OPEC and oil production quotas, and set rules governing other
aspects of the behavior of members. Setting rules is especially important in oligopolistic
markets, as predicted in game theory. A significant attraction of cartels to producers is that they
set rules that members follow, thus reducing risks that would exist without the cartel.

The negative effects on consumers include:

(i) Higher Prices

Cartel members can all raise prices together, which reduces the elasticity of demand for any
single member.

(ii) Lack of Transparency

Members may agree to hide prices or withhold information, such as the hidden charges in credit
card transactions.

(iii) Restricted Output

Members may agree to limit output onto the market, as with OPEC and its oil quotas.

(iv) Carving up a market

Cartel members may collectively agree to break up a market into regions or territories and not
compete in each other's territory.

Price Leadership
Price leadership occurs when a pre-eminent firm (the price leader) sets the price of goods or
services in its market. This control can leave the leading firm's rivals with little choice but to
follow its lead and match the prices if they are to hold on to their market share. Price leadership
is common in oligopolies, such as the airline industry, in which a dominant company sets the
prices and other airlines feel compelled to adjust their prices to match.

Price leadership has a greater impact on goods or services that offer little differentiation from
one producer to another. Price leadership is also apparent where levels of consumer demand
make a particular price selected by the market leader viable because consumers are drawn
from competing products. Price leadership is assumed to stabilize prices and maintain pricing
discipline. In general, effective price leadership works when

• The number of companies involved is small

• Entry to the industry is restricted

• Products are homogeneous

• Demand is inelastic, or less elastic

• Organizations have a similar long- run average total cost (LRATC)

Types of Price Leadership

In business economics, there are three primary models of price leadership: barometric, collusive,
and dominant.

1.Barometric

The barometric model occurs when a particular firm is more adept than others at identifying
shifts in applicable market forces -like a change in production costs-which in turn allows it to
respond most efficiently -by initiating a price change, for instance. It is possible for a firm with a
small market share to act as a barometric leader if it is a good producer, and attuned to trends
in its market. Other producers follow its lead, assuming that the price leader is aware of
something that they have yet to realize. However, because a barometric leader has very little
power to impose its decisions on other firms in the industry, its leadership might be short-lived.

2. Collusive

The collusive price-leadership model may emerge in an oligopoly as a result of an explicit or

implicit agreement among a handful of dominant firms to keep their prices in mutual alignment.
The smaller firms follow the price change initiated by the dominant firms. This practice is most
common in industries where the cost of entry is high, and the costs of production are known.
Such agreements can be illegal if the effort is designed to defraud the public. There is a fine line
between actual collusion, which is unlawful, and price leadership- especially if the price changes
are not related to changes in operating costs.

3. Dominant
The dominant model occurs when one firm controls the vast majority of market share in

its industry. The leading firm is flanked by small firms that provide the same products or
services, but which cannot influence prices. Often the dominant company ignores the interests
of the smaller companies. Therefore, dominant price leadership is sometimes referred to as a
partial monopoly.

A drawback of this model is that the leader might engage in predatory pricing by lowering its
prices to levels that smaller firms cannot sustain. Such practices that are aimed at hurting
smaller companies are illegal in most countries.