What is a market structure?
A market structure is the type of market a firm sells in. We sort markets using four questions:
- How many sellers (and buyers) are there?
- Are the products identical or different?
- How easy is it for new firms to enter or leave (barriers to entry)?
- How much can one firm control the price?
| Perfect competition | Monopolistic competition | Oligopoly | Monopoly | |
|---|---|---|---|---|
| Firms | Very many | Many | A few | One |
| Product | Identical | Differentiated | Same or different | Unique |
| Entry | Free | Easy | Hard | Blocked |
| Price power | None (price taker) | Some | Large, but interdependent | Price maker |
Markets with fewer firms are called concentrated. The n-firm concentration ratio is the share of total sales held by the biggest n firms (for example the top 4).
Perfect competition
Features: very many small buyers and sellers, identical (homogeneous) products, free entry and exit, perfect information, and no transport or selling costs.
Because each firm is tiny, it is a price taker: its demand curve is horizontal at the market price, so P = AR = MR. It produces where MR = MC.
Types of profit: normal profit is the minimum needed to keep the firm in the industry (TR = TC including opportunity cost). Supernormal (abnormal) profit is anything above this. A loss is below it.
Short run → long run: supernormal profit attracts new firms; supply rises and price falls until only normal profit remains. Losses make firms leave until price rises back. In the short run a firm keeps producing as long as price covers average variable cost (shutdown point).
Monopolistic competition
Many firms sell differentiated products: similar, but each with its own brand, quality, design or location. Entry is easy.
- Each firm faces a downward-sloping demand curve, so it has a little power over price.
- Firms compete through advertising, branding and finding a market niche (a small group of buyers with special needs).
- Short run: a firm can earn supernormal profit. Long run: new firms copy the idea, demand for each firm falls, and profit returns to normal.
Oligopoly and game theory
A few large firms control most of the market, and barriers to entry are high. The key feature is interdependence: each firm's best choice depends on what rivals do.
Game theory studies these choices. In a payoff grid, if both firms keep prices high they share big profits, but each is tempted to undercut. If both undercut they both earn less. This is the prisoner's dilemma, and the outcome where neither wants to change alone is a Nash equilibrium.
- Collusion: firms agree on prices or output (a cartel). It is illegal in most countries.
- Price leadership: one big firm sets the price, others follow.
- Non-price competition: loyalty schemes, advertising, better service.
- Prices are often sticky: firms fear a price war.
Over time markets change: new technology, mergers and innovation can open or close a market (dynamics of competition, creative destruction).
Monopoly and price discrimination
A pure monopoly is the only seller of a product with no close substitute. (In practice, a firm with a very large share, often above 25% or 40% depending on the country, may be treated as having monopoly power.)
Barriers to entry: patents and copyrights, government licences, control of a key raw material, economies of scale (a natural monopoly such as a water network), and strong brands.
The monopolist is a price maker. It sets output where MR = MC and reads the price from the demand curve. Compared with perfect competition: higher price, lower output, possible supernormal profit in the long run, and a deadweight welfare loss. Possible benefits: economies of scale and money for research.
Price discrimination: selling the same product at different prices to different groups (student tickets, peak and off-peak train fares). It needs: price-setting power, groups with different price elasticities, and no resale between groups.
Objectives of firms and contestable markets
Objectives: most models assume profit maximisation (MR = MC). Firms may also aim for revenue maximisation (MR = 0), sales or market share growth, survival, or social goals. Owners and managers may want different things (divorce of ownership and control).
Contestable market: a market where entry and exit are cheap (low sunk costs). Even with one or a few firms, the threat of "hit-and-run" entry keeps prices close to the competitive level.
Long-run costs: as a firm grows, average cost first falls (economies of scale) and may later rise (diseconomies). Where large scale is very cheap, few firms can survive, so the market becomes concentrated.
Competition authorities in many countries watch mergers and ban cartels to protect consumers.
Try it
List five things your family buys (vegetables, a phone plan, a haircut, train tickets, a soft drink). For each, count the sellers you could choose from and decide: are the products the same or different? Is it easy to start a new business? Place each on the scale in step 6.
Key formulas and definitions
- Profit maximisation: MR = MC
- Perfect competition: P = AR = MR (price taker)
- Normal profit: TR = TC (includes opportunity cost); supernormal profit: TR > TC
- Short-run shutdown: produce only if P ≥ AVC
- n-firm concentration ratio = combined market share of the largest n firms (%)
- Revenue maximisation: MR = 0
Worked examples
1. In a market the top four firms have shares 30%, 25%, 15% and 10%. Find the 4-firm concentration ratio and name the structure.
CR4 = 30 + 25 + 15 + 10 = 80%. A few firms hold most sales, so it is an oligopoly.
2. A wheat farmer tries to sell at ₹26 per kg when the market price is ₹24. What happens and why?
She sells nothing. Wheat is identical, buyers know the price and there are many sellers, so buyers go elsewhere. A perfectly competitive firm is a price taker.
3. A café chain earns supernormal profit. What happens in the long run if it is in monopolistic competition?
New cafés open because entry is easy. Demand for each café falls until only normal profit is left.
4. Two airlines each choose High or Low fares. Profits (A, B): High-High 10, 10; A Low-B High 14, 3; A High-B Low 3, 14; Low-Low 5, 5. What will each choose?
Whatever B does, A earns more by choosing Low (14 > 10, 5 > 3). The same holds for B. So both choose Low and get 5 each, a Nash equilibrium, although both would prefer 10.
5. A cinema charges ₹300 to adults and ₹150 to students. What conditions make this work?
The cinema has price-setting power, students are more sensitive to price than adults, and students cannot resell cheap tickets (ID is checked).
6. Why can a single water company be the cheapest way to supply a city?
The pipe network is very costly. One firm can spread this fixed cost over all users, so its average cost is lowest. Two networks would double the cost. This is a natural monopoly, usually regulated.
Common mistakes
- Saying monopolists can charge any price they like. They still face the demand curve: a higher price means fewer sales.
- Thinking normal profit means zero profit in everyday language. It includes the reward the owner could earn elsewhere.
- Mixing up monopolistic competition (many firms, different products) with monopoly (one firm).
- Believing few firms always means high prices. If the market is contestable, the threat of entry keeps prices low.