MARKET STRUCTURE

INTRODUCTION:

Theorists sometimes contemplate conditions of a perfect market. It does not exist. A

market that involves transaction costs, carrying costs, firms trying to limit their risks, individuals

trying to increase their profits, and all subject to the uncertainty of nature and nations, is going to

be considerably less than perfect. In order to make informed choices, a trader needs to

understand the market.

DEFINITION:

The interconnected characteristics of a market, such as the number and relative strength of

buyers and sellers and degree of collusion among them, level and forms of competition, extent of

product differentiation, and ease of entry into and exit from the market

Four basic types of market structure are (1) Perfect competition: many buyers and sellers, none

being able to influence prices. (2) Oligopoly: several large sellers who have some control over

the prices. (3) Monopoly: single seller with considerable control over supply and prices. (4)

Monopsony: single buyer with considerable control over demand and prices.

CONTENT:

In economics, market structure is the number of firms producing identical products which are

homogeneous. The types of market structures include the following:

Monopolistic competition , also called competitive market, where there is a large number

of firms, each having a small proportion of the market share and slightly differentiated

products.

Oligopoly , in which a market is dominated by a small number of firms that together

control the majority of the market share.

o Duopoly , a special case of an oligopoly with two firms.

Monopsony , when there is only one buyer in a market.

Oligopsony , a market where many sellers can be present but meet only a few buyers.

Monopoly , where there is only one provider of a product or service.

o Natural monopoly , a monopoly in which economies of scale cause efficiency to

increase continuously with the size of the firm. A firm is a natural monopoly if it

is able to serve the entire market demand at a lower cost than any combination of

two or more smaller, more specialized firms.

Perfect competition , a theoretical market structure that features no barriers to entry, an

unlimited number of producers and consumers, and a perfectly elastic demand curve.

The imperfectly competitive structure is quite identical to the realistic market conditions where

some monopolistic competitors, monopolists, oligopolists, and duopolists exist and dominate the

market conditions. The elements of Market Structure include the number and size distribution of

firms, entry conditions, and the extent of differentiation.

These somewhat abstract concerns tend to determine some but not all details of a specific

concrete market system where buyers and sellers actually meet and commit to trade. Competition

is useful because it reveals actual customer demand and induces the seller (operator) to provide

service quality levels and price levels that buyers (customers) want, typically subject to the

seller’s financial need to cover its costs. In other words, competition can align the seller’s

interests with the buyer’s interests and can cause the seller to reveal his true costs and other

private information. In the absence of perfect competition, three basic approaches can be adopted

to deal with problems related to the control of market power and an asymmetry between the

government and the operator with respect to objectives and information: (a) subjecting the

operator to competitive pressures, (b) gathering information on the operator and the market, and

(c) applying incentive regulation.[

Normal Markets

A carrying charge is the cost to have a good on hand from one point in time until another point in

time. There are three types of carrying charges:

1. Storage

2. Insurance

3. Financing

*Transportation costs are not considered carrying charges.

Regardless of the underlying product, storage and insurance costs are generally the least

significant. Considering that financial data are intangible and can be stored and backed up on

inconsequentially small disks, it is no surprise that currency, index and interest rate futures

require virtually no storage costs. These costs will be higher for agricultural products that need to

be held in warehouses, but then again square footage in the farm belt is still quite inexpensive.

Insurance, although required for virtually any business dealings, is generally a small factor.

Transportation for financial instruments could range from nothing for an e-mail to a few dollars

for a wire transfer. It is different for physical commodities, however. There is a cost to move

frozen concentrated orange juice from Florida to Alberta, or crude oil from the North Sea to

Italy.

Consistently, the most significant carrying cost is financing. Among futures traders, it is usually

set equal to a short-term benchmark called the repurchase or repo rate. The repo is usually

quoted at a slight premium over the Treasury bill, because the futures contract itself serves as

collateral and the players are often money-center banks with impeccable creditworthiness.

Typically, the repo is quoted as an overnight rate.

Unless otherwise stated, we shall assume that, for purposes of the Series 3 exam and this study

guide, storage, insurance and transportation costs are negligible. That is, the cost of carry equals

the repo rate.

Market structure and innovation

Which market conditions are optimal for effective and sustained innovation to occur? This is a

question that has vexed economists and business academics for many years.

High levels of research and development spending are frequently observed in oligopolistic

markets, although this does not always translate itself into a fast pace of innovation.

The recent work of William Baumol (2002) provides support for oligopoly as market structure

best suited for innovative behaviour. Innovation is perceived as being “mandatory” for

businesses that need to establish a cost-advantage or a significant lead in product quality over

their rivals.

“As soon as quality competition and sales effort are admitted into the sacred precincts of theory,

the price variable is ousted from its dominant position…But in capitalist reality as distinguished

from its textbook picture, it is not that kind of competition which counts but the competition

which commands a decisive cost or quality advantage and which strikes not at the margins of

profits and the outputs of the existing firms but at their foundations and their very lives. This

kind of competition is as much more effective than the other as a bombardment is in comparison

with forcing a door”

Supernormal profits persist in the long run in an oligopoly and these can be used to finance

research and development.

CONCLUSION:

Market structure is best defined as the organisational 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.