The four market structures are perfect competition, monopolistic competition, oligopoly, and monopoly.
These four market structures are described based on the number of firms competing for the demand of consumers, the nature of costs, the extent of barriers to entry and also the bargaining power of consumers on the demand–side of the market.
Among these market structures, monopolistic competition, oligopoly and monopoly can be considered as imperfect competitive market structures.
1. Perfect competition
Perfect competition is the market structure that comprises extreme competition. In this market,
1. A large number of firms sell identical products (homogeneous products) to a large number of buyers, there are no restrictions to enter and exit from this market.
2. Both sellers and buyers know about the market information including price without any restriction.
3. As examples of perfect competition, we can say the market for agricultural products, foreign exchange, and so on.
4. In the short run, firms in the perfect competitive market produce economic profits, normal profits, or economic losses. In the long run, firms in perfect competition produce normal profits.
2. Monopolistic Competition
Monopolistic competition refers to the market that many competitive firms sell products but each company sells different products from others. In the monopolistic competitive market,
1. There are a large number of firms
2. There are no entry or exit barriers
3. Each firm produces differentiated products.
4. As examples for monopolistic competition, we can say the market for restaurants, saloons, retail businesses, and so on. A country contains many restaurant services but the foods and beverages of the restaurants differ from each other.
5. Monopolistic competition is mostly similar to perfect competition, but producers in monopolistic competition have some extent of power to set the market price.
6. In the short run, firms in the monopolistic competitive market produce economic profits, normal profits, or economic losses. In the long run, firms in monopolistic competition produce normal profits.
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Oligopoly is the market structure; producers have significant power to set the market price. As examples of the oligopoly, we can say the airline industry of Malaysia which comprises with only a few competitors such as Malaysia Airlines, AirAsia, Firefly, and so on. Because in the oligopolistic market, there are small numbers of firms. So one firm produces a large percentage from the Total Supply. The airline industry in Malaysia has 8 scheduled airline companies. Each airline companies have a large proportion of the market share.
1. Collusive oligopoly and non-collusive oligopoly are two different types of oligopolies. A collusive oligopoly is a market scenario in which businesses collaborate to determine pricing or production, or both pricing and production. But in non-collusive oligopoly businesses are compete rather than collaborate.
2. In the oligopoly market firms depend on non-price methods. Such as advertising, after-sales services, warranties, etc. These non-price methods help to increase demand, brand recognition and gain competitive advantages.
3. There is a significant level of entry and exit barriers in the oligopoly. The firms in the oligopoly market earn super-normal profits in long run. Because there are some barriers that prevent to enter the market. Such as patents, licenses, controlling power of raw material and, etc.
4. Products of the oligopoly firms are either homogeneous or differentiated. One of the characteristics of an oligopoly is that its members are focused on improving product quality or providing benefits to distinguish their brand.
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1. In the monopoly market, there is only one firm that produces a product with no close substitutes.
2. There is no competition and that firm has complete power to decide the market price. As examples of the monopoly, we can say the train industry of Malaysia. Because only government runs the trains and the price of the train tickets is determined by the government.
3. Monopolistic companies earn economic profit in the short run as well as long run. The following graph shows that how a monopolistic firm earns economic profit (supernormal profit).
According to the above graph 1 at point E, marginal cost (MC) equals marginal revenue (MR). The amount of quantity that relates to this point (E) is Qf units. So, the firm produces Qf units. At the Qf units of production, the average cost per unit (AC) is “B” and the average revenue per unit (AR) is “A”. We can see that here AR is greater than the AC. So, we can calculate the total profit of the firm by multiplying the number of Qf units from the difference between AR and AC. In other words, amount of supernormal profit is earned by the firm can be presented from the ABCD rectangular area.
4. There is a higher level of entry and exit barriers. There are two major types of factors that can block a firm from entering industry. They are Natural (Structural) Barriers to Entry and Artificial (Strategic) Barriers to Entry
Barriers of entry and exit for market structures
1. Natural (Structural) Barriers to Entry
Economies of scale, network effect, high research and development costs are the types of natural barriers to entry.
Economies of scale:
Firms can decrease their average cost of producing for a unit when the production capacity is increasing. In this situation, the existing firms can produce goods and services at a lower cost than a new firm can and it blocks the entrance of new firms. Specially in the monopoly situation, one firm comes to the situation where single firm can produce entire production of the industry.
Network effect says that when there are larger number of participants, it can add a higher value on a business organization. So, existing larger firms always comprises with these kinds of network effects but newcomers usually do not have.
High research and development costs:
Research and development is very important to introduce new products, to improve the quality, to introduce new products and so on. Well established firms can spend sufficient funds on these factors. So, new firms should have a financial capability to compete with existing firms.
2. Artificial (Strategic) Barriers to Entry
Legal costs, patents and licenses costs are the type of artificial barriers to entry.
To enter some kinds of the industries, newcomers have to pass a legal process. For that, they have to spend time, money and effort. As examples, they have to pay for the lawyers, registration fees and so on. This is a barrier to enter an industry.
Patents and licenses cost:
These barriers are created by the government of a country. Patents mean the exclusive right for producing goods or service for a certain period. Licenses are the government-granted recommendations to do some activity. Both of patents and licences reduce the competition while improving the quality of the goods and services. So, these can be considered as a factor that block the entrance of new firms.