MARKET STRUCTURE

A market is a medium through which goods and services are exchanged between sellers and
buyers. In defining a market, economists do not reserve the term to mean only the organized
exchange operating in a well – defined physical location. But it can also refer to a group of
sellers and buyers whose activities affect the price at which a particular commodity is sold.
Markets are categorized into groups based on the characteristic features of a given market
arrangement and these groupings are referred to as market structures.

There are majorly four market structures namely;

Perfect completion
Monopoly
Monopolistic competition and
Oligopoly

The following are the criteria used to classify markets

1. Number of firms in a market. If there are numerous firms, then the market is either perfect
competition or monopolistic competition and if there are few firms, then it is oligopoly and if
a single firm, then it is monopoly.
2. Nature of the product: if the goods are homogenous, then it is perfect competition, if
differentiated – it is monopolistic competition or imperfect oligopoly.
3. Freedom of entry and exit. If entry and exit is easy, then it is perfect competition. If entry
and exit is restricted, then it is oligopoly and if entry and exit is blocked, then it is monopoly.
4. Level of advertisement. If the level of advertisement is high and persuasive, then it is either
monopolistic competition or oligopoly. If advertisement is only informative, such a market
structure is monopoly and if there is no advertisement, then it is perfect competition.
5. Availability of information. If information is available and costless, such a market structure
is perfect competition.
6. Degree of collusion. If there is a possibility of collusion, then the market structure is
oligopoly, though at times collusion can be possible under monopolistic competition.
PERFECT COMPETITION:

This is a market structure characterized by the complete absence of rivalry among the individual
firms. This market structure is based on the following assumptions.

1. There is a large number of buyers and sellers in the market such that there is no single
buyer who can influence price and output on the market. As a result even the removal of
one firm does not affect price and output on the market therefore firms under perfect
competition are considered to be price takers because the price is determined through
forces of demand and supply.
2. The firms deal in a homogenous product that is the produce is almost identical such that
there is no preference of one firm’s product against the other that is why the firms usually
charge an identical price.
3. There is freedom of entry and exit of firms. Firms have the freedom to move in and out of
the industry. Any firm with capital is free to join production and there incurring losses
can leave the industry. When the industry is making supernormal profit, new firms can
enter production.
4. There is no government interference in the price and output decisions of the firm.
5. The firms aim at profit maximization.
6. There is no transport costs incurred. It is assumed that the producers and consumers are
all in the same area.
7. The firms do not undertaken persuasive advertising.
8. There is perfect knowledge of market conditions both in the goods and capital market.
9. There is perfect mobility of factors of production i.e. factor of production can move from
one occupation to another or firm where poorly paid to where they are better paid.
10. There is no collusion of firms in the market (they do not sit to agree on prices) firms are
price takers.
11. Perfectly elastic demand curve. This is because no firm has an influence on the market
conditions and also the pricing is fixed because of product and factor mobility.
Illustration:

Price

AR=MR=DD=P

0 Quantity
Short run equilibrium of a firm under perfect competition

A perfectly competitive firm is in equilibrium when

Under perfect competition, a firm in the short run may make super normal profits or losses
because of free entry of firms, the supernormal profits in the short run attract other firms to join
the industry as a result of output increases and the firms in the long run enjoy normal profits.

On the other hand firms which are making losses in the short run will leave the industry, output
will fall and the firms that remain will earn normal profits.

Long run equilibrium under perfect competition

Advantages of perfect competition
1. The competition results into fair and stable prices
2. It ensures efficient resource allocation i.e. operation at full or optimum capacity in the
long run hence resources are allocated to the production of needed goods
3. Because of perfect knowledge of the market, factors of production go to where they are
best paid and consumers will buy from the cheapest source and producers will sell to
where they can make high profits.
4. It provides an efficient standard or measuring rod for comparison of prices determined in
other markets.
5. It ensures equitable distribution of income because of existence of many firms and free
entry and exit of such firms in the industry.
6. There is production of quality output because of high competition
7. It encourages innovations and invention by firms in a bid to lower their costs and
compete favorably in the market.
8. In the long run there is minimal wastage of resources because firms produce at the least
possible cost and they produce maximally to maximize their revenue.
9. There is production of high output due to freedom of entry of firms.
10. Consumers enjoy commodities at fair prices.

Disadvantages of perfect competition

1. The Firms produce at excess capacity that is production at low levels of competition on
the goods market.
2. There is a lot of duplication in production which results into wastage of resources.
3. Industries cannot grow or expand because of limited market e.g. shop
4. It may lead to unemployment as a result of inefficient firms leaving the industry getting
outcompeted or being posted out of the industry.
5. Since the goods produced are homogenous, there is limited choice and variety.
6. Price wars are likely to result as firms try to get a wider share of the market
7. It assumes ideal market conditions which are unrealistic e.g. in reality transport costs
exist.
8. There is limited expansion hence no economies of scale are enjoyed.
9. Only normal profits are enjoyed in the long run which limits research
10. Since the major aim is profit maximization goods which are necessary for welfare but not
profitable will be ignored e.g. water and sanitation facilities.
MONOPOLY
This is a market situation where there is only one producer or seller of a commodity which has
many buyers and has got limited or no close substitutes.
 Monopoly may be simple monopoly where the commodity may have substitutes
 It could also be pure monopoly or absolute monopoly where the commodity has no
substitute at all
 Under simple monopoly, the cross elasticity of demand is low but under pure monopoly,
the cross elasticity of demand is zero.

Features of monopoly
1. There is a single producer/seller in the market and many buyers
2. There is existence of a single product with limited or no close substitute
3. There is absence of persuasive advertising but informative advertising is present
4. There is blocked /restricted entry into the industry
5. The main aim of the firm is profit maximization.

Bases and types of Monopoly

1. Patent rights: Monopoly arises from patent or copy rights. A patent right is a grant by the
government to an inventor of a new product or technique of production. This gives him a
monopoly right over his production for a period of time, usually 10 years. Copy rights are
enjoyed by writers who enjoy exclusive right over publication for a stated period of time.
2. Foreign trade restrictions or protectionism by government through tariff barriers and non-
tariff barriers. This may make the domestic firms and industries to be monopolies.
3. Merging of firms: Monopoly may arise due to merging or amalgamation of various firms
in the industry. Merging by collusion gives rise to a collective monopoly.
4. Through capital requirements:Some monopolies come into existence through the amount
of initial capital required for investment. When it is high, only a few firms can be able to
afford and it would not only be possible for new firms to enter.
5. Small markets:Sometimes the market may be too small for many firms to be
economically viable. In such cases, the one plant becomes a monopoly.
6. Through government statutes and acts of parliament:This is where monopolies are
established by government and their existence is governed by acts of parliament. This
gives rise to statutory monopoly.
7. A firm or group of firms may control a very large portion of the raw material supplies,
this gives them control over basic inputs resulting into existence of monopoly.
8. Distance between producers: This is where there is a very long distance between
producers such that each producer becomes a monopolist in his own locality since it
would not be worthwhile for consumers to travel to other localities. The transport costs
would be prohibitive. This gives rise to spatial monopoly.
9. Long periods of apprenticeship: Long periods of training and familiarization. In certain
occupations, long periods of training may be required for one to join that particular
occupation. In the intervening period, the people in that occupation would enjoy some
monopoly powers.
10. Natural Resource endowment: Because the distribution by nature, the raw materials or
source of a certain product may be formed in only one place or country. Such a place
becomes a natural monopoly.
11. Uniqueness of talent: Certain individuals with unique talent may enjoy monopoly powers
because there will be limited individuals who can compete e.g. singers, footballers
12. Product differentiation: This is where as a result of product differentiation, a firm enjoys
monopoly over its brand and this is referred to as Partial monopoly.
EQUILIBRIUM POSITION ON MONOPOLY SHORT RUN

Advantages of Monopoly
1. Economies of scale are enjoyed because the firm utilizes all the market that is available.
2. The firm has low operational costs because of limited or no advertising costs.
3. There is limited duplication and resource wastage because there is only one firm.
4. Where the monopoly is in form of a public utility, provides cheap services to the
population.
5. Abnormal profits are enjoyed in the short run and long run, this encourages investments
and high products
6. Research and innovations are encouraged because of the high profits enjoyed by the firm
as well as patent rights and copy rights.
7. Monopoly firms practice price discrimination and it enables even low income earners to
get access to good at prices that they can afford
8. Patent rights and copyrights foster industrial growth
9. In the case of statutory monopolies, there is enlargement of employment opportunities
10. Where the monopolies are private, they are a source of government revenue through
taxation by paying surtax.

Disadvantages of Monopoly

1. Production is at excess capacity leading to resource wastage and under utilization of

resources
2. Poor quality services and goods are produced because of limited competition
3. There is consumer exploitation because of the high prices charged.
4. There is limited variety of goods for consumers to choose from because the good has
limited or no close substitute
5. There is unemployment and under employment since it is a single firm that engages in
production
6. Income inequality is increased because the monopolist through exploitation grows richer
and the consumers he exploits become poorer.
7. Shortages sometimes result especially in terms of breakdown of the production process.
8. Monopolies sometimes use their economic power to exert pressure on government
decisions so that they are in their favour

The Control of Monopoly

Because of the various disadvantages of monopoly, the government tries to control the powers of
monopoly firms in the following ways;

1. Price controls
The government may fix a price for the product of a monopolist so that it becomes illegal for the
monopolist to charge a price above that one set by the government.

2. Taxation
The government can impose taxes on the profit of the monopolist in order to control his power.
Since taxes are a cost to the producer, taxes reduce his profit and power.

The taxes which are imposed may take the form of:
a) Lumpsum tax
This is a tax imposed on the profit of the monopolist regardless of the output e.g. A tax of
500,000/= per annum can be imposed. The lumpsum tax is a fixed cost and it raises the
AC of the producer hence reducing his profit and the power of the monopolist.
b) Specific tax
A specific tax is a tax imposed on each unit of output produced therefore it is a variable
cost, i.e. it affects both the AC and MC. When the tax is charged, it increases both the AC
and the MC decreasing the profits of the producer hence controlling monopoly powers.
3. The government can remove foreign trade restriction so that domestically produced
goods compete with foreign goods forcing domestic firms to improve their quality of
output, to sell their output at reasonable prices as well as improving their efficiency.
4. The government can nationalize monopolizes especially those that produce essential
commodities like water, electricity, etc. This would promote efficiency and eliminate self
interest in production.
5. The government can put in place antitrust laws which discourages merging of firms to
discourage monopolies. But this limits the enjoyment of economies of scale in
production.
6. The government can reduce the period of patent rights and copy rights although this may
discourage research and innovations.
7. The government may establish a production quota for monopolists. This prevents the
monopolies from restricting output.
8. The government can allow consumers to establish consumer protection associations to
check on the quality of produce like UNBS so that the monopolist has no room for
lowering the quality of products.
9. The consumers themselves can threaten to boycott the product unless the quality is
improved and the prices are made fair.
The Concept of Price Discrimination Under Monopoly
Price discrimination is the practice of a monopolist selling the same commodity produced, under
the same conditions at different prices to different customers for different reasons not associated
to differences in cost.

Price discrimination may take the following forms;

1. Discrimination based on the level of income. The rich pay a higher price for a product
and the poor pay a lower price for the product/service.
2. Discrimination can be based on the nature of product. E.g. Hard covered edition of books
are sold at higher prices than soft cover edition books
3. Discrimination can be geographical/ local where the monopolies vary the prices
according to locality.
4. Discrimination can be based on the use of the product e.g. day telephone users may be
charged differently from nigh users.
5. Discrimination can be based on age, sex and status of the consumer e.g. students in
uniform, military personnel may be admitted to theatres, trade fairs, soccer stadiums at
lower rates than those without uniforms.
6. Time e.g. most perishable product will be lower in the evening, than morning.

Conditions Necessary for the Success of Price Discrimination

1. The product should have only one producer with limited or no substitute
2. It should be possible for the producer to divide the market into sub-markets or segments.
3. There should be different price elasticity of demand for the product in the different
markets
4. It should be cheap for the producer to keep the different sub-markets apart
5. The transport cost between the different markets should be prohibitive such that it is not
easy for people to buy from a cheaper market and resale in the expensive market
6. The difference in price should not be substantial in the different markets.
The Degrees of Price Discrimination

1. First degree/perfect price discrimination:

This is where the monopolist charges a different price to different consumers for the same unit of
the commodity sold. In this situation, a monopolist identifies those consumers who are prepared
to pay a higher price and consequently charges them that higher price

2. Second degree price discrimination/multipart pricing:

This is where consumers who make large scale purchases are given discounts such that on
average, the price they pay is lower than for consumers who make ordinary purchases.

3. Third degree price discrimination/market segmentation

This is where the monopolist divides the market into sub markets or divides consumers into
different classes and charges each class or group of consumers differently. This is the most
common form of price discrimination.

Advantages of Price Discrimination

1. The producer’s revenue is increased
2. All groups of income earners in an economy gets access to the commodity at the prices they
can afford. Whether they are rich, poor or middle class.
3. Price discrimination helps to reduce on income inequalities since the rich pay a higher price
than the poor.
4. The sales of the producer are increased especially if he reduces the price in the market where
the elasticity of demand is elastic and this promotes economic welfare.
5. The monopolist gets a lot of profits which he uses to increase the efficiency of the firm.
6. Where the monopolist sells the products, abroad, foreign exchange is earned for the country.

Disadvantages of Price Discrimination

1. Poor quality services and goods are likely to be sold where the prices are low.
2. Resources may be diverted from social optimal use to concentrate on those fields where
the monopolist can practice price discrimination
3. The gap between the monopolist and the poor consumes increases resulting in gross
income inequalities
4. Where discrimination is based on dumping, the infant industries of the recipient county
are retarded.
MONOPOLISTIC COMPETITION
This is a market structure where there are many buyers and sellers of differentiated commodities.
The various sellers is the market make effort to attract more buyers by making their commodity
appear different from that of their rivals through branding, coloring, scent etc.

Assumptions of monopolistic competition

1. There are a large number of firms in an industry and none of the sellers controls a big
proportion of the total market
2. There is product differentiation. The products are made to appear different and yet they
have the same use.
3. There is freedom of entry and exit of firms in the industry. When the industry is making
supernormal profits, new firms enter the industry with ease and firms that are making
losses leave the industry without hindrance.
4. There are a large number of buyers in the market such that no single buyer can influence
the market forces in relation to price and quantity.
5. There is intensive, persuasive or competitive advertising
6. The demand curve of each firm is highly elastic because the products of the various firms
are very close substitutes of one another.
7. The firms produce at excess capacity
8. The firms are price markets for their brands
9. There is an element of brand loyalty by buyers. Buyer may prefer certain brands of a
product to another
10. Goods are good but not perfect substitutes of each other.

Product differentiation is the act of making the product of one firm to appear different from those
of rival firms through creating artificial differences in the commodity.

Advantages of Monopolistic Competition

1. There is variety of output for consumers to chose from leading to a good standard of
living
2. The prices are reasonable because of the element of competition and the close substitutes.
3. There is production f quality output because of the high degree of competition
4. High output, high levels of GDO and economic growth are realized because of the
existence of many firms.
5. There is productive efficiency as each of the firm tries its best to produce at the least cost
possible.
6. There is utilization of idle reserves because many firms are engaged in production.
7. The high level of competition facilitates innovation and inventions which lead to
technological development.
8. There is a lot of government revenue realized from taxation of the many firms engaged in
production process.
9. There are high employment levels created because of the large number of firms engaged
in production especially in the short run.
10. The different forms of advertisement provide entertainment
11. There are high levels of sale promotion/non price competition in the form of gifts, free
offers, price reductions which improve the people’s welfare.
12. High profits are realized in the short run and these can be used to sponsor sports, or
cultural events for the benefits the consumers.

Disadvantages of Monopolistic Competition

1. Production is at excess capacity by all firms and this constitutes resource wastage.
2. That threat competition which exists between the firms deters industrial development.
3. A lot of resources are wasted on extensive advertising and yet such funds should be
channeled to production elsewhere.
4. There is limited employment because many of the firms produce less than optimum
capacity.

OLIGOPOLY

This is a market structure where there are few sellers and many buyers of products which are
homogenous or differentiated. Where the product is homogenous, it gives rise to perfect
Oligopoly. Where the product is differentiated, there is perfect or differentiated oligopoly.

In Uganda, examples of oligopoly: The satellite digital television companies, Nile breweries etc.

Assumption of Oligopoly
1. There are few sellers so that each seller produces for a considerable portion of the market.
2. Each firm can indirectly influence the market by increasing or decreasing what it puts on
the market and this in turn influences the prices.
3. There are many buyers and no single buyer can influence the market price or output.
4. There is limited entry of firms into the market. This is because of the high costs involved
in the establishment of the industries or because of the high costs involved in the
establishment of the industries or because of the limit pricing policy/deliberate effort by
firms to keep the price of their product very low in order to discourage entry of new firms
in the industry.
5. There is extensive persuasive advertising of the products of the firms.
6. There is high degree of uncertainty in the industry because each firm cannot predict in
advance what the reaction of the competitors will be as a result of its decision.
7. The firms pursue non-price competition. This is a practice where each firm uses other
means other than price under cutting price wars to get a large share of the market. Non
price competition takes the form of offering free gifts, giving after sales services, offering
free samples, opening up of more branches, giving promotional offers to customers, free
and attractive packaging, or sponsoring sports and other events.
8. There are varying sizes of the firms, some firms are large and others small.
9. There is no unique pattern of pricing in the market. The firms experience kinked demand
curves with an administered price.
10. There is close interdependence of firms, the actions of one firm affects the others in the
industry since …
Assumptions on which the kinked demand curve works
1. The industry is mature i.e. operates in the long run
2. There is an administered price at which the sellers are comfortable
3. Each of the seller’s attitude depends on the attitudes of his rivals which brings in a high
degree of uncertainty.
4. The firms are rational such that when one firm increases its price, the others will not
follow suit.
5. If one firm reduces the price, the others are likely to undercut so that it is deprived of
customers.
6. The MC curve passes through the dotted portion of the MR curve such that changes in the
MC curve do not affect output and price. That is the point of stability.

Why Firms Under Oligopoly Tend to Have Price Rigidity

1. The firms may be satisfied with the profits they are getting at the prevailing price and see
no need to change that price.
2. The price has been reached through agreement under collusive determination so that
individual firms be not culling to deviate from it.
3. The firms may be pursuing limit pricing policy where they want to keep competitions out
of the industry, so they won’t change the price.
4. The firms may have heard from experience the bad effects of price wars.
5. The sellers may have decided to use non price competition to attract more sales.
6. The firms may have spent a lot of money on advertising and don’t want to deprive
themselves of the market they would have gained.
Forms of Price Determination under Oligopoly

Other than the administered price, the oligopolistic can use other means of determining the price
of their conducts.

1. Independent pricing
This is where in differentiated oligopoly, each firm sets its own profit maximizing price but this
results into price wars in the short run as firms try to underrate the prices of their rivals.

2. Perfect collusion
This is where firms have a cartel arrangement and the price and output decisions are made by the
central cartel board which determines production quotas for the firms and the prices to be
charged. Where it is a market sharing cartel, the central cartel board determines where each of
the producers are to sell their products.

3. Price leadership/imperfect competition

Under this arrangement, one firm in the industry sets a price for its product and the other firms
fix their prices in accordance with what the leading firm has fixed. The firm which fixes the
initial price may be a dominant firm/low cost firm.

A dominant firm is one which commands a larger share of the market and a low cost firm is
one which produces at the least average cost possible.

Price leadership may take on the following forms

a) Barometric price leadership

The firm which is very good at determining the market conditions announces a price change first
and other firms in the industry change their prices accordingly on the basis of atacit agreement.

b) Dominant price leadership:

This is where the largest firm in the industry sets a price and the other small firms adjust
accordingly. The small firms usually follow the leader firm for fear of being eliminated from the
industry.

c) Aggressive/exploitative price leadership

Is where the dominant firm selfishly set a price which benefits it alone irrespective of the interest
of other firms and the leaders firm deliberately sets a low price which will cause some of the
competing firms to leave the industry.

d) Affective price leadership

Is where the rice leader controls the source of all raw materials/inputs which it supplies to firms
at a uniform price so that they have identical costs and therefore charge uniform prices. This
helps to reduce competition among oligopoly firms.
ADVANTAGES OF OLIGOPOLY

1. Price tend to be relatively stable and this enables consumers to plan their expenditure
2. The existence of competition leads to provision of efficient service to the consumers.
3. Producers get supernormal profits both in the short run and in the long run and this
initiates investment
4. Consumer enjoy a variety of output under differentiated oligopoly
5. Competition leads to production of high quality goods
6. A lot or research, inventions and innovation is done leading to product improvement and
development
7. The producers are price makers to some extent especially for their brands because of
existence of brand loyalty by the consumers.
8. Consumers benefit because they get free gifts, prices and sometimes free goods in the
form of samples.
9. The cartel arrangement leads to promotion of sales by each of the firms
10. Creation of job opportunities since they operate on large scale
11. It boost government revenue through taxes

Disadvantages of Oligopoly
1. Firms produce at excess capacity leading to resource underutilization
2. A lot of resources are wasted on sales promotion activities
3. The firms restrict output leading to consumer exploitation
4. High prices are charged under oligopoly leading to consumer exploitation
5. There is distortion of consumer choice due to persuasive advertising.
6. There is duplication in production of differentiated commodities resulting in wastage.
7. Worsened income inequalities due to low employment since some firms are forced out of
production.

Reasons why loss making firms continue to exist

Firms may continue with production despite the fact that they are making losses(when their AR
is less than AC or TR is less than TC) also they may continue in production despite the fact that
they are not earning any abnormal profits when TR equals to TC or AR equals to AC or when
making normal profits. This is because of the following reasons;

1. When the firm has just began production. Infant firm or firms that have just began
production have high average costs which prevent them from making profits and as time
goes on they expand output which reduce average cost and start making abnormal profits.

2. When a firm has hope of changing management. Sometimes losses as a result of

inefficient management but as a firm employ a better management the level of efficiency
increases and the firm starts making profits.

3. When a firm hopes to obtain a bank loan. By use of a bank loan the firm can expand its
output, pay some of its costs which enables it to continue in production and in the long
run; it starts making abnormal profits.
4. When the firm is able to pay for the variable costs. This enables the firm to obtain
variable factor of production e.g. raw materials which enable the firm continue in
production until when time comes to pay for the fixed factor of production.

5. Fear to lose its market/customers. Once the firm stops production, its customers have to
switch to other firms. Therefore the firm has to continue operating even when making
losses so as to maintain its customers.

6. When the losses or high costs of production are seasonal e.g. there are seasons where
inputs are in limited supply and very expensive which greatly increases the firm’s cost of
production but in other seasons, supply of inputs increases which reduces their prices and
the firm’s costs of production.

7. Fear to lose its supply of raw materials. As a firm closes, its supply of raw materials
switch to other firms or competitors which put the firm that has closed down at a
disadvantage.

8. Fear of high costs of depreciation. As the firm stops production, its fixed assets e.g.
machinery depreciates at a very high rate. Sometimes it may not be possible to dispose
off these fixed assets as quickly as possible.

9. When a firm has a hope of merging with other profit making firm, as firms merge, the
level of output increases and it enjoys economies of large scale production which leaves
the average cost. Thereby resulting into some profits in a firm.

10. Fear to loose contact. Sometimes, firms have signed contracts to supply commodities in a
given period of time, so if they close down, these contracts may be awarded to other
supplies

11. When the firm is experimental/research firm. Such firms are usually funded by
government/organization to establish some findings and their aim is not making profits.

12. A firm may be a branch of another profit making industry/firm such that its losses can be
covered up by the profit making firm.

13. Fear of losing the firm’s skilled labour. As the firm closes down, its skilled labour
switches to the firm for employment

14. A firm may be a state owned firm and providing essential commodities to the society
other than profit making.