In O level tutorials, we learned what Economics is about. Economics is about how people utilize the available resources to satisfy their wants. Firms are set up so that they can produce goods and services suitable for consumption.
A market consists of all the consumers and producing firms of a particular good or service. We remember that firms are usually trying to maximise their profit and the consumers are always trying to maximise their satisfaction. The firms will decide on what level of output to produce and at what price to sell their product for. The way in which a firm behaves in making these two decision depends on the type of market in which the firm is operating and the conditions it faces.
Market structures are based on the characteristics of a market. Economists identify a number of characteristics which determine the market structure a firm is said to operate in:
• the size and number of firms in the market
• the ease or difficulty with which these new firms might enter the market (barriers to entry and exit)
• the extent to which goods in the market are similar (homogeneity)
• the extent of knowledge shared by firms in the market
• the extent to which the actions of one firm will affect another firm (interdependence).
The number of firms in an industry
The number of firms in an industry may vary from one to many. For example, Thames Water is the sole supplier of water in the London area, ie a monopoly. In agriculture, on the other hand, there are tens of thousands of farms supplying eggs to the market.
1. Monopoly is said to exist where there is only one supplier in the market.
2. Oligopoly is said to exist in a market dominated by a few large producers alongside a large number of small and relatively unimportant firms.
3. Perfect Competition and Monopolistic Competition. In this market structure there are a large number of small firms, none of which are large enough to influence price. Monopolistic competition is less intense than perfect competition.
Barriers to entry
Market structures are also affected by the ease with which new entrants can access the market. Firms that are in an industry, which is unlikely to experience many new entrants, may behave differently to those operating in an industry which has low barriers to entry.
Product homogeneity and branding
In some industries, such as gas and oil extraction and agriculture, the product is essentially the same whoever produces it. These identical goods are known as homogenous goods. This means that no producer has a monopoly over production. Firms find it much easier to maximise profits if they are able to differentiate their product by creating
brand loyalty and reducing the elasticity of demand for the good. This also creates barriers to entry reducing the competitiveness of the market.
Buyers and sellers are said to have perfect knowledge if they are fully informed about price and output. Therefore, if one producer puts its prices up, then that producer will lose all its customers because they will buy the good from elsewhere in the industry.
Perfect knowledge does not mean that all firms or consumers possess all the knowledge, but instead that this information is freely available; it is up to firms and consumers to access this. Imperfect knowledge exists where there are patents protecting a particular process, such as the recipe for Coca Cola. Individual firms may not be aware of all the new innovations to be introduced. A lack of information acts as a barrier to entry, preventing or discouraging new firms from entering the market.
Interrelationships within markets
Firms may be independent of each other, in other words the actions of one firm will have no
significant impact on any other firm in the industry.
If firms are interdependent then the actions of one firm will have an impact on others. For example, when one firm advertises it is hoping to create more demand for its products. This will necessarily have an impact on other producer’s level of demand.