A market structure demonstrates how a market is organized. The characteristics that make up that structure help to define the market and how it works and how companies in that structure interact.
While market structure certainly involves both pricing and competition within the market, that’s not all that’s involved.
Related: THE PROBLEM WITH OLIGOPOLIES
Key Features Of A Market Structure
- The number of companies involved in the market.
- Market share of the largest companies.
- The nature of costs within the market.
- The degree to which the industry is vertically integrated, i.e., control of production and distribution lies with individual companies.
- The extent of product differentiation.
- Structure of buyers in the market.
- The amount of market churn within the market.
Importance To Investors
As with everything else involved in investing, knowledge is a powerful tool. That knowledge includes knowing as much as possible about the market structure of companies in which you are considering making an investment.
Understanding how companies work, not only as entities unto themselves, but as part of the market structure in which they operate is critical to making intelligent, safe investments. There are four basic market structures. Each is unique though all are in some ways connected.
Types of Market Structure
Perfect Competition Market Structure – The ideal to which all market structures are compared. In a way, a perfect competition market represents an unattainable – or nearly so – example of supply and demand in action.
Perfect competition assumes that the climate cooperates with the buildings within it. There is free entry and exit. Companies move into the market when it is profitable and leave when it is not. There are so many competitors, one company has little to no impact on the market. Products within the market are homogenous or identical.
Monopolistic Competition Market Structure – A monopolistic competition structure does not assume the lowest possible cost. Companies in this structure sell similar products with small differences differentiated by marketing and advertising.
Producers are price maximizers. When profits are there, producers enter the market. Slight differences between products create differences in the information available about quality and price. Examples include companies in the service and repair markets such as HVAC, beauty salons and spas and companies that provide tutoring or learning experiences.
Monopoly Market Structure – Monopoly structures consist of just one supplier that owns the market. There are high barriers to entry resulting in one player. That one player is the price-maker and it sets the price to maximize profits. It is the exact opposite of a perfectly competitive market.
Some monopolies occur naturally – others through legislation (such as state-regulator liquor stores). Monopolies are considered bad and result in efforts to break them up through antitrust legislation. Examples of companies accused of antitrust behavior include: Microsoft Corp. (NASDAQ:MSFTA), AT&T Inc. (NYSE:TC) and Eastman Kodak Co. (NYSE:KODKC).
Related: TRADING VERSUS INVESTING
Oligopoly Market Structure – The easiest way to think of the oligopoly structure is to think of it as several companies that form a monopoly. These companies work together or collude to limit competition and/or dominate a market.
The companies involved can be large or small. The largest ones have patents, finance, physical resources and control over raw materials. These things erect barriers to entry by competitors. Areas where oligopolies thrive include gasoline, fast food or airlines.