9 Market structures and concentration ratios

Market structures

-The characteristics of a market which determine the behavior of firms within the market

-main characteristics

• The number of firms in the market and their relative size

• Number of firms that might enter the market and the ease or difficulty with which these new entrants might enter or exit

• The extent to which goods in the market are similar

• Extent to which the actions of one firm will affect another firm

The number of firms in the market and their relative size

• Market concentration -The degree to which the output of an industry is dominated by its largest producers

• Measured using concentration ratio (market share of the largest firms in an industry

• A pure monopoly is said to exist where there is one supplier

• A oligopoly is when it is dominated by a few large producers

• Perfect competition or in monopolistic competition there are large number of small suppliers none which are large enough to dominate the market

The number of firms that might enter the market and the ease or difficulty with which these new entrants might enter or exit

• Not only affected by the number of firms and their relative output but also the potential number of new entrants

• In an industry where there is unlikely to be any new entrants firms may behave differently to firms in an industry where there is many strong potential competitors

• There might be barriers to entry and there are difficulties to leave the market which makes it a barrier to enter in the first place (barriers to exit)

The extent to which goods in the market are similar

• Homogeneous goods -goods made by different firms but which are identical

• Firms find it easier to control their markets if they can produce non-homogeneous goods - goods made by different firms which are similar but not identical such as branded good

• Product differentiation- aspects of a good or service which serve to distinguish one product from another such as product formulation packaging marketing or availability -helps build brand loyalty leading to a reduction in elasticity of demand

• Brand or branded goods - a name design symbol other feature that distinguishes a product from other similar products and which makes it non homogenous- branding has value for the firm because consumers think the product is different from rivals

The extent to which all firms in the market share the same knowledge

• Perfect knowledge- exists if all buyers in a market are fully informed of prices and quantities for sale while producers have equal access to information about production techniques- if one firm were to rise their prices then it would lose all its customers because they would buy elsewhere therefore there can only be one price

• Implies that firm has access to all other information which is available to all other firms

• Does not imply that al firms in an industry will possess all information as inefficient firms will not bother to gather revenant information that is readily available and in the LT will be driven out of business

• They have to look at the probability of all this happening And it only means that all firms have the same knowledge

• Firms have imperfect knowledge when there are industrial secrets this acts as a barrier to entry preventing or discouraging new firms from entering

The extent to which the actions of one firm will affect another firm

• two possible relationships

• Independent- in market theory when the actions of one firm will have no significant impact on any other single firm in the market

• Interdependent- in market theory when the actions of one firm will have an impact on other firms in the market

• Interdependence means uncertainty - when one firm does not know how other firms in the market will react if it changes its strategy such as changing its price

Competition and market structure

• Perfect competition exists where a large number of firms compete in the industry but none of the firms are large enough to have a direct impact. There is freedom of entry and exit

• Monopolistic competition exists where there is few firms dominating

• Monopoly exists where there is only one firm in the industry

Market concentration

• The degree to which the output of an industry is dominated by its largest producers

• The more narrowly a market is defined the more likely it is that there will be relatively few producers

Concentration ratios

• total sales of N firms in the industry/ total sales of all the firms in the industry X 100%

• The higher the number of the concentration ratio the more concentrated the industry and fewer firms dominate

• The lower the ratio the more competitive

• Total share of the market held by the three largest producers

• The significance of concentration ratio is that it indicates the extent to which an industry is dominated by a few large firms and is therefore a monopoly

• 3 firm , 4 firm ,5 firm

• It’s useful for governments when considering whether to allow a merger or takeover to go ahead as too much power concentrated will lead to exploitation of consumers

• It can also be compared overtime to see if an industry is becoming more or less competitive