Market structure
The behaviour of a firm depends on the features of the market in which it sells its product(s) and
on its production costs. The major organisational features of a market are called the structure of
the market (or market structure).
The different market structures
Nearly every market or industry is unique, and no simple classification system can accurately
reflect this enormous variety. Nevertheless, economists usually distinguish between four broad
sets of markets: perfect competition, monopoly, monopolistic competition and oligopoly.
Perfect competition: a market in which buyers and sellers are so numerous and well informed
that the market price of a commodity is beyond the control of individual buyers and sellers.
Monopoly: A market structure characterized by a single seller, selling a unique product in the
market
Monopolistic competition: A market structure in which several or many sellers each produce
similar, but slightly differentiated products. Each producer can set its price and quantity without
affecting the marketplace as a whole.
Oligopoly: a market form in which a market or industry is dominated by a small number of
sellers (oligopolists).
The key features of the four different types of market structure are summarised in the table
below.
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1. Number of firms: this can vary between one and many. The most important question is the
behaviour of firms, in particular whether or not an individual firm can influence the price
at which its product is sold.
Perfectly competitive firms are all price takers (ie they cannot influence the price of their
product), but monopolists and imperfectly competitive firms are price makers or price
setters (ie they each have some influence on the price of their product).
2. Nature of the product: the product can be homogeneous (identical, standardised) or it can
be heterogeneous (differentiated, non-standardised). Consumers ultimately decide
whether two products are identical or different, if they are different in the eyes of buyers,
the product is classified as a heterogeneous or differentiated product.
3. Entry: refers to the ease or difficulty with which firms can enter and exit the market. Entry
can vary from perfectly free (under perfect competition) to totally blocked (under
monopoly).
4. Information (or degree of knowledge): perfect competitors are assumed to possess full
information (or perfect knowledge) of market conditions. This assumption also applies in
the case of monopoly. Under monopolistic competition and oligopoly, however, firms have
incomplete information (ie they operate under conditions of uncertainty).
Unlike the first four criteria, the next four criteria in the table are not basic assumptions, but
logical consequences of the basic assumptions.
5. Collusion: collusion occurs when two or more sellers enter into an agreement,
arrangement or understanding with each other to limit competition between or among
themselves. Collusion is only common in oligopolies.
6. Control over the price of its product: a perfectly competitive firm has no has no control
over the price of its product (ie it is a price taker), whereas other firms have a varying
degree of control (but never absolute control) over the prices of their products. They are
price makers or price setters.
7. Demand curve for the firm’s product: Under perfect competition the individual firm (as a
price taker) is faced with a horizontal (or perfectly elastic) demand curve for its product (at
the level of the market price). In contrast, other firms are all faced with downward-sloping
demand curves for their products and therefore have some scope for “making” or “setting”
their own prices.
8. Long run economic profit: perfectly competitive firms do not earn any economic (or
supernormal) profits in the long run (only normal profits). This also applies to the case of
monopolistic competition. However, as we explain later, monopolistic and oligopolistic
firms may earn economic profits in the long run.
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Market concentration
The number and size distribution of firms in a market is called the degree of concentration in the
market. Economists use measures to quantify the extent to which a market is dominated by a
small number of large firms.
One of these is the four-firm concentration ratio which is the fraction (or percentage) of the total
value of assets, output or sales in an industry that is accounted for by the four largest firms in the
industry. For example, a four-firm concentration ratio of 0,80 (or 80 per cent) means that the four
largest firms account for 80 per cent of industry assets, output or sales.
They also show that there is no definite correlation between the number of firms in an industry
and the degree of economic concentration. For example, the baking industry consisted of more
than twice as many firms than the footwear industry, but the degree of concentration in the
baking industry was much larger.
The
Herfindahl-Hirschman index (HHI, sometimes simply called the Herfindahl index) has become
increasingly popular among competition authorities in recent years
This index is calculated by adding the squares of the market shares of each firm in the industry
HHI = Σ(% market share)2

For example, if there is only one firm in the industry, the value will be (100)2 = 10 000.

For an industry in which four firms each control 25 per cent of the market, the HHI = 252 +
252 + 252 + 252 = 625 + 625 + 625 + 625 = 2 500.
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If, on the other hand, there are 100 firms with equal market shares of 1 per cent each, then the
Herfindahl-Hirschman index will be equal to 100.
In South Africa the HHI, included in Table 13-2, is calculated somewhat differently. The formula is
basically the same but the market shares are expressed as fractions not percentages. As a result
there is a maximum value of 1, (1 indicating that there is only one firm in the industry).
Concentration ratios and indices are usually based on national data. However, many goods and
services are sold in local, regional or global markets, where these measures have little meaning.
For example, the fact that there are hundreds or thousands of restaurants nationally does not
mean that there is sufficient competition in every town or suburb.
On the other hand, a domestic monopolist may be subject to intense competition from
international firms, so a high concentration ratio or HHI does not necessarily signify the absence of
actual competition.
Market structure, conduct and performance
We have now established that there is no definite or necessary correlation between the number
of firms in an industry and the degree of concentration. Moreover, even when concentration is
high, it does not necessarily mean that there is little competition or that the market is inefficient.
The performance of a market in attaining economic objectives such as efficiency, full employment,
price stability and progressiveness depends on the conduct of the participants as well as on
concentration.
Market conduct refers to the efforts of suppliers to market their products, to gain a competitive
advantage over rivals, or to limit competition among themselves.
The concern of governments and other interested parties over business concentration has led to
the adoption of measures aimed at limiting or regulating economic concentration (or power) and
stimulating competition, such as the competition legislation in South Africa.
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