Market Structure :: It's 4 X4 ingrediants

Structure-Conduct-Performance (S-C-P) hypothesis states that the performance of a firm is determined by its conduct, which in turn is determined by the structure of the market in which it is operating.  Thus, market structure forms the crux of market analysis. 

Below 4 X 4 grid helps us understand market structure in detail.

Four Market Types:

Markets are traditionally classified into four basic types as described below:

(i) Perfect competition is characterised by a large number of buyers and sellers of an essentially identical product. Each member of the market, whether buyer or seller, is so small in relation to the total industry volume that he is unable to influence the price of the product. Since there is free entry and exit, no firm can earn excessive profits in the long run. 

(ii) Monopoly is a market situation in which there is just one producer of a product. The firm has substantial control over the price. Further, if product is differentiated and if there are no threats of new firms entering the same business, a monopoly firm can manage to earn excessive profits over a long period.

(iii) Monopolistic competition implies a market structure with a large number of firms selling differentiated products. The differentiation may be real or is perceived so by the customers. Two brands of soaps may just be identical but perceived by the customers as different on some fancy dimension like freshness. Firms in such a market structure have some control over price. By and large they are unable to earn excessive profits in the long run. Since the whole structure operates on perceived product differentiation, entry of new firms cannot be prevented. Hence, above normal profits can be earned only in the short run.

(iv) Oligopoly is a market structure in which a small number of firms account for the whole industry’s output. The product may or may not be differentiated. For example, only 5 or 6 firms in India constitute 100% of the integrated steel industry’s output. All of them make almost identical products.The nature of products is such that very often one finds entry of new firms difficult. Oligopoly is characterised by vigorous competition where firms manipulate both prices and volumes in an attempt to outsmart their rivals.

Four Market Characteristics:

The four characteristics used to classify market structures are:

(i) Number and size distribution of sellers: If there are a large number of sellers, the influence of any one firm is likely to be less. Consider the number of firms selling fruits and vegetables in your locality. It is unlikely that any one of them will exercise a great influence over price. On the contrary, if there are only few sellers in the market, an individual firm can exercise greater control over price and total supply of the product. 

(ii) Number and size distribution of buyers: The firm "TISCO" in Jamshedpur is a large and perhaps the only firm in the area. TISCO will thus be able to exercise considerable influence on the price at which it buys inputs from suppliers in the area. Similarly, Maruti Udyog Limited (MUL) in Gurgaon is one of the large automobile manufacturers and has considerable influence over the price at which it buys inputs such as glass, radiator caps and accessories from other suppliers located in the region. Both MUL and TISCO are firms that are said to have ‘monopsony’ power in their buying decisions

However, if there are a large number of buyers they will be unable to demand lower prices from sellers. One reason why large firms are able to negotiate lower prices is because of large volume purchases.

(iii) Product differentiation: Product differentiation is a fact of life and there is some amount of differentiation for almost all products that we buy in markets. For example, ingredients in different soaps could be different as can be the packaging, advertising etc. Even seemingly homogeneous goods such as apples and bananas are at present differentiated on the basis of the orchards where they have been grown and the way these are marketed.

(iv) Conditions of entry and exit: It refers to the difficulty or ease with which a new firm can enter or exit a market. Consider a firm such as Ranbaxy that has a patent on a particular drug. A patent is an exclusive right to market the product for a given period of time, say 12 years. If there are no close substitutes to that drug, the firm will be free from competition for the duration of the patent. Thus the barriers to entry in the market for this drug are high. Similarly, since Indian Railways, is a public monopoly no new entrant can enter the market. 

On the other hand, retail outlets and the restaurant business witness several new firms entering the market periodically, implying that entry barriers are relatively low.

Classification of Markets based on their characteristics