Market Structures: Perfect and Imperfect Market Structures
Market structure is best defined as the organizational and other characteristics of a market. We focus on those characteristics which affect the nature of competition and pricing – but it is important not to place too much emphasis simply on the market share of the existing firms in an industry.
Traditionally, the most important features of market structure are:
- The number of firms (including the scale and extent of foreign competition)
- The market share of the largest firms (measured by the concentration ratio – see below)
- The nature of costs (including the potential for firms to exploit economies of scale and also the presence of sunk costs which affects market contestability in the long term)
- The degree to which the industry is vertically integrated – vertical integration explains the process by which different stages in production and distribution of a product are under the ownership and control of a single enterprise. A good example of vertical integration is the oil industry, where the major oil companies own the rights to extract from oilfields, they run a fleet of tankers, operate refineries and have control of sales at their own filling stations.
- The extent of product differentiation (which affects cross-price elasticity of demand)
- The structure of buyers in the industry (including the possibility of monopsony power).
- The turnover of customers (sometimes known as “market churn”) – i.e. how many customers are prepared to switch their supplier over a given time period when market conditions change. The rate of customer churn is affected by the degree of consumer or brand loyalty and the influence of persuasive advertising and marketing.
Perfect Market Structure
The Perfect Competition is a market structure where a large number of buyers and sellers are present, and all are engaged in the buying and selling of the homogeneous products at a single price prevailing in the market.
In other words, perfect competition also referred to as a pure competition, exists when there is no direct competition between the rivals and all sell identically the same products at a single price.
Features of Perfect Competition
- Large number of buyers and sellers
In perfect competition, the buyers and sellers are large enough, that no individual can influence the price and the output of the industry. An individual customer cannot influence the price of the product, as he is too small in relation to the whole market. Similarly, a single seller cannot influence the levels of output, which is too small in relation to the gamut of sellers operating in the market.
- Homogeneous Product
Each competing firm offers the homogeneous product, such that no individual has a preference for a particular seller over the others. Salt, wheat, coal, etc. are some of the homogeneous products for which customers are indifferent and buy these from the one who charges a less price. Thus, an increase in the price would let the customer go to some other supplier.
- Free Entry and Exit
Under the perfect competition, the firms are free to enter or exit the industry. This implies, If a firm suffers from a huge loss due to the intense competition in the industry, then it is free to leave that industry and begin its business operations in any of the industry, it wants. Thus, there is no restriction on the mobility of sellers.
- Perfect knowledge of prices and technology
This implies that both the buyers and sellers have complete knowledge of the market conditions such as the prices of products and the latest technology being used to produce it. Hence, they can buy or sell the products anywhere and anytime they want.
- No transportation cost
There is an absence of transportation cost, i.e. incurred in carrying the goods from one market to another. This is an essential condition of the perfect competition since the homogeneous product should have the same price across the market and if the transportation cost is added to it, then the prices may differ.
- Absence of Government and Artificial Restrictions
Under the perfect competition, both the buyers and sellers are free to buy and sell the goods and services. This means any customer can buy from any seller and any seller can sell to any buyer. Thus, no restriction is imposed on either party. Also, the prices are liable to change freely as per the demand-supply conditions. In such a situation, no big producer and the government can intervene and control the demand, supply or price of the goods and services.
Thus, under the perfect competition, a seller is the price taker and cannot influence the market price.
IMPERFECT MARKET STRUCTURE
An imperfect market refers to any economic market that does not meet the rigorous standards of a hypothetical perfectly or purely competitive market, as established by Marshellian partial equilibrium models.
An imperfect market is one in which individual buyers and sellers can influence prices and production, where there is no full disclosure of information about products and prices, and where there are high barriers to entry or exit in the market. It’s the opposite of a perfect market, which is characterized by perfect competition, market equilibrium, and an unlimited number of buyers and sellers.
Imperfect markets are found in the real world and are used by businesses and other sellers to earn profits.
Understanding Imperfect Markets
All real-world markets are theoretically imperfect, and the study of real markets is always complicated by various imperfections. They include the following:
- Competition for market share
- High barriers to entry and exit
- Different products and services
- Prices set by price makers rather than by supply and demand
- Imperfect or incomplete information about products and prices
- A small number of buyers and sellers
For example, traders in the financial market do not possess perfect or even identical knowledge about financial products. The traders and assets in a financial market are not perfectly homogeneous. New information is not instantaneously transmitted, and there is a limited velocity of reactions. Economists only use perfect competition models to think through the implications of economic activity.
The term imperfect market is somewhat misleading. Most people will assume an imperfect market is deeply flawed or undesirable, but this is not always the case. The range of market imperfections is as wide as the range of all real-world markets—some are much more or much less efficient than others.