There are many forms of economy in human history, but seeing as Capitalism is seen to be the most evolved in allowing transaction and trade to occur in today’s world we will aim break this down simply and quickly. This is also known as the Competitive Environment or the Market Economy. On the other hand there are Command Economies which are more commonly known as Communism and in part Socialsim. For a breakdown on Mixed Market Economies please follow this link.
However, in this instance we will focus on Market/Competitive Economies. There are 4 commonly known forms of structure:
- The Perfectly Competitive Market
- The Monopolistically Competitive Market
- The Oligopolistically Competitive Market
- Monopoly Markets
The Perfectly Competitive Market
There are common traits that run throughout this form of market structure. These include:
- being made up of many firms.
- selling identical or homogenous products.
- complete freedom.
- no barrier to entry.
- they are seen to be price takers & not price makers.
- eg commodity markets (coffee, timber etc).
The Monopolistically Competitive Market
Typical features in this form of market structure are:
- many sellers
- there is seen to be a slight variation in goods and services sold.
- they are also seen as imperfectly competitive markets.
- typical examples are retail, clothing brands, service sectors.
The Oligopolistic Competitive Market
Typical breakdown of this market structure includes:
- a few large firms operating in this market.
- they are aware of the dealings of the other companies in the same sector.
- the products and services offered are in principal the same, but in reality some differentiation may occur.
- they are common in developed economies.
- high price entry to market.
- they are generally price makers.
- this is also seen as imperfectly competitive markets.
- eg commercial banking, mobile phone networks.
Common features seen are:
- there is one sole supplier.
- in this instance the firm is very much the price maker.
- it is not that common in practice.
- The Competition Law stipulates a Monopoly exists when a firm has a market share of 25% or 40%.
- In Economics, we define a Monopoly as when there is no close substitue for the product or service produced by the firm in question.
- A pure Monopoly is seen when there is only one suppler to the market.
- In this instance the market is ‘non-contestable’, as seen with Patents, Governmental contracts etc.
How do you define the nature of a market? Well in reality there seems to be a mixture of the above, with many overlapping sectors. But it is important as economists to be able to segregate. We can begin by looking at the size and distribution of buyers and sellers in the market, and secondly by looking at the differentiation of products or services offered. Thirdly, we should appreciate the barriers to entry for a firm wishing to partake in a given market, and the Sunk Costs associated with this.
Sunk Costs are the irrecoverable costs associated with entering a market spent by a firm.
The Porter 5 Forces Model
Michael Porter offers a system that looks at 5 influencing factors over any market structure, and allows us to gauge potential profitability of a firm. This is called Porters Five Forces Model.
Its looks at the following influencing factors of any firm:
- The Buying Power. This includes: order volumes, price sensitivity, product differentiation, brand identity, buyer leverage etc.
- Supplier Power. This includes: the concentration of suppliers, the dependence on goods of buyer, presence of substitue suppliers etc.
- Threats from new entrants into the market.
- Threat of substitue products or services.
- Degree of competition in the market place.
It can be seen easily that potential profitability is a function of market structure.