Market Structure: The Four Forms

4. The firm's control over price. Whether the individual seller has to accept the market price or can set it. The word for a firm that must accept it is a price taker; for one that can set it, a price maker.

5. Knowledge. Whether buyers and sellers know the prices and qualities available. Perfect knowledge means nobody can charge more than the going rate without losing every customer.

A sixth criterion is sometimes added: the presence of selling costs, meaning advertising, which is absent under perfect competition and heavy under monopolistic competition and oligopoly.

The four forms, and why there are four

The two ends of the range are theoretical. Perfect competition has so many sellers of an identical product that none has any influence on price at all. Monopoly has one seller and no substitute. Neither exists in a pure form in any real economy, and both exist as benchmarks: one is what competition would look like if it were complete, and the other is what its absence would look like.

Between them lie the two forms in which almost all real business is done. Monopolistic competition has many sellers of a product each of whom has made their version a little different from the others. Oligopoly has a few sellers, each large enough that what one does affects the others.

The middle two were the great addition of the 1930s, made independently by Edward Chamberlin in the United States, whose Theory of Monopolistic Competition appeared in 1933, and Joan Robinson in England, whose Economics of Imperfect Competition appeared the same year. Before them, textbooks had only the two extremes and could not describe an ordinary retail street.

The comparison table

This is the table the next four chapters fill in, and it is the highest yielding thing in this topic. An examiner who asks for the features of any one form is asking for one column of it.

Two words that must not be confused: firm and industry

A firm is a single producing unit under one management.

An industry is all the firms producing the same or closely similar goods.

Under perfect competition the distinction is sharp and useful: the industry's supply curve slopes upward while the individual firm's demand curve is horizontal. Under monopoly the two collapse into one, because the firm is the industry. Under monopolistic competition the word industry is replaced by Chamberlin's product group, because the products are not the same good, and that is why the boundary of a monopolistically competitive industry is always arguable.

Why market structure matters in law

Because dominance, not size, is what Indian law regulates. Section 4 of the Competition Act 2002 prohibits the abuse of a dominant position, and the explanation to that section defines dominance as a position of strength in the relevant market in India that enables an enterprise to operate independently of competitive forces, or to affect its competitors or consumers in its favour. That definition is a description of market structure, not of turnover.

Because the relevant market must be defined before anything else. Whether an enterprise is dominant depends entirely on how widely the market is drawn. A firm with the whole of the market for one brand of soft drink has no power at all if the market is soft drinks; it may have a great deal if the market is one flavour sold in one city.

Because different structures call for different remedies. A monopoly created by statute is corrected by amending the statute. A monopoly created by a patent is time limited by the patent law itself. An oligopoly that colludes is attacked under section 3(3), which presumes that price fixing, output limitation, market sharing and bid rigging have an appreciable adverse effect on competition. Monopolistic competition needs no competition remedy at all, but it does need consumer protection law, because its characteristic problem is misleading differentiation rather than high price.

A worked example: how wide is the market for a bus ride?

The facts. Konkan Coaches runs the only private overnight bus between two towns. A passenger association complains that its fares are excessive and that it is dominant.

If the relevant market is "overnight private bus services on this route", Konkan Coaches has all of it. Its market share is one hundred per cent.

If the relevant market is "overnight travel between the two towns", the railway, shared taxis and a second operator running a morning service are all in it, and the share falls sharply.

How the question is decided. By the statutory factors: are the alternatives interchangeable or substitutable by the consumer having regard to characteristics, price and intended use, under section 2(t)? Do passengers actually switch when the fare rises, which is cross elasticity? Section 19(7)(b) makes price a factor and section 19(7)(c) makes consumer preference one, and section 19(6) brings in transport costs and the geographic reach.

Why the answer matters so much. Everything else in the case follows from it. Draw the market narrowly and Konkan Coaches is a monopolist whose pricing is examinable under section 4. Draw it widely and it is one competitor among several in an oligopoly, and its fares are its own business unless it has agreed them with somebody else.

What beginners get wrong

"Market means a place." It means the set of buyers and sellers between whom a single price tends to rule.

"A monopolist can charge any price it likes." No. It can set the price, but the quantity it then sells is decided by the demand curve. A monopolist chooses a point on the demand curve, not a point in the air. [Monopoly] works this through.

"Perfect competition is the best market." It is a benchmark for efficiency, not a policy target, and it cannot exist where products genuinely differ or where production requires large fixed investment.

"A large market share means dominance." Under Indian law, dominance is the ability to act independently of competitive forces, and share is evidence of it rather than a definition of it. A firm with sixty per cent of a market with free entry may have no such ability.

Limits of the classification

Real markets are mixed. The market for cars in India is an oligopoly at the top and closer to monopolistic competition in the small car segment.

The boundary between the forms is not sharp. How few is a "few" sellers? The classification is a set of ideal types used to organise thinking, not a taxonomy of nature.

It is static. It describes a market at a moment and says little about how the structure came about or how technology will change it.

It ignores the buyer's side. A market with one buyer is a monopsony, and with a few buyers an oligopsony. Indian agricultural markets before reform were often described this way, with many farmers selling to few licensed traders, and the analysis of market power runs the same way with the sides reversed.

Quick revision

1. A market is the set of buyers and sellers of a good among whom one price tends to rule. Indian law splits it into the relevant product market, section 2(t), and the relevant geographic market, section 2(s).
2. Five classifying criteria: number of sellers, nature of the product, freedom of entry, control over price, and knowledge. Selling costs make a sixth.
3. Four forms: perfect competition, monopolistic competition, oligopoly, monopoly. The two extremes are benchmarks; the two middle forms describe real business.
4. Chamberlin and Joan Robinson, both 1933, added the middle forms.
5. Price taker accepts the market price, price maker sets it.
6. The firm's demand curve is horizontal under perfect competition, downward sloping and highly elastic under monopolistic competition, kinked under oligopoly, and downward sloping and less elastic under monopoly.
7. In law: section 4 of the Competition Act 2002 regulates the abuse of dominance, and dominance is defined by the ability to act independently of competitive forces within a relevant market, which is why defining the market comes first.
8. Monopsony is one buyer; oligopsony a few.

Test yourself

1. Define market structure and state the criteria by which markets are classified. Market structure means the organisational characteristics of a market which determine the nature of competition within it and the extent of an individual firm's control over price. The criteria are the number and relative size of sellers; whether the product is homogeneous or differentiated; the freedom with which firms may enter and leave; the degree of control the individual firm has over price; and the state of knowledge among buyers and sellers. Selling costs and the degree of interdependence between firms are often added.

2. Distinguish a price taker from a price maker. A price taker must accept the price ruling in the market and can sell as much as it wishes at that price but nothing at all above it, so its own demand curve is horizontal. This is the position of a firm under perfect competition. A price maker can choose its price, but only along its downward sloping demand curve, so a higher price is always bought at the cost of a smaller quantity. This is the position of a monopolist and, within a narrower range, of a firm under monopolistic competition.

3. Name the four forms of market and give one Indian example of each. Perfect competition, approached by agricultural produce sold in a regulated market and by trading in a listed share. Monopolistic competition, seen in toothpaste, restaurants, salons and coaching classes. Oligopoly, seen in telecom, cement, airlines and passenger cars. Monopoly, seen in long distance rail travel provided by Indian Railways and in a medicine during the life of its patent.

4. Why must the relevant market be defined before dominance can be assessed? Because dominance is a position of strength within a market, and how strong an enterprise appears depends entirely on how widely the market is drawn. Section 2(t) of the Competition Act 2002 defines the relevant product market by reference to interchangeability or substitutability, and section 19(7) lists the factors, including physical characteristics or end use, price, consumer preferences and the costs of switching. Draw the market narrowly and an enterprise may hold all of it; draw it to include the substitutes buyers actually use and its share may be small and its conduct unremarkable.

5. Distinguish a firm from an industry, and say where the distinction breaks down. A firm is a single producing unit under one management; an industry is the group of firms producing the same or closely similar products. The distinction is sharpest under perfect competition, where the industry's supply curve slopes upward while each firm faces a horizontal demand curve. It disappears under monopoly, where the single firm is the whole industry. Under monopolistic competition it becomes blurred, because the products are similar but not identical, which is why Chamberlin used the term product group instead of industry.

6. What are monopsony and oligopsony? Monopsony is a market with a single buyer, and oligopsony one with a few buyers, so that market power lies on the buying side rather than the selling side. A single large purchaser can force the price down in the same way that a monopolist forces it up. Agricultural markets in which many small farmers sell to a small number of licensed traders have often been described in these terms, and the analysis of the resulting price distortion runs exactly parallel to the analysis of monopoly with the two sides reversed.