Author: Geoff Riley Last updated: Sunday 23 September, 2012
A market structure describes the characteristics of a market which can affect the behaviour of businesses and also affect the welfare of consumers. Some of the main aspects of market structure are listed below:
The number of firms in the market
The market share of the largest firms
The nature of production costs in the short and long run e.g. the ability of businesses to exploit economies of scale
The extent of product differentiation i.e. to what extent do the businesses try to make their products different from those of competing firms?
The price and cross price elasticity of demand for different products
The number and the power of buyers of the industry’s main products
The turnover of customers - this is a measure of the number of consumers who switch suppliers each year and it is affected by the strength of brand loyalty and the effects of marketing. For example, have you changed your bank account or your mobile phone service provider in the last year? What might stop you doing this?
What is a monopoly?
A pure monopolist in an industry is a single seller. It is rare for a firm to have a pure monopoly – except when the industry is state-owned and has a legally protected monopoly.
A working monopoly: A working monopoly is any firm with greater than 25% of the industries' total sales. In practice, there are many markets where businesses enjoy some degree of monopoly power even if they do not have a twenty-five per cent market share.
An oligopolistic industry is characterised by the existence of a few dominant firms, each has market power and which seeks to protect and improves its position over time.
In a duopoly, the majority of sales are taken by two dominant firms.
How monopolies can develop
Monopoly power can come from the successful organic (internal) growth of a business or through mergers and acquisitions (also known as the integration of firms).
This is where two firms join at the same stage of production in one industry. For example two car manufacturers may decide to merge, or a leading bank successfully takes-over another bank.
This is where a firm integrates with different stages of production e.g. by buying its suppliers or controlling the main retail outlets. A good example is the oil industry where many of the leading companies are explorers, producers and refiners of crude oil and have their own retail networks for the sale of petrol and diesel and other products.
Forward vertical integration occurs when a business merges with another business further forward in the supply chain
Backward vertical integration occurs when a firm merges with another business at a previous stage of the supply chain
The Internal Expansion of a Business
Firms can generate higher sales and increased market share and exploiting possible economies of scale. This is internal rather than external growth and therefore tends to be a slower means of expansion contrasted to mergers and acquisitions.
Barriers to Entry
Barriers to entry are the means by which potential competitors are blocked. Monopolies can then enjoy higher profits in the longer-term. There are several different types of entry barrier – these are summarised below:
Patents: Patents are legal property rights to prevent the entry of rivals. They are generally valid for 17-20 years and give the owner an exclusive right to prevent others from using patented products, inventions, or processes. Owners can sell licences to other businesses to produce versions of their patented product.
Advertising and marketing: Developing consumer loyalty by establishing branded products can make successful entry into the market by new firms much more expensive. Advertising can also cause an outward shift of the demand curve and make demand less sensitive to price
Brand proliferation: In many industries multi-product firms engaging in brand proliferation can give a false appearance of competition. This is common in markets such as detergents, confectionery and household goods – it is non-price competition.
Monopoly, market failure and government intervention
Should the government intervene to break up or control the monopoly power of firms in market?
The main case against a monopoly is that it can earn higher profits at the expense of allocative efficiency. The monopolist will seek to extract a price from consumers that is above the cost of resources used in making the product. And higher prices mean that consumers’ needs and wants are not being satisfied, as the product is being under-consumed. Under conditions of monopoly, consumer sovereignty has been partially replaced by producer sovereignty.
In the two diagrams above we contrast a market where demand is price inelastic (i.e. Ped <1) with one where demand is more sensitive to price changes (i.e. Ped>1). The former is associated with a monopoly where consumers have few close substitutes to choose from. When demand is inelastic, the level of consumer surplus is high, raising the possibility that the monopolist can reduce output and raise price above cost thereby operating with a higher profit margin (measured as the difference between price and average cost per unit).
If a monopoly reduces output from the equilibrium at Q1 to Q2 then it can sell this at a price P2. This results in a transfer of consumer surplus into extra producer surplus. But because price is now about the cost of supplying extra units, there is a loss of allocative efficiency. This is shown in the diagram by the shaded area which is not transferred to the producer, merely lost completely because output is lower than it would otherwise be in a competitive market.
Example: UK Cement Monopoly under Scrutiny The Competition Commission is investigating the market for aggregates, cement and ready-mix concrete. Five businesses account for 90% of the cement market, 75% of aggregates and 68% of ready-mix concrete. There are worries that a lack of competition has raised building costs, meaning the government is paying too much for schools, hospitals and roads.
Source: News reports, Aug 2011
Example: Sky Film Monopoly criticized
Sky's control over pay-TV movie rights in the UK is restricting competition, leading to higher prices and reduced choice, the UK Competition Commission has ruled. The commission may decide to restrict the number of Hollywood studies from which Sky currently has the exclusive rights to be the first to air their new releases. Sky has twice as many pay-TV subscribers as all its rivals combined - a reflection of its market dominance.
Source: News reports, Aug 2011
Higher costs – loss of productive efficiency:
Another possible cost of monopoly power is that businesses may allow the lack of real competition to cause a rise in costs and a loss of productive efficiency.
When competition is tough, businesses must keep firm control of their costs because otherwise, they risk losing market share.
Some economists go further and say that monopolists may be even less efficient because, if they believe that they have a protected market, they may be less inclined to spend money on research and improved management.
These inefficiencies can lead to a waste of scarce resources.
Evaluation – Potential Economic Benefits of Monopoly
The possible benefits of monopoly power suggest that the government and the competition authorities should be careful about intervening directly in markets and try to break up a monopoly. Market power can bring advantages both to the firms themselves and also to consumers and these should be included in any evaluation of a particular market or industry.
Research and development spending: Huge corporations enjoying big profits are well placed to fund capital investment and research and development projects. The positive spill-over effects of research can be seen in more innovation. This is particularly the case in industries such as telecommunications and pharmaceuticals. This can lead to gains in dynamic efficiency and social benefits.
Exploitation of economies of scale: Because monopoly producers often supply on a large scale, they may achieve economies of scale – leading to a fall in average costs.
Monopolies and international competitiveness: The British economy needs multinational companies operating on a scale large enough to compete in global markets. A firm may enjoy domestic monopoly power, but still face competition in overseas markets.
Here is a good way to remember some of the issues we have covered regarding monopoly, efficiency and economic welfare
Service - does the lack of competition affect the quality of service to consumers? Prices - how high are prices compared to competitive / contestable market Efficiency - productive, allocative and dynamic Welfare - what are the overall welfare outcomes? Is there a net loss of welfare in markets dominated by businesses with monopoly power? Acknowledged source: Ruth Tarrant
Government Intervention in Markets – an introduction to UK competition policy
Competition policy involves the regulation of markets to protect and improve consumer welfare:
The Competition Commission – its main concern is to investigate mergers and takeovers to examine if these mergers will have a negative effect on competition. It also engages in in-depth investigations of markets where there are competition worries. A good example was the recent report into the UK supermarket industry.
The Office of Fair Trading reports on allegations of anti-competitive practices including claims of collusive “price-fixing” behaviour.
The European Competition Authority examines anti-competitive behaviour, mergers and takeovers between European businesses and investigates state aid to struggling businesses to make sure that subsidies do not reduce or distort competition.
Utility regulators such as OFGEM, OFCOM and OFWAT monitor the industries that were privatised during the 1980s and 1990s. The regulators have used the power to introduce and review price capping and they have also have sought to bring fresh competition into markets. Competition was introduced into the telecommunications in 1984; in Gas from 1996-98 and in Electricity from 1998.
Many markets have firms with monopoly power but they seem to work perfectly well from the point of view of the consumer. Although there is a consensus among many economists that competition is a force for good in the long-run, we should be careful not simply to assume that monopoly power is bad and competition is good. There are persuasive arguments on both sides.
Competition Policy Snapshots
In the Frame
The European Commission has launched two competition inquiries to study whether IBM has abused its dominant position in mainframe computers. The study will examine whether IBM has put obstacles in place that prevent competitors from operating freely. The other inquiry, launched by the Commission itself, will look at IBM’s relations with maintenance suppliers. (August 2010)
Seventeen bathroom equipment makers have been fined a total of 622m Euros by the European Commission for price-fixing. Given the relatively homogenous nature of the products offering in this industry, and the high concentration ratio, it is ripe for collusion and cartel-like behaviour. (June 2010)
Capping mobile charges
The Telecoms regulator OFCOM has ordered UK mobile phone companies to cut the cost of termination charges - levied when people phone different networks from 4.5p to 0.5p by 2015. Mobile termination rates are the wholesale charges that operators make to connect calls to each others’ networks. (April 2010)
Heavy fines for tobacco cartel
The Office of Fair Trading (OFT) has given out the largest ever total fine in a case under the UK Competition Act 1998. A huge fine has been imposed on two tobacco manufacturers and ten retailers engaged in illegal price fixing for tobacco products in the UK. This is a good example of the financial risks that companies face when found guilty of anti-competitive behaviour. The tobacco manufacturers involved are Imperial Tobacco and Gallaher, and the retailers are Asda, The Co-operative Group, First Quench, Morrisons, One Stop Stores (formerly T&S Stores), Safeway, Sainsbury’s, Shell, Somerfield and TM Retail.
Imperial Tobacco was fined £112m and Co-op and Asda were penalized by £14m each (April 2010)