MARKET STRUCTURE

AND POWER
Chapter 13.1
 Market Structure
 Market structure: establishes the overall environment within
which each firm operates.

 Number and size distribution of buyers and sellers

 Type of product for sale
 Whether firms in the same industry produce standardized
products or differentiated products
 Differentiated products are less substitutable
 Barriers to entry
 These reflect any increased costs that new firms must incur
relative to existing firms when entering a particular market
 High costs deter entry
 Whether any asymmetry of information exists between buyer and
sellers
Market Structure vs Market Power
 Market structure affects market power
 Market power refers to the firms ability to restrict
output (or quality and thereby raise the price)
 will dictate to some extent how firms behave
 Market Structure vs. Market Power
Degree of Market Power
0% ……………………………………..100%
Perfect Monopolistic Oligopoly Monopoly
Competition Competition
No. sellers Many Many Few One
Individual firm Tiny Small Large 100%
mkt. share
Type of product H D H or D H
Barriers to entry None None Substantial Complete
Consumer info. Perfect Slight Perfect or Perfect or
Imperfect Imperfect Imperfect

H=Homogenous D=Differentiated
Measuring Market Concentration
 Market concentration: reflects the number and
size distribution of firms in an industry
 E.g. perfect competition has a large number of
firms with small market shares
 Want to capture this structure with a statistics
 Two measures of market concentration
 Concentration ratio
 Herfindahl-Hirschman Index
Measuring Market Concentration
 Concentration ratio
 % of industry output produced by the largest firms
in the industry
 Industry output measured in terms of sales or volume
of output
 Four-Firm Concentration Ratio (CR 4)
 % of industry output produced by 4 larges firms
 60% indicates that the four large firms account for 60
percent of industry output
 <40% competitive
 40-60% monopolistic competition
 60+ oligopoly
Measuring Market Concentration
 Limitations
 Only considers number and size distribution of firms
when determining market structure
 Does consider barriers to entry
 Does not consider the distribution of output among
the largest firms
 Firms more likely to be price competitive when
similarly sized compared to when one firm dominates
the industry and others are much smaller
Measuring Market Concentration
 Herfindahl-Hirschman Index (HHI)
 Takes into account the relative size of the largest firms in
the concentration ratio
HHi   i 1 S i2  S 12  S 22  ......  S N2
N

Si is the % of market share or % industry output produced by

the ith firm.
N is the total number of firms in the industry
0  HHI  10, 000 (100 2 )

0 many firms, 10,000 one firm

Measuring Market Concentration
 Market structure and HHI
 No specific cut offs that reflect structure of the market
using HHI
 Department of justice has some guidelines concerning
when the level of HHI triggers concern about the
potential exploitation of market power
 HHI<1000: reasonably competitive
 1000>HHI<1800: mildly concentrated
 HHI>1800: highly concentrated market