The Four Types of Market

Structure
Four basic types of market structure characterize most economies: perfect competition,
monopolistic competition, oligopoly, and monopoly. Each of them has its own set of
characteristics and assumptions, which in turn affect the decision-making of firms and the profits
they can make.

It is important to note that not all of these market structures exist in reality; some of them are just
theoretical constructs (which can be really useful in economics sometimes). Nevertheless, they
are critical because they help us understand how competing firms make decisions. With that said,
let’s look at the four market structures in more detail.

1. Perfect Competition
Perfect competition describes a type of market structure where a large number of small firms
compete against each other. In this scenario, a single firm does not have any significant market
share or market power. As a result, the industry as a whole produces the socially optimal level of
output because none of the firms can influence market prices.

Perfect competition is defined by the following characteristics:

1. All firms maximize profits

2. Entry and exit to the market are free (i.e., no barriers to entry or exit)

3. All firms sell entirely identical (i.e., homogenous) goods

4. There are no consumer preferences.

By looking at those assumptions, it becomes obvious that we will hardly ever find perfect
competition in reality. This is important to note because it is the only market structure that can
(theoretically) result in a socially optimal level of output.

Probably the best example of an almost perfectly competitive market we can find in reality is the
stock market. If you are looking for more information on different types of competitive firms,
you can also check our post on perfect competition vs. imperfect competition.

2. Monopolistic Competition
Monopolistic competition also refers to a type of market structure where a large number of small
firms compete against each other. However, unlike in perfect competition, the firms in
monopolistic competition sell similar but slightly differentiated products. That gives them a
certain degree of market power despite small market shares, which allows them to charge higher
prices within a specific range.
 Monopolistic competition is defined by the following characteristics:

1. All firms are profit-maximizing

2. Entry and exit to the market are free (i.e., no barriers to entry or exit)

3. Firms sell differentiated products

4. Consumers may prefer one product over the other (however, they are still very close substitutes).

Note that those assumptions are a bit closer to reality than the ones we looked at in perfect
competition. However, this market structure no longer results in a socially optimal level of
output because the firms have more power and can influence market prices to increase their total
revenue and profit at the expense of the consumers.

An example of monopolistic competition is the market for cereals. There is a vast number of
different brands (e.g., Cap’n Crunch, Lucky Charms, Froot Loops, Apple Jacks). Most of them
probably taste slightly different, but at the end of the day, they are all breakfast cereals.

3. Oligopoly
An oligopoly describes a market structure that is dominated by only a small number of firms that
serve many buyers. That results in a state of limited competition. The firms can either compete
against each other or collaborate (see also Cournot vs. Bertrand Competition). By doing so, they
can use their collective market power to drive up prices and earn a higher profit.

An oligopoly market is defined by the following characteristics:

1. All firms maximize profits

2. Oligopolies can set prices (i.e., they are price-makers)

3. Barriers to entry and exit exist in the market

4. Products may be homogeneous or differentiated

5. Only a few firms dominate the market.

Unfortunately, it is not clearly defined what a “few firms” means precisely. As a rule of thumb,
we say that an oligopoly typically consists of about 3-5 dominant firms.

To give an example of an oligopoly, we can look at the gaming console industry. This market is
dominated by three powerful companies: Microsoft, Sony, and Nintendo. That leaves all of them
with a significant amount of market power.

4. Monopoly
 A monopoly refers to a type of market structure where a single firm controls the entire market. In
this scenario, the firm has the highest level of market power, as it supplies the entire demand
curve and consumers do not have any alternatives. As a result, monopolies often reduce output to
increase prices and earn more profit.

A monopoly is defined by the following characteristics:

1. The monopolist is profit-maximizing

2. It can set the price (i.e., it is the price-maker)

3. There are high barriers to entry and exit

4. Only one firm dominates the entire industry.

From the perspective of society, most monopolies are not desirable because they result in lower
outputs and higher prices compared to competitive markets. Therefore, they are often regulated
by the government.

An example of a real-life monopoly could be Monsanto. This company trademarks about 80% of
all corn harvested in the US, which gives it a high level of market power. You can find additional
information about monopolies in our post on monopoly power.

Summary
There are four basic types of market structure in economics: perfect competition, imperfect
competition, oligopoly, and monopoly. Perfect competition describes a market structure where a
large number of small firms compete against each other with homogeneous products.
Meanwhile, monopolistic competition refers to a type of market structure where a large number
of small firms compete against each other with differentiated products. An Oligopoly describes a
market structure where a small number of firms compete against each other. And last but not
least, a monopoly refers to a type of market structure where a single firm controls the entire
industry.