Two key conditions determine the level of competition in a given market: the number and relative size of buyers and sellers, and the extent to which the product is standardized. These factors, in turn, are influenced by the nature of the product and production systems, the scope of potential entry, and buyer characteristics.
Effect of Product Characteristics on Market Structure
Good substitutes increase competition. To illustrate, rail freight and passenger service between two points is typically supplied by only one railroad. Transportation service is available from several sources, however, and railroads compete with bus lines, truck companies, barges, airlines, and private autos. The substitutability of these other modes of transportation for rail service increases the degree of competition in the transportation service market.
It is important to realize that market structures are not static. In the 1800s and early 1900s— before the introduction of trucks, buses, automobiles, and airplanes—railroads faced very little competition. Railroads could charge excessive prices and earn monopoly profits. Because of this exploitation, laws were passed giving public authorities permission to regulate railroad prices. Over the years, such regulation became superfluous given intermodal competition. Other firms were enticed by railroad profits to develop competing transportation service systems, which ultimately led to a much more competitive market structure. Today, few would argue that railroads retain significant monopoly power, and public regulation of the railroads has been greatly reduced in recognition of this fact.
Physical characteristics of a product can also influence the degree of competition. A low ratio of distribution cost to total cost, for example, tends to increase competition by widening the geographic area over which any particular producer can compete. Rapid perishability of a product yields the opposite effect. In considering the level of competition for a product, the national, regional, or local nature of the market must be considered.
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