Types of Markets – Dealers, Brokers, Exchanges

A place where different parties, particularly a buyer and seller, meet to exchange goods and services

Author: Adin Lykken
Adin Lykken
Adin Lykken
Consulting | Private Equity

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The Boston Consulting Group as an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Reviewed By: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Last Updated:October 26, 2022

In simple words, a market is a commonplace that can be characterized as an area where business people set up shops and stalls, and hundreds of buyers visit those places to buy goods and services in exchange for money. However, this concept of markets needs to be more specific. 

In economics, a market is where different parties, particularly buyers and sellers, meet to exchange goods and services for consideration, which is paid in cash or plastic money like credit or debit cards.

Markets can be physical, where the parties meet in person to facilitate the transaction, and online markets, where the entire transaction happens at the click of a button, such as online websites like eBay and Amazon.

Factors that help to characterize a market are:

  • A physical/online platform, 

  • Involvement of parties, namely, the buyer and the seller 

  • A particular good or service that is being sold

Other types of markets where different items are being traded are known as financial markets (exchange of shares), auction markets (sale of antiques and other kinds of valuable things), and illegal markets (black markets where illicit items are sold).

Prices in these markets are determined by the market forces of demand and supply. 

Classification of Markets

Markets are diverse and can be defined or classified based on their features. However, a few standard features of economic markets are as follows:

Classification

  • A market refers to a place for trading one commodity, for instance, the stock market, clothes market, fruit market, etc.

  • Markets are not restricted by geography. Instead, the forces driving them are the consumers’ demand for the commodity, service, and information they provide and supply.

  • There are multiple buyers and sellers in a market who compete with one another for business.

  • Information about products and services is equally available across the market to all buyers and sellers.

  • For a given good or service, there can only be one price at which it is available throughout the market.

By defining markets based on the above attributes, we have the following classifications:

Classification based on Geography  

  • Regional Markets – Regional markets cover a larger area, such as a district or a suburb.

  • National Market – National market refers to a market where a particular good or service is demanded within the borders of a given country, and the government doesn’t allow the trade of those goods overseas. 

  • International Markets – International markets are those markets where a particular product is demanded beyond the borders of its home country, and thus, parties exchange products across countries (import and export).

Classification based on time

  • Short-Term Markets – These are markets where the product supply is fixed, for instance, in a flower market, and cannot be increased or decreased according to demand. Prices are dependent upon the product demanded.

  • Long-Term Markets – In long-term markets, the supply of goods and services can be varied following demand. Prices are determined according to market equilibrium.

Classification based on Type of Transactions 

  • Spot Markets – This is the type of market where transactions are conducted at a price prevalent at that particular time, and funds are transferred immediately.

  • Futures Markets – In this market, transactions are made with a promise to deliver the product at a future date. The price paid for the product also depends upon the product's price at the delivery date. 

Classification based on Regulations

  • Unregulated Markets – As the name suggests, the exchange of goods and services in these markets is not governed by an official authority.  

  • Regulated Markets – Regulated markets are the ones in which an appointed government authority oversees the functioning of the market to ensure the law is upheld in all trade practices.

Concept of Market Structure 

A market structure is defined based on the level of competition in different industries in the market. Therefore, the type of economy that prevails is determined by its market structure. 

The nature of products and services in a market and the concentration of buyers and sellers determine its structure. Other factors like the difficulty or ease with which new businesses can enter or exit the market also define the design of the market in an economy. 

Moreover, a market structure also helps to determine the relationship between different players in the market, such as the relationship between two sellers, the relationship between a seller and a buyer, and the relationship between two buyers. 

Several industrial factors help classify different market structures, such as buyer composition, customer turnover, nature of production costs, degree of product differentiation, level of competition, and variations in the market share of sellers.

There are four basic market structures; 

  • Perfect competition - A large number of firms selling the same product 

  • Monopolistic competition - A large number of firms selling differentiated products

  • Monopoly - One firm with the entire market share

  • Oligopoly - A few firms in a particular industry controlling the prices and supply

Not all of these exist in the real world but theoretically, understanding them helps us better comprehend the underlying principles of market structures.

Considering the factors above, certain similarities are drawn that help to group the firms into the four different market structures.

Perfect Competition

A perfect competition market is a theoretical market model that helps us better understand markets with similar attributes. Such market conditions do not exist in real-world situations. Perfect competition is when many market players compete with one another.

Small firms need more resources to drive sales through excessive marketing. So instead, they produce similar products in optimal amounts, and firms in the market set reasonable prices.

In perfect competition markets, due to the existence of a large number of buyers and sellers exchanging identical goods and services, the prices of products in these markets are determined by the forces of demand and supply.

New players may enter such markets as there are fewer barriers to entry. However, an increase in players would mean a lowered market share of existing players, as both the product and pricing are identical. In addition, consumers are believed to have the perfect product knowledge, and no seller can exploit them for profit.

Sellers in these markets are price-takers, implying that they cannot influence the prices of goods and services. Each firm has a unique market share due to the similarity in the products and pricing strategies. 

Any firm needs to be incentivized to bring innovation and increase its profit margin in a market structure. However, innovations would cost money, and a subsequent price increase will result in the loss of customers.

Buyers in such markets have complete access to the products sold in the market and the prices the sellers are charging for them. Moreover, resources and labor in these markets are perfectly mobile. 

Monopolistic Competition

In economics, market competition refers to the market structure where different economic firms are competing against each other and are trying to procure goods and services that are limited by changing the elements of the marketing mix: price, place, promotion, and product.

Monopolistic competition refers to the type of market competition in which firms offer identical products and services but aren’t considered perfect substitutes for each other. 

The firms engaged in this form of competition in the market cannot reduce the supply of products or increase the prices to increase their profits, as is the case in a monopoly where all the decision-making power lies in the firm. 

Monopolistic competition is based on the marketing idea of product differentiation. To be successful in such environments, firms tend to focus on differentiating their products from competitors to earn above-average returns.

Economists Edwards Chamberlain and Joan Robinson gave the term monopolistic competition in the 1930s to describe the competition between firms with similar but not completely identical products. 

This form of competition is supposed to be the middle ground between a monopoly and perfect competition (products are perfect substitutes). As a result, demand elasticity is considered low in the long run, and profits in the short run tend to be positive. 

Marketing strategies in monopolistic markets are essential in ensuring a firm’s success. Firms rely on product differentiation, pricing strategies, and heavy advertising techniques to ensure higher profit margins, thereby increasing market shares. 

The barriers to entry and exit in these markets are low. New firms enter the market when the existing firms are making abnormal profits; due to the access of new firms, the total supply of goods and services in the market increases, forcing downward pressure on prices. 

Monopoly Markets 

A monopoly refers to a market condition where only one firm offers goods and services to the consumers. It is considered the opposite of perfect competition, where an infinite number of firms can provide products. 

In these markets, the single firm that dominates the market share controls the supply of goods and services. As a result, the dominating firm has the power to change the prices of goods at their convenience, and the demand is considered to be highly inelastic. 

Entry of new firms into these market conditions is extremely difficult due to several reasons: government regulations, license requirements, high capital requirements, expensive technology, economies of scale, and even patents and trademarks.

Since only one company dominates the market, there is no product differentiation as no other firm offers similar products, thereby eliminating the difference between the firm and the industry. Thus, firms in these markets are price-setters.

Some famous examples of monopolies are Microsoft and Windows, DeBeers and diamonds, and water, natural gas providers, and electricity providers in the United States. 

Moreover, due to only one firm in the market, buyers need complete information about the pricing and product qualities. 

A monopoly can exist when the firm controls a specific resource necessary for producing the goods, thereby restricting competition in the market.

Price discrimination and profit maximization are critical characteristics of monopoly markets as the firm can fluctuate the prices of the products to maximize their returns.

Oligopoly Markets 

Oligopoly refers to the market structure where a small number of firms operate and cannot let other firms capture a higher market share. Typically, in these markets, the number of firms must be more than two, and these firms will strongly influence the economy. 

Although the group in a particular industry holds high market power, no individual firm can undermine another firm’s market share. Thus prices in such sectors are pretty much the same to avoid excessive competition. 

These small firms operate tactically in these markets by fluctuating prices and output quantity to earn above-average returns. Prices in these markets are set collectively (in a cartel or by the influence of a single firm) and not by market forces. 

As a result, profit margins in these markets are generally higher than in other market structures where a higher level of competition exists. To gain a higher market share in these markets, firms heavily rely on advertising and other marketing techniques.

Moreover, the high number of entry and exit barriers in these markets restricts new firms from entering. The market is characterized by high capital requirements, extensive technology requirements, and patents and licenses to produce certain goods.

Firms in an oligopoly cannot compete against each other based on pricing, as a reduction in price by one firm can lead to another firm taking the same action, thereby leading to a price war in the industry until the prices return to normal. 

However, one of the problems faced by firms in oligopolies is the incentive to cheat by lowering prices to maximize profits. This concept is termed the ‘Prisoner’s Dilemma,’ which is based on the idea of game theory. 

Researched and authored by Mehul Taparia | LinkedIn

Reviewed Sakshi Uradi | LinkedIn

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