A critical determinant of market structure is the way in which demand and cost interact to determine the likely number of market participants in a given sector or market. Structure also evolves over the long run: Time is required for entry and exit.
Figure 11.1 shows the demand
curve D for the output of an industry in the long run. Suppose, initially, that all firms and potential entrants face the long-run average cost curve
. At the price 
, free entry and exit means that each firm produces q1. With the demand curve D, industry output is 
. The number of firms in the industry is 
. If q1, the minimum average cost output on 
, is small relative to D, then 
is large. This outcome might be perfect competition – N virtually infinite – or monopolistic competition – N large with
slightly differentiated products produced by each firm.
With a cost structure defined by 
this market has space for many
firms – perfect or monopolistic competition, each producing approximately q1. If costs correspond to
, where scale economies are substantial, there may be space for just one producer. The intermediate case, 
, can give rise to oligopoly, with each firm producing more than q1 but less than a
monopolist. These curves encounter their MES at very different output levels.
Instead, suppose that the production structure in the industry is such that the long-run average cost curve is 
. Here, scale economies are vast, relative to the market size. At the lowest point on this cost curve, output is large relative to
the demand curve D. If this one firm were to act like a monopolist it would produce an output where MR = MC in the long run and set a price such that the chosen output is sold. Given the scale
economies, there may be no scope for another firm to enter this market, because such a firm would have to produce a very high output to compete with the existing producer. This situation is
what we previously called a “natural” monopolist.
Finally, the cost structure might involve curves of the type 
,
which would give rise to the possibility of several producers, rather than one or very many. This results in oligopoly.
It is clear that one crucial determinant of market structure is minimum efficient scale relative to the size of the total market as shown by the demand curve. The larger the minimum efficient scale relative to market size, the smaller is the number of producers in the industry.
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