Why Defining the Market Comes First
A firm may be the only seller of a narrowly described product without being the only realistic option available to customers. A single ferry operator, for example, may face competition from a bridge or another route. Conversely, several brands may sell a product while one firm still has substantial influence over its customers. To assess monopoly, first ask which products compete for the same customers, and in what geographic area?
Market definition is therefore more than a matter of naming an industry. It determines which sellers and customers are included in the comparison. A market drawn too narrowly can make ordinary competition look like monopoly; a market drawn too broadly can hide the lack of alternatives customers actually face. This tutorial is aligned with the SOA VEE Economics (Validation by Educational Experience) syllabus.
The qualification about market power matters. A seller may be alone within a narrow product label yet constrained by customers switching to alternatives. Also, observing one seller does not by itself reveal how much freedom that seller has over price or terms. The number of firms is a useful starting point, not a complete test.
Two Boundaries: Product and Geography
A relevant product market includes the products or services customers regard as realistic alternatives for the use in question. Products need not be identical. The key issue is whether enough customers would switch between them when the terms of one become less attractive. A substitute is not relevant merely because it has a similar name or general purpose; it must be a practical alternative for the customers being considered.
A relevant geographic market is the area in which customers can realistically turn to competing sellers. Distance, travel time, delivery, local access, and the nature of the purchase may all matter. A customer buying a routine service nearby may have a smaller practical choice set than a customer buying a product delivered across a region.
These boundaries must be considered together. A useful description states both what is being sold and where customers can obtain it. It should also specify the customer group when different groups have different alternatives. For example, a product may face one set of substitutes for commercial buyers and another for households.
| Question | What to examine | Why it matters |
|---|---|---|
| Product boundary | Can customers switch to another good or service that meets the relevant need? | Determines which products constrain the seller. |
| Geographic boundary | Can customers practically buy from sellers in another area? | Determines which locations and sellers belong in the comparison. |
| Customer group | Do the customers being studied have similar options? | Different groups may face different competitive constraints. |
Substitution and the Meaning of Market Power
The economic logic is straightforward: when customers can readily switch away, a seller’s ability to worsen its terms is limited. If alternatives are inconvenient, unsuitable, or unavailable, customers may be less able to respond. The seller’s demand in the relevant market is the demand remaining after customers’ realistic choices are taken into account. A firm’s position depends on that constraint, not merely on whether another firm sells an item with a similar label.
Evidence about substitution can include actual customer switching, purchasing patterns, the availability and practical use of alternatives, and responses to changes in price or service. No single observation automatically settles the boundary. For instance, a customer might say two products are different but still switch between them when prices change; another might describe two products as similar but never consider one a workable substitute.
A common way to summarize a firm’s position is its market share. If shares are calculated using sales quantities, every seller included must be measured over the same period and within the same market. If revenue shares are used instead, use revenue for every seller. The choice of measure should be stated because sellers’ prices may differ.
Worked Examples
Worked Example: Is a Specialty Water Brand a Monopolist?
A hypothetical city’s premium sparkling-water segment records annual sales of 10,000 cases: Brand A sells 3,600, Brand B sells 2,400, Brand C sells 2,000, and Brand D sells 2,000. A report describes Brand A as “the city’s only mineral-rich sparkling water.” Decide whether that description establishes that Brand A is a monopolist. Then calculate its share under two broader product definitions: all bottled water, with total sales of 18,000 cases, and bottled water plus other beverages customers use with meals, with total sales of 30,000 cases. Assume Brand A’s sales remain 3,600 cases in each broader total.
Method. Identify the product boundary before interpreting the share. Then divide Brand A’s sales by total sales for each stated market. Do not treat a distinctive product description as proof that customers lack substitutes.
Narrow segment. The four sellers’ sales add to \(3{,}600+2{,}400+2{,}000+2{,}000=10{,}000\) cases. Brand A’s share is \(3{,}600/10{,}000=0.36\), or 36%. It is not the sole seller even in this segment.
All bottled water. Brand A’s share is \(3{,}600/18{,}000=0.20\), or 20%.
Bottled water plus other meal beverages. Brand A’s share is \(3{,}600/30{,}000=0.12\), or 12%.
The calculations show that Brand A’s share depends on the product boundary: it is 36%, 20%, or 12% under the three definitions. The report’s phrase may identify a distinctive feature, but it does not establish that customers view Brand A’s product as a separate market. Evidence about whether customers switch to other sparkling water, still water, or other beverages would be needed to assess the boundary. Under none of the stated definitions is Brand A the sole seller. Common mistake avoided: treating a unique product description as proof of monopoly while ignoring competing alternatives.
Check. The narrow-market shares sum to \(36\%+24\%+20\%+20\%=100\%\), consistent with the four sellers accounting for all 10,000 cases.
Worked Example: Drawing a Geographic Market for a Local Service
Three hypothetical appliance-repair firms serve a city. Their annual city sales are $480,000, $320,000, and $200,000, for a city total of $1,000,000. Firms outside the city sell an additional $1,000,000 in nearby towns. Some city customers travel to those towns for repairs, but the information does not say how many. Calculate the first firm’s share if the market is the city alone and if it is the wider city-and-nearby-towns region. Explain what else must be established before choosing a boundary.
Method. Compute both possible shares from the given totals, then distinguish a calculation conditional on a boundary from evidence that the boundary is economically appropriate.
City-only calculation. The first firm’s share is \(480{,}000/1{,}000{,}000=0.48\), or 48%.
Regional calculation. Total regional sales are \(1{,}000{,}000+1{,}000{,}000=\$2{,}000{,}000\). The first firm’s share is therefore \(480{,}000/2{,}000{,}000=0.24\), or 24%.
The first firm has a 48% share if only city sales belong in the market and a 24% share if nearby-town sales are included. Neither calculation establishes which boundary is correct. The fact that some city customers travel to nearby towns suggests that those sellers may constrain city firms, but the extent and practicality of that option matter. Relevant evidence would include how many customers make the trip, whether travel is feasible for typical repairs, and whether customers can obtain comparable service there. Common mistake avoided: adding every nearby seller automatically, or excluding them automatically, without asking whether customers can realistically use them.
Check. The city accounts for $1,000,000 of the $2,000,000 regional total, so the regional denominator is twice the city denominator. With the first firm’s sales unchanged, its regional share is half its city-only share: \(48\%/2=24\%\).
Worked Example: One Ferry Operator, Several Ways to Cross
A hypothetical strait has one ferry operator, which carries 80,000 passenger crossings per year. A bridge carries 20,000 passenger crossings by a route customers can use to reach the same destinations. For this example, assume the question concerns passenger travel across the strait and that both options provide a practical way to make that trip. Calculate the ferry operator’s share in (a) a market defined as ferry crossings only and (b) a market defined as passenger crossings by ferry or bridge. What does each result establish?
Method. State the product boundary, add the sales included by that boundary, and calculate the operator’s share. A 100% share in a narrowly defined category does not settle whether that category is the relevant market.
Ferry-only market. The ferry operator is the only seller of ferry crossings, so the denominator is 80,000. Its share is \(80{,}000/80{,}000=1\), or 100%.
Ferry-or-bridge market. Total passenger crossings are \(80{,}000+20{,}000=100{,}000\). The ferry operator’s share is \(80{,}000/100{,}000=0.80\), or 80%.
The ferry operator is the sole seller if the product is defined as ferry crossings. If customers regard the bridge as a practical alternative for the same trip, the broader market includes both options; the ferry operator then has an 80% share, not 100%. That share alone does not prove or disprove substantial market power. The stipulated substitution makes the bridge relevant to the boundary, while further evidence about customer choices and constraints is needed to assess the strength of competition. Common mistake avoided: concluding that one ferry operator has a monopoly over passenger travel simply because no second ferry firm operates.
Check. The two crossing counts total 100,000, and \(80{,}000+20{,}000=100{,}000\), so the ferry and bridge shares in the broader market sum to 100%.
A Short Justification: Why Boundaries Change the Share
The market-share formula explains why the boundary must be stated. Hold a firm’s sales \(q_i\) fixed, and let \(Q\) be total sales in the selected market. Its share is \(q_i/Q\). If the market is broadened to include additional sales \(R\), the new share is \(q_i/(Q+R)\). For positive \(R\), \(Q+R>Q\), so:
Thus, adding products or locations can lower a firm’s calculated share even when its own sales do not change. The arithmetic does not prove that a broader boundary is correct: that depends on whether the newly included sellers genuinely constrain the firm. It does show why a share without a clearly stated market is incomplete information.
Common Traps and Practical Checks
- Using a label instead of a market. A brand name or narrow product category does not establish that customers lack alternatives. Ask what buyers can actually switch to.
- Counting firms before defining the boundary. The number of sellers is meaningful only after deciding which products and locations to include.
- Treating a high share as conclusive. A large share can support an assessment of market power, but shares alone do not establish the extent of customers’ options.
- Mixing measures. Do not compare one seller’s revenue with another seller’s units. Use a consistent measure and time period for numerator and denominator.
- Assuming geography is obvious. A seller outside a city may still constrain local firms if customers can realistically purchase there; a nearby seller may not be a practical option for every customer.
In practice, proceed in order: describe the customer need, identify plausible product substitutes, determine which sellers customers can practically reach, and only then calculate shares or assess market power. This keeps the definition tied to competitive constraints rather than to convenient labels.
Check Your Understanding
For each problem, define the market carefully before interpreting any share.
- A hypothetical town has one seller of “artisan oat drink,” with sales of 500 units. Two other sellers offer oat drinks with sales of 300 and 200 units. Calculate the first seller’s share in the oat-drink market. Does its distinctive product label establish that it is the sole seller? (Answer: \(500/(500+300+200)=50\%\); no, it is not the sole seller in the stated oat-drink market.)
- A city’s three bike-repair firms have sales of $150,000, $100,000, and $50,000. Nearby shops sell $200,000 to customers from both the city and surrounding towns. Calculate the largest city firm’s share under a city-only boundary and a city-plus-nearby-shops boundary. What remains uncertain? (Answer: city-only total is $300,000, so the share is 50%; broader total is $500,000, so it is 30%; whether nearby shops belong depends on customers’ practical access and substitution.)
- A hypothetical island has one scheduled passenger boat carrying 6,000 trips per year and an air shuttle carrying 4,000 trips. Assume both provide practical travel between the same two locations. Calculate the boat operator’s share in the boat-only market and in a passenger-travel market including both services. (Answer: 100% in the boat-only market; \(6{,}000/(6{,}000+4{,}000)=60\%\) in the broader market.)
- A seller accounts for $720,000 of sales. A proposed narrow market has total sales of $1,200,000; a proposed broader market adds $800,000 in sales by other providers. Calculate the seller’s share under both boundaries and explain why the figures do not decide which boundary is right. (Answer: narrow share is \(720{,}000/1{,}200{,}000=60\%\); broader share is \(720{,}000/2{,}000{,}000=36\%\); the appropriate boundary depends on whether the added providers constrain customers’ choices.)
- A district has two sellers of a service, with revenues of $420,000 and $280,000. A firm in a neighboring district earns $300,000, but the problem gives no information about whether district customers use it. Calculate the first seller’s share under a district-only and a combined-district definition, then identify the missing evidence. (Answer: district-only total is $700,000, giving \(420{,}000/700{,}000=60\%\); combined total is $1,000,000, giving 42%; evidence is needed about customers’ ability and willingness to obtain the service in the neighboring district.)