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CFA Level I Exam · Industry and Competitive Analysis

Industry Structure and Pricing Power for CFA Level 1

Updated 7 October 2026 · Fact-checked

Industry structure describes how many firms compete, how alike their products are, and how easily new firms can enter. It sets pricing power: monopoly has the most, perfect competition none. Concentration measures such as the N-firm ratio and HHI quantify structure. To solve questions, identify the structure, then link it to pricing and returns.

Understand Industry Structure and Pricing Power

Industry structure is the competitive setup of a market. Four features define it: the number of sellers, how differentiated the products are, how easy it is to enter or leave, and how much control firms have over price.

Pricing power is a firm's ability to raise price without losing most of its customers. It comes from few close substitutes, high barriers to entry and strong differentiation. The more of these a firm has, the more pricing power it has.

The four market structures run in a line. Perfect competition: many sellers, identical products, free entry, no pricing power (price takers). Monopolistic competition: many sellers, differentiated products, low barriers, limited pricing power from branding. Oligopoly: a few large sellers, products identical or differentiated, high barriers, and firms are interdependent, so each one's price move depends on how rivals react. Monopoly: one seller, no close substitutes, very high barriers, the most pricing power (price maker), though regulation or the threat of entry may limit it.

The key difference between oligopoly and monopolistic competition is the number of firms and interdependence. Monopolistic competition has many firms that mostly ignore each other. Oligopoly has few firms that watch each other closely.

Structure affects returns. In the long run, free entry competes away economic profit in perfect and monopolistic competition. High barriers let oligopolists and monopolists earn economic profit for longer. Analysts therefore ask whether a firm's returns are sustainable, which depends on barriers and rivalry.

Concentration measures show how dominated a market is. The N-firm concentration ratio adds the market shares of the largest N firms. The Herfindahl-Hirschman Index (HHI) squares each firm's share and adds them, so large firms count for more.

Key formulas to remember

N-firm concentration ratio
CRN = sum of market shares of the N largest firms
Common choices are N = 4 or 5. Easy to compute but ignores the split among the top firms and the small firms.
Herfindahl-Hirschman Index (HHI)
HHI = Σ (sᵢ)², with shares sᵢ in percent (or as decimals)
Include all firms if data allow, or the top N firms if that is what the question gives. With percent shares, a monopoly scores 10,000. With decimal shares, it scores 1.
HHI for N equal-sized firms
HHI = 1 ÷ N with decimal shares, or 10,000 ÷ N with percent shares
Four equal firms give 0.25 with decimal shares, or 2,500 with percent shares.
Pricing power ranking
Monopoly > Oligopoly > Monopolistic competition > Perfect competition
Oligopoly can vary, since price wars or collusion change outcomes.
Profit-maximizing rule
Produce where marginal revenue = marginal cost
Perfect competition: price = marginal revenue. Other structures: price is above marginal revenue.

How to solve Industry Structure and Pricing Power questions

Use this order for any question on market structure, concentration or pricing power.

  1. 1Read the stem for clues: number of sellers, product differences, entry barriers and whether firms react to each other.
  2. 2Name the structure: perfect competition, monopolistic competition, oligopoly or monopoly.
  3. 3If the question gives market shares, decide whether it asks for CRN or HHI. Check that shares are in the same units.
  4. 4For HHI, square each share, then add. For CRN, add the top N shares only.
  5. 5Judge pricing power from barriers, substitutes and differentiation, then rank it against the options.
  6. 6Link to returns: high barriers support sustained economic profit, free entry erodes it.
  7. 7Eliminate the two wrong options by checking each against the structure's defining features, then confirm your pick.

Quickest way: Clue-word shortcut

When to use it: Use it for conceptual questions that name or describe a structure and ask about pricing power, entry or returns.

  1. Spot the clue: 'many sellers, identical' = perfect competition; 'many, differentiated' = monopolistic competition; 'few, interdependent' = oligopoly; 'single seller' = monopoly.
  2. Match pricing power: none, limited, considerable but depends on rivals, highest.
  3. Cross out any option that gives an oligopolist or monopolist no barriers, or a perfect competitor price-setting ability.
  4. For HHI, square and add in your head or on the calculator. Use shares in percent.

Common mistakes in Industry Structure and Pricing Power

  • Confusing oligopoly with monopolistic competition.

    Both involve differentiated products, so students focus on branding.

    Fix: Count the firms. Many firms with low barriers is monopolistic competition. A few firms that react to each other is oligopoly.

  • Adding market shares instead of squaring them for HHI.

    Students mix up the HHI with the concentration ratio.

    Fix: HHI squares each share first, then sums. CRN simply sums the top shares.

  • Mixing units, such as squaring 0.30 but comparing to a 10,000 scale.

    Shares are given as decimals in one place and percent in another.

    Fix: Pick one unit. In percent, a monopoly is 10,000. In decimals, it is 1.

  • Assuming a high concentration ratio always means high pricing power.

    It is treated as a certain rule rather than an indicator.

    Fix: Concentration is only a guide. Easy entry, strong buyers or close substitutes can still limit pricing power.

  • Saying firms in monopolistic competition earn lasting economic profit.

    Differentiation is mistaken for a barrier to entry.

    Fix: Barriers are low, so new entrants copy successful products and erode economic profit over time.

Worked examples

Example 1

An industry has four firms with market shares of 40%, 30%, 20% and 10%. What is the HHI using percent shares? A) 2,000 B) 3,000 C) 4,000

Show the solution
  1. Square each share: 40² = 1,600; 30² = 900; 20² = 400; 10² = 100.
  2. Add: 1,600 + 900 + 400 + 100 = 3,000.
  3. Check: four equal firms would give 2,500, so a concentrated split must be higher. 3,000 fits.

Answer: B) 3,000

Example 2

A market has many sellers of similar but branded products, easy entry, and firms that largely ignore each other's prices. Which structure and long-run outcome fit best? A) Oligopoly with sustained economic profit B) Monopolistic competition with economic profit eroded by entry C) Perfect competition with price-setting power

Show the solution
  1. Many sellers, branded products and easy entry point to monopolistic competition.
  2. Firms ignoring each other rules out oligopoly, which has interdependence.
  3. Perfect competition needs identical products and no price-setting power, so C is wrong.
  4. With low barriers, entrants compete away economic profit in the long run.

Answer: B) Monopolistic competition with economic profit eroded by entry

Exam tips

  • Questions are standalone, three options and no penalty for wrong answers, so never leave one blank. Eliminate two options using the defining features.
  • HHI questions usually give percent shares. Square each, add, and compare with the three listed values from smallest to largest.
  • Watch for wording that links barriers to entry with sustainable returns. High barriers support them, free entry removes them.
  • Know the key difference between oligopoly and monopolistic competition: few interdependent firms versus many independent ones.

Practice questions from Industry and Competitive Analysis

Industry Structure and Pricing Power: frequently asked questions

What is the difference between oligopoly and monopolistic competition?

Monopolistic competition has many firms selling differentiated products with low entry barriers. Oligopoly has a few large firms with high barriers, and each firm's decisions depend on how rivals respond.

How do you calculate HHI?

Square each firm's market share and add the results. With shares in percent, a market with one firm scores 10,000. With decimal shares, it scores 1.

Does a high concentration ratio always mean strong pricing power?

No. It is only an indicator. Close substitutes, easy entry, powerful buyers or regulation can limit pricing power even when a few firms dominate.

Which market structure has the most pricing power?

Monopoly, because there is a single seller with no close substitutes and high barriers. Regulation or the threat of entry can still restrain it.