The Perfect Competition Market Structure - Research Paper Example

Market structures The perfect competition market structure is a situation in which traders sell homogenous products, have no artificial entrants and exists to the market and producers are so many that they have no effect on market outcomes. No such industry exists in reality but the ideas and concepts are useful in analyzing how markets are supposed to work. Conversely, monopolistic competition structure is one in which small but many players exist. These numerous players only exert a small degree of control in the market. Furthermore, even though the players operate within the same industry, they tend to sell products that are not identical to one another. This implies that product differentiation exists and each one is capable of satisfying divergent consumer needs. Barriers to entry are few thus explaining why the competitors are many in number (Makiw, 2008). The oligopolistic market structure is one in which a small number of players operate, and they can control the market. Usually, these players are large enough and account for a substantial market share. They make decisions interdependently and are highly motivated by the need to cooperate. Therefore, players exert a degree of control over market conditions. Furthermore, this model is characterized by many barriers to entry. A monopoly is a market in which only a single producer exists. The person is therefore capable of exercising considerable control over the market. Products sold do not have close substitutes thus prompting consumers to stick to them. Normally, the monopoly thrives in water distribution, electricity and gas industries. Barriers to entry are also quite high. 2. Real life example of a market structure in my local city A Shell retail outlet is an example of an oligopolistic market in my city. The organization has relatively few competitors in the gas pump market. Retail outlets may be high in number but the number of companies controlling those outlets is relatively few. Furthermore, Shell is a large company that accounts for about 20% of the market share. This degree of concentration in the oil retail industry makes Shell gullible to collusions with its rivals. For a number of times, the company has been accused of setting artificial prices that do not relate to world oil prices. Regardless, the organization’s products are often sold for a price that is relatively close to market rates. In oligopolistic markets, this is typical for many organizations as competition based on price could lead to inefficiencies. Barriers to trade are also substantial as certain restrictions exist. Shell has control over oil as a natural resource. It is also a vertically integrated firm in which other aspects of oil production take place. The facilities and equipment needed to carry out this work are quite expensive. Therefore, new entrants would not have the economies of scale needed to make significant profits in the market. They would have to raise their prices in order to cover production costs, yet this would drive away consumers who would seek inespensice alternatives. Shell also enjoys large revenue streams from its elaborate business model. Therefore, it is likely that a competitor interested in entering the market would have difficulties advertising or matching Shell’s marketing expenditure (Frank and Bernanke, 2009). 3. How high entry barriers into markets influence long run profitability Entry barriers may come in the form of patents, government licensing, benefits that accrue from economies of scale or resource control. Industries with high entry barriers will not have many alternative suppliers. Therefore, market forces will be weakened. Profitability will mostly depend on the supply side of the equation. Usually, when a seller sets their prices, they normally do this on the basis of their costs. Marginal costs refer to those additional expenditures incurred when a seller makes an additional item. In markets with low entry barriers, sellers will price their commodities on the basis of their marginal costs. However, in industries with high entry barriers, players can make them much higher and get away with it thus incurring long run profits. Additionally, long run profitability stems from their ability to supply fewer units than the market demands In monopolistic markets, high entry barriers tend to protect them from competitive pressures. This implies that they are in a position to earn long run profits. Nonetheless, the monopolist may encounter problems when they expand their output beyond the point where the marginal costs are equal to marginal revenues. If the player goes above this limit, then they will not earn a profit. This is because the business will not be in a position to recover its average total cost (ATC). The graph below illustrates when a firm in an industry with high entry barriers will record losses. This occurs at the shaded region. Source: Harford, T. (2008). Perfect competition, monopoly and monopolistic power. Retrieved from http://www.econ.jku.at/members/WinterEbmer/files/Teaching/managerial/lecture4.pdf 4. Competitive pressure that is present in markets with high barriers to entry Sometimes competitive pressures may exist in markets with high barriers to entry. However, these usually occur on a relatively minimal scale compared to industries with few barriers to entry like perfect competition and monopolistic competition. Frequently, these entrants will compete on the basis of product quality. Alternatively, they may try to develop substitutes as a part of the competition. The degree of competition will be manifested through high prices and profitability levels. Many players in market structures with high barriers to entry will refrain from competing on the basis of price because of the kinked demand curve. Firms in these industries tend to exhibit asymmetric behavior. If a player increases their prices, then non cooperative behavior will result. Conversely, if a firm decreases their prices, than the rest of the competitors will exhibit cooperative behavior. When one company reduces their prices, the business could make a lot of sales if other organizations do not follow suit. The figure below shows that the demand curve will be relatively elastic (blue line). On the other hand, if other companies imitate this first one, then demand will be inelastic as seen through the same line. A kink will occur in the demand curve at the prevailing price. Firms will not be motivated to change if they have a kinked demand curve meaning that the equilibrium price will prevail. Source: Harford, T. (2008). Perfect competition, monopoly and monopolistic power. Retrieved from http://www.econ.jku.at/members/WinterEbmer/files/Teaching/managerial/lecture4.pdf Competitive pressures may also be manifested in the form of advertising. Some firms will use advertisements to stand out even though this approach may not always work in the long run. Other organizations may also be inspired to raise advertising costs. Conversely product quality may be another source of competitive pressure in high barrier markets. Players may work to improve quality and thus boost demand. However, this is only contingent on the existence of heterogeneous products in the industry. 5. Price elasticity of demand in each market structure Price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in the price of the product. In the perfect competition market, it is assumed that every seller is a price taker and no one has control over the market. In this market, a high price causes the trader to expand their output or enter the market. If prices are low, then the seller should contract output or even leave the market. Therefore, these adjustments occur automatically and are not limited by external forces. As such, a graph of quantity demanded against price will be straight. The elasticity of demand will be perfectly elastic since it will have a ratio of one (Andrews and Benzing, 2010). Conversely, in the monopolistic market, it presumed that the seller is a price maker. This means that the business entity will not adjust their output in accordance to price. Sometimes these sellers have a tendency to contract output below their costs thus creating inefficiency in the market. Since consumers can find no substitute for these products, they are forced to stay with that supplier. As a result, elasticity of demand is inelastic. This implies that the ratio will be greater than one. Consumers will keep demanding for the product irrespective of is increases in price. The monopolistic competition market has many highly differentiated sellers. They will offer products in a manner that meets specific consumer needs. Therefore, it is difficult to substitute their services. This implies that consumers will not be overly sensitive to price changes as they have few alternatives. Demand for the product is inelastic in this market structure even though the quantity of the ratio will not be as high as it is in monopolistic markets. However, if the time period in which the price change occurs is relatively long, then consumers will look for cheaper alternatives. A case in point is fuel; most people may rely on an oligopolistic supplier, and when prices go up, they will still purchase the item. However, if these prices remain high for a long time, then they will look for other alternatives or minimize their expenditure on fuel by carpooling. In an oligopoly, the price elasticity of demand is elastic. The market structure has several players who are highly dependent on each other. Therefore, if one player makes a move, the other will follow suit and this will affect the demand curve. For this reason, many stakeholders call the oligopoly demand curve indeterminate. However, the price elasticity of demand will not be perfectly elastic since several oligopolists avoid alterations of prices as this will invite their competitors to a price war or could cause them to lose market share to others when it raises it prices. 6. How the government affects each market structure Governments have several alternatives that they can use to curtail the market power of oligopolies or monopolies. First, they start with the law, where they establish antitrust policies. These are laws that forbid market structures in which uncompetitive behavior exists. For instance, restrictions on collusions exist. Furthermore, even mergers and acquisitions that may lead to excessively contracted oligopolies or monopolies may be limited. The government may also encourage organizations to compete by eliminating barriers to entry; usually, this relates to oligopolies. It may involve removal of resource restrictions as well as other laws that limit participation. In close association with this measure is the employment of economic regulations. Here, the government acts as a facilitator of business through the use of regulatory agencies. Individuals in business will be given guidance on how and what do in business. These agencies normally take care of aspects of production like entry, outputs, exits and prices (Baumol and Blinder, 2006). In oligopolies as well as monopolistic competition models, the government may exert price control. This often occurs during tumultuous political situations like wars. Their main interest is to minimize the degree of inflation that could arise due to failure to keep prices down. Since these industries have relatively few players, price increments do not allow consumers to get any alternatives. In a monopoly, the government may intervene through taxation. Monopolies have a tendency to enjoy abnormal profits which are not socially acceptable. Therefore, taxes are ways of minimizing the income distributing effects of monopolies. 7. How international trade affects each market structure International trade has perhaps the greatest effect on monopolies. Since several of them derive their market power from the existence of no other competitors in the market, international trade often challenges this state of affairs. It makes goods or services available to buyers who would otherwise have had no alternatives. Therefore, price and quantity demanded may reduce if buyers can find another provider in the international market (Hall and Lieberman, 2007). Monopolistic competitors are also affected by international trade because the latter is a source of substitutes for their products. These players usually enjoy market power due to the lack of substitutes within their market spaces. However, international trade may challenge this state of affairs and this give consumers an alternative from which to select different products. In perfect competition, international trade would still leave the prices and quantity demanded unaltered. Since it is assumed that there are infinite players who have no effect on price, then this market structure would still continue to operate under market forces. Furthermore, demand for commodities would still be determined by the market side of the equation. Conversely international trade would dramatically change the playing field for oligopolistic markets. International trade will increase the number of players in the market this reducing their degree of control in the market. They would also take on a sizeable market share which will be difficult to counter by the local players. References Andrews, T. and Benzing, C. (2010). Simplifying the price elasticity of demand. Journal of Economic Educators, 10(1), 1-13. Baumol, P. and Blinder, H. (2006). Microeconomics: principles and policies. NY: Prentice. Frank, A. and Bernanke, O. (2009). Principles of microeconomics. London: McMillan. Harford, T. (2008). Perfect competition, monopoly and monopolistic power. Retrieved from http://www.econ.jku.at/members/WinterEbmer/files/Teaching/managerial/lecture4.pdf Hall, R. and Lieberman, M. (2007). Microeconomics: Principles and applications. NY: Lachina Publishing. Makiw, G. (2008). Principles of microeconomics. Boston: South Western Cengage. Read More