Perfect Competition, Monopolistic Competition, Oligopoly and Monopoly - Assignment Example

TYPES OF MARKET STRUCTURES Introduction The industry is made up of all firms that make identical or similar products that are homogenous. The market structure of the industry depends on the number of firms as well as how they compete. There are four fundamental market structures namely (Kurtz & Boone, 2011): Perfect competition is a market structure that occurs when there are numerous firms that compete against each other. Firms in this market structure manufacture the socially optimal level of output at the minimum possible per unit cost. Monopoly is a market structure that has no competition because there is only one firm in the industry. Such market structure reduces output in order to drive up prices and hence increase profits (Tragakes, 2012). Such a firm, therefore, produces less than the socially responsible level of output and manufactures at greater costs than competitive firms. Oligopoly is an industry that has only a few firms that can collude to decrease costs and drive up profits just like monopoly. However, such firms may end up cheating against each other due to strong incentives to cheat on such collusive agreements. Finally, monop0listic competition is an industry that contains many competing firms. The firms sell a similar or identical but at least somewhat different product. The products are highly differentiated in terms of features and prices (OConnor, 2004). The paper discusses the features or characteristics of the dour basic market structures. It then explains the key differences and similarities between the markets in terms of output and price determination. Further, the paper explains whether the allocative and productivity efficiencies can be achieved in the monopoly and perfect competition. Main characteristics of the four markets Perfect competition A perfectly competitive market exhibits the following characteristics: 1) Large number of sellers and buyers The market has numerous sellers and buyers who buy, this reduces the bargaining power that buyers and sellers have, for instance if a seller of Milk tries to increase its profits by increasing the price of milk, the buyers in the market shifts to other milk sellers. The sellers are simply price takers and not price makers. 2) Homogenous products The products sold in such a market are almost the same or identical as other. The products are indistinguishable from each other because they are perfect substitutes for each other. The products are perfectly similar in quantity, quality, size and shape. Commodities like corn, oil and wheat are examples of homogenous products (Kurtz & Boone, 2011). 3) No barriers to entry and free exit Buyers and sellers are totally free to enter and leave the market. There is no restriction imposed on the entry and exit of buyers and sellers. The firms get normal profit and hence there is no tendency for both new and existing firms to leave the market (Tragakes, 2012).  4) Uniform price The ruling market price in the market is the same because the products are identical. Price is fixed by all the sellers and buyers in the market and not by an individual effort of the seller or a buyer. If a seller sells t a price that is higher than the prevailing market price, he will lose most of his customers to the rivals. Alternatively, if the seller sells at lower price than the ruling market price, he will experience such a high demand that he cannot be able to sustain (OConnor, 2004). 5) Perfect knowledge about the market The buyers and sellers are aware of all the conditions in the market. Sellers are aware of the prevailing market price, and buyers are aware of prices charged by different sellers. The condition is necessary for the uniform price assumption to hold. 6) Perfect mobility Under this market structure, various factors of production are completely mobile; they are able to freely move from one region to another and from one occupation to another. 7) No transport cost The uniform price charged in the market is free of transportation cost. Prices charged by sellers are not affected by the locations of the sellers in the market. Price and output determination In the short run, the equilibrium price and output occur at a point where MC=MR and the MC cut MR from below. The price is determined at the lowest point of AC. In the long run, the equilibrium occurs at the tangency of AR and AC, where AR is minimum and hence at that point AC=AR=MC=MR=Price (Kurtz & Boone, 2011). Short run Long Run The equilibrium price is at P while the equilibrium output is at Q. Monopoly Monopolistic market exhibits the following characteristics: 1) One seller and many buyers There is a single seller in the industry that has complete control on the commodity’s output. However, there are a large number of buyers in the market (Tragakes, 2012). 2) No close substitutes The firm produces a single commodity that cannot be easily substituted. 3) Strong barriers to entry A new firm is restricted from entering the market because this market structure is a one-firm industry hence there is no difference between an industry and a firm (Kurtz & Boone, 2011). 4) Firm is a price maker Under this market structure, the firm is a price maker because it has market power. Buyers, on the other hand, are price takers. 5) Price-discrimination A monopolist can charge different prices for different consumers. It may fix different prices for different places or different prices for consumers. 6) Profit in the long run The firm is able to earn abnormal profit both in the short run and long run because it is not faced with a competitive seller that can dislodge him from this position (OConnor, 2004). Price and output determination Under monopoly, the equilibrium price and output are at a point where MC=MR and the MC cut MR from below. Price id fixed at left to the lowest point of AC. Price is normally higher and output lower. Price is at point M and output is at point P Monopolistic competition 1) Large number of sellers The market has many sellers that satisfy the market demand hence stiff competition. The sellers have limited the share of the market and cannot control price of output. The products are not perfect substitutes but are close substitutes for each other (Kurtz & Boone, 2011). 2) Product differentiation The many firms bring out highly differentiated products. The prices are not very much different from each other. The product differentiation makes the firms compete with each other. 3) Freedom of entry and exit New firms are free to enter and leave the market. This condition allows firms to maintain normal profit for a long period of time (Tragakes, 2012).  4) Selling cost Each firm has to incur additional expenses in terms of selling costs to make buyers know the differences in the products. Such costs include advertising expenses, sales promotion expenses, salaries of marketing staff, etc. Such costs have to be spent in order to persuade buyers to purchase a given product brand in [preference to brands of the competitors (OConnor, 2004). 5) Absence of interdependence The firms are different in their sizes, and every firm has its own production as well as marketing policy. Therefore, no firm is influenced by other firms. Price and output determination A monopolistic competition firm is in equilibrium in the short run when MC=MR In the long run many firms have entered the market and the firm is not making supernatural profit. Equilibrium point occurs when AR=AC (Kurtz & Boone, 2011). Oligopoly 1) Interdependence Firms in this market structure are interdependent in making decision due to few numbers of competitions and any change in product or price by one firm has a direct influence on the rivals’ fortunes and hence they have to retaliate by changing their output and product. For instance, if Pepsi reduces its price by 50 cents per bottle, Coke will be affected, and it has to lower its prices too because it may lose a significant market share (OConnor, 2004). 2) Price rigidity Under this market structure, the prices of products tend to be rigid and sticky. For instance, if one firm makes a price cut, other firms immediately retaliate by the same price cut, and this creates a price war (Tragakes, 2012). 3) Elements of monopoly With product differentiation, firms in this market structure control a greater portion of the market. The firms, therefore, act as a monopoly in lining output and price (Kurtz & Boone, 2011). 4) Few sellers There are few sellers who control sales in the industry. They can collude to maximize their profits (Tragakes, 2012). 5) Barriers to entry The firms in the industry are large and benefit from economies of scale; it, therefore, takes considerable capital and know-how to compete in the industry (OConnor, 2004). Price and output determinations Oligopolistic firms normally collude when determining prices and outputs. In this case we are going to use two firms. The equilibrium of the cartel occurs when MC=MR. MCc is the sum of MCa and MCb. The equilibrium price for the cartel is at P and output at Q Economic efficiency In a perfectly competitive market structure, competitive pressures on the prices of commodities force firms to produce at the lowest price possible. This allows firms to achieve product efficiency, which is a situation in which products are produced at the lowest cost possible. Firms produce their commodities for the minimum ATC (average total cost) (Tragakes, 2012).  In addition, the firm achieves allocative efficiency since the products is offered at the lowest possible price. P = MC ensures Allocative efficiency. This lower price allows many consumers to enjoy the product and maximizes consumer surplus as well (Kurtz & Boone, 2011).  A monopolistic firm is less efficient than a competitive firm because it generates less surplus. This results in deadweight loss. Such firms fail to achieve product efficiency because it is not able to set a price that is equal to the minimum ATC. There is an assumption that a monopoly price is higher than both average and marginal cost thus leading to a loss of allocative efficiency as well as a market failure and many consumers will not enjoy the product due to its higher price. The ones, who manage to buy it, enjoy less consumer surplus (OConnor, 2004). Conclusion The industry is made up of four basic market structures namely, monopoly, perfect competition, oligopoly and monopolistic competition. Each market structure exhibits different features. Perfect competition has several firms; monopoly has only one firm, oligopoly has few firms that can collude, and monopolistic competition has many competitive firms. Different market structures determines their equilibrium output and price differently, in monopoly it occurs where MC=MR and the MC cut MR from below while in oligopoly it occurs where MC=MR and Mc is the sum of MCs of the firms in the industry. In monopolistic competition, it occurs where AR=AC in the long run while in perfect competition in occurs where AC=AR=MC=MR=Price in the long run. Monopolistic competition has both allocative and product efficiencies while monopoly do not. References OConnor, D. E. (2004). The basics of economics. Westport, Conn: Greenwood Press. Kurtz, D. L., & Boone, L. E. (2011). Contemporary business. Hoboken, NJ: Wiley. Tragakes, E. (2012). Economics for the IB Diploma. Cambridge ... [et al.: Cambridge University Press. Read More