Types of Market Structures - Essay Example

Market Structures and number Submitted Market Structures INTRODUCTION The paper discusses four maintypes of market structures, which are perfect competition, monopolistic competition, monopoly and oligopoly. Market structures are differentiated by the level of entry and exit barriers, number of producers in each structure, their profitability levels, elasticity of demand, and price decisions. Government intervenes in the market when market failure arises such as in monopoly or oligopoly, which restricts competition to earn abnormal profits. The paper ends by studying the impact of international trade on the economy under each market structure and states perfect competition as the ideal type of system, which is hardly possible to operate in the real-world scenario. TYPES OF MARKET STRUCTURES Perfect Competition A market is said to be in perfect competition when there are a large number of buyers and sellers perfectly aware of the market prices, and no firm is large enough to have any economic power over the industry (Amacher & Pate, 2013). The two main characteristics of a perfect market are low barriers to entry and exit, i.e. any new firm can enter the market because of no restrictions such as high setup cost, legal barriers or any other. All the firms are earning normal profit as there is strong competition within the industry. Secondly, homogenous products are produced, i.e. all products are identical or standardized and are substitutes of each other, thus sharing the same price as well (Amacher & Pate, 2013). An imperfect competition is where there are not many producers in the market and there is less competition as buyers and sellers are not fully aware of the prices so different prices exist for same product in the market (Amacher & Pate, 2013). There are three forms of an imperfect market: Monopolistic Competition Under this structure, there are few sellers as compared with perfect competition and the products produced are differentiated due to branding, which gives the producer a way to have his own pricing policy and thus can earn more than normal profits (Amacher & Pate, 2013). Oligopoly There are a few suppliers in the market in this structure, and every supplier has a substantial control over the prices, and output produced because few suppliers control the entire supply in the market. There is strong rival consciousness because of the interdependence of suppliers. There is a possibility of product differentiation as well as substitute products, and the price-output policy of each supplier depends upon the degree of homogeneity or heterogeneity (Amacher& Pate, 2013). Monopoly There is a single seller or producer who controls the entire market. As he controls the whole supply, he can fix the price and earn abnormal profits. There are high barriers to entry and exit from this industry, which prevents competitors from entering into it (Amacher& Pate, 2013).It’s a one firm industry in which there is no need for differentiation because no substitutes are available. There is a single product completely under the control of a monopolist who is the price maker (Amacher & Pate, 2013). EXAMPLE OF MARKET STRUCTURE There are different industries or markets operating in a city, with each of them following a different market structure according to the nature of the business there. One such dominant industry is the women’s clothing, which is operating in the monopolistic competition market structure. It is a real-life example of this structure, and one can clearly categorize its features as those present in this market structure. There is high number of sellers in the market with each producing a differentiated product and heavily advertising and promoting its brand name to create customer awareness. The aim of firms is to crate brand loyalty, which allows them to charge a higher price than their competitor, meaning that sellers have some control over price but not full control because of their interdependency. In the long-run, firm with effective advertising and innovation will only earn normal profits because of the competition as it will not be able to charge too high a price. However, in short run, some firms can earn abnormal profits with their non-price competition, quality, design or attractive advertising, just like in women’s clothing. The products are produced almost same style except some variation in the designs, quality and a strong brand name associated with it. There is easy entry or exit from the industry because the setup cost is not too high. In the era of technology, stores can open and sell online at very low costs or hold exhibitions and open retail stores easily, and if the firm is not able to face competition then it can easily exit from the market. Moreover, the demand curve of clothing is elastic, which means if the price is increased more than then a certain extent, then consumers will switch over to other brands available in the market. Thus similar to monopolistic competition, the demand is said to be responsive to prices. INFLUENCE OF ENTRY BARRIERS ON LONG-RUN PROFITABILITY Barriers to entry prevent any firm to enter an industry and thus decreases the competition faced by existing firms (Sloman, n.d.). This is usually done in the monopoly market structure. Barriers to entry give the seller a freedom to charge his own price to the product because the chance of competition is eliminated from the market. With no competition and only one seller controlling the entire supply, the firm earns abnormal profits in the long run because there is no other producer to produce substitute product or encourages the sales by differentiation and creating brand loyalty (Sloman, n.d.). Consumers are obliged to buy at a price above then marginal cost, thereby providing abnormal profits for the firm in both short and long run. Barriers to entry can be in such forms as high setup costs, which limit the entry because of potential risk of failure, economic or legal barriers and most commonly economies of scale can serve as a high barrier too(Sloman, n.d.). Economies of scale gives firms the ability to produce at lower than average costs, and prevent others to enter due to its so low costs, which render others unable to compete. Low costs and high prices result in high profits for the firm (Sloman, n.d.). A monopolist focuses on increasing the marginal revenue and decreasing the marginal costs and earns abnormal profits. Also, there are high entry barriers in an oligopoly market structure, as oligopolies form collusions to maximize their joint profits and eliminate any risk to their profitability by using aggressive tactics and even bearing short-term losses and reducing prices to discourage competitors. By preventing competition, they can sustain their profits even in the long-run (Sloman, n.d.). COMPETITIVE PRESSURES IN MARKET STRUCTURES High barriers to entry in market structures like monopoly or oligopoly prevents the competitors from entering the market and thus reduces the competitive pressures that are present under competition (Bamford et al., 2002). Barriers like high setup cots, legal barriers or economies of scale already achieved by existing firms discourages new entrants to enter the market because of the fear of losses. Especially in monopolies where there is just one single firm operating as the industry, there is no fear of rivals because a monopolist uses different techniques to reduce any chance of competition like limit pricing, i.e. charging low price than new entrants and restricting its profits to deter new entrants, price wars, and other aggressive tactics (Bamford et al., 2002). Using such tactics would ensure no competition and thus ensure long-run abnormal profits for the monopoly. No competitive pressures mean the exploitation of consumers who are forced to buy the product even at very high prices as there is no other supplier in the industry, and inefficient use of resources leading to allocative and productive inefficiency (Bamford et al., 2002). However, the situation is a bit different for oligopoly where some firms are controlling the supply. Competitive pressures can be both high and low in oligopoly, depending on the degree of collusion. To maximize profits, oligopolists will collude together and act as a monopoly because they are few and prevent others from entering the market (Bamford et al., 2002). A price is set by the dominant firm or the price leader and other firms are to follow it. With the price set, the firms will compete for market share, but to gain the greatest market share; the firms would be tempted to cheat on the other firms by charging low prices or using some other strategy (Bamford et al., 2002). Though there can be non-collusive behavior also followed by oligopolists meaning that every firm has its own pricing and market share strategy, which is set by eyeing the strategy of rivals. In such a situation, there is going to be fiercer competition, more advertising and product differentiation is focused to achieve a competitive edge (Bamford et al., 2002). Competitive pressure from outside is low because firms do not let others to enter but there are high competitive pressures faced by the firms already existing in the market with each competing to have the greatest market share and a profitable price (Bamford et al., 2002). PRICE ELASTICITY OF DEMAND Price of elasticity of demand is the responsiveness of the consumers to a change in price. That means to what degree the price will affect the buying decision of consumers (McConnell & Brue, 1996). In a perfectly competitive market structure, firms are price takers and not makers, thus, they face a perfectly elastic demand curve meaning that even a slight change in price by any one firm will lead to a great change in its demand. If it decreases the prices, then the demand will increase to extremes because consumers will leave other sellers and buy from the firm with low price, the products having perfect substitutes (McConnell & Brue, 1996). On the contrary, in a monopoly, the firm is the price maker, and thus it has an inelastic, downward-sloping demand curve. This means that even if price is increased, the demand will not go down like in case of essentials like food and petrol. the demand is not responsive to price change (McConnell & Brue, 1996). However, in a monopolistic competition, the demand is relatively elastic. It means that it is not perfectly elastic like perfect competition because there are few rivals, and firms have some control over prices due to product differentiation (McConnell & Brue, 1996). Though some control means if the change in price is more than a limit, then it will cause a great change in demand as well. Elasticity of demand is relatively inelastic for oligopolistic firms, which are interdependent on each other and enter collusive behavior to maximize joint profits by increasing their prices. People have to buy as the entire supply is controlled by them, so there are not many options (McConnell & Brue, 1996). So, elasticity of demand is highest for perfect competition, relatively elastic for monopolistic competition, inelastic for monopoly and relatively inelastic for oligopoly (McConnell & Brue, 1996). GOVERNMENT’S INFLUENCE ON PRICES Government can play different roles to control prices and increase competition in the market by reducing entry barriers and putting price constraints to ensure maximum efficiency and consumer welfare (Anderton, 2000). A government intervenes in the market when the market failure arises, that is, a deviation from any of the conditions required for perfect competition occurs. Government is focused on improving competition and increasing consumer awareness about the product, all leading to economic growth and productivity in the long run (Anderton, 2000). A market structure like prefect competition is ideal and serves as a benchmark for the market because there are many suppliers of a single product in the market, with each of them competing fiercely and the price being determined at the optimal level where demand is equal to supply (Anderton, 2000). There are no supernormal profits earned, and consumers have complete knowledge of the prices in the market. Such a market structure provides efficiency and consumer benefit and therefore, government intervention ensure the efficient working of this system, by means of regulations like taxes, licenses and laws and policies. However, there are some industries in which existence of only one firm is most beneficial creating a monopoly (Anderton, 2000). A monopoly can charge high prices to earn abnormal profits and exploit consumers as they have no other place to buy the product from, but by imposing restrictions like price ceilings, taxes, pollution and/or environmental taxes, government can reduce their power or negative effects (Anderton, 2000). The monopolist would not be able to charge a higher price than the one fixed by the government. Moreover, government can also put limitations on the forming of cartels or collusions in oligopoly markets thus ensuring that there is no high price fixed, and every firm competes with others providing a variety for consumers at optimal prices (Anderton, 2000). Additionally, if any firm is producing negative externalities like pollution, then it might be charged on the amount of pollution created leading to high costs and with price ceilings an optimal price determination. In monopolistic competition and oligopoly where firms use advertising and product differentiation to compete and make profits, government can impose truth-in-advertising laws to make sure that there are no false claims made by the sellers (Anderton, 2000). Government can also nationalize or break up some monopolies to increase competition and reduce entry barriers, all of which in turn will lead to competition and thus reduction in prices and making of normal profits only (Anderton, 2000). EFFECTS OF INTERNATIONAL TRADE International trade is the selling and buying of goods and services outside the home country. There are many benefits and costs of trade liberalization affecting each market structure, but its benefits outweigh its costs (“Goods and Imperfect Competition”). For a perfectly competitive market producing a unified product at a single price, the international price of that commodity would also be same. Thus, the country with the comparative advantage in producing a single good would produce and export it, and import the good in which it does not have a comparative advantage (“Goods and Imperfect Competition”, n.d.). The situation would be different for monopolistic competition, which produces diversified products. International trade would bring more competition in this industry and variety for consumers as the products will be slightly differentiated by advertising and marketing strategies (“Goods and Imperfect Competition”, n.d.). As the number of firms increases in totality, that means supply is pushed outward causing a fall in the price originally charged by the monopolistic firms. Intense advertising and promotion will be used to create brand loyalty and provide better quality to gain customers which will ensure customer surplus and a reduction in producer surplus, which was being gained earlier by the high prices (“Goods and Imperfect Competition”, n.d.). A major benefit of international trade is that it brings competition and eliminates the abnormal profits earned by monopolies or oligopolists. With international trade, the barriers to entry decrease and there is not a single supplier or some suppliers (like in a cartel) controlling the entire supply and holding the market power (“Goods and Imperfect Competition”, n.d.). Therefore, the monopolists will have to lower prices and increase efficiency to stay in the market. Moreover, gains from the economies of scale are also achieved as the domestic firm gets opened to international demand and thus produce large quantities, which again mean low prices (“Goods and Imperfect Competition”, n.d.). Inefficient or technologically obsolete firms are driven out of the market with the international trade, and society’s welfare is maximized rather than producer’s welfare (“Goods and Imperfect Competition”, n.d.). CONCLUSION The paper analyzes each of the four market structures in detail from different perspectives. Perfect competition and monopolistic competition is characterized by high entry barriers, normal profits while monopoly and oligopoly features high entry barriers and abnormal profits. Perfect competition is thought of as to be the most efficient structure where prices are determined by the forces of demand and supply and does not need regulation. Government intervenes to control the selfish activities of monopolies and oligopolists, which creates negative externalities. International trade is healthy for an economy because it encourages competition, which in turn brings efficiency, low prices, and high living standards for public. References Amacher, R., & Pate, J. (2013).Principles of Microeconomics. San Diego: Bridgepoint Education. Anderton.(2000). Economics. (3rd ed., p. 115). Causeway Press Limited. Bamford. , Brunskill, , Cain, , Grant, , Munday, , & Walton, (2002). Economics. (pp. 164-174). United Kingdom: Cambridge University Press. Goods and imperfect competition.World Bank. Retrieved from McConnell. , & Brue, Economics Principles, Problems and Policies (13th ed., pp. 457-520). United States of America: McGraw-Hill. Inc. Sloman. Economics. (6th ed., pp. 156-166). University of the West of England and the Economic Network. Read More