Characteristics of a Market Structure - Example

Economics al Affiliation) Market Structures Introduction In economics, market structure is the feature of a particular market in the economy. The features of a market can be organizational, competitive, or any other characteristics that define the commodity market. The major yardstick that economists use in defining market structures is the pricing modes and the nature of competition in a particular market. Alternatively, economists define a market structure in terms of the number of participant firms that produce similar goods and services. Market structure has a great impetus on the conduct of individual firms in the market (Robson, 2011). For instance, the market structure affects how firms price their commodities in the industry .For example; firms in a competitive market are price takers whereas the industry plays the role of price setting. Market structures affect the supply of commodities in the market. The supply of products and services is high in a competitive environment as different firms compete for market dominance. On the other hand, a noncompetitive environment leads to an inefficient supply of products and services as the dominant firms concentrate on maximizing profits over meeting consumer needs (Norman, 2000). Market structures also affect the barriers to entry for firms intending to join a particular market. Monopoly market structure has the greatest level of barriers to entry whereas the perfectly competitive markets have zero barriers to entry. Furthermore, efficiency influences the behavior of firms under a particular market structure (Triffin, 2004). Generally, firms in a competitive environment are more efficient those in a monopoly market structure. The type of market structure determines the level of competition between firms in a market. This paper discusses the features of market structures as well as the four types of market structures and the economic efficiency of the structures (Townsend, 2002). Characteristics of a Market Structure There are different factors that define market structures. Firstly, the number of firms in a particular market can define the type of market structure. Secondly, the concentration ratio of firms in a market helps in identifying the market share of large firms. The nature and amounts of costs in a market shows how different costs affect the contestability in the market. This includes sunk costs and economies of scale. The level of vertical integration, which is the practice of merging the different phases of production and distribution by individual firms, is also a feature of market structure (Chioveanu, 2005). Types of Market Structures There are four different types of market structures, that is, perfect competition, monopolistic, monopoly and oligopoly markets. Features of market structures In a perfectly competitive market, there are many sellers that one seller’s decisions do not have any impact on the pricing of products and services in the market. The products and services in a competitive market are homogenous. Sellers in this market have identical commodities. Firms in this market are price takers. Firms do not have any influence on the market prices of commodities. There are no barriers to entry in a competitive market. Firms can freely enter and exit a competitive market (Norman, 2000). In monopolistic competition markets, there are many firms. Each firm owns a percentage of the total market share. Additionally, products are differentiated in pricing strategies, style, location, brand name, packaging, and advertisement. Just like the perfect competitive markets, it is easy to enter and exit a monopolistic market (Stackelberg, 2011). In a monopoly market, there is a single seller such that the industry and firm are synonymous. Monopoly markets have unique services and products that do not have close substitutes. The firm in a monopoly market is the price maker and has considerable control over the price as it can control the supply of the product. Monopoly markets have barriers to entry and exit (Townsend, 2002). In an oligopoly market, there few large firms with each firm considerate of their rivals’ decisions and reactions to its decisions regarding output, advertising, and prices. Products in an oligopoly market are differentiated. There are barriers to entry in this market due to the requirement of huge capital investments and economies of scales (Triffin, 2004). Market Demand Individual firms in a perfectly competitive market view their demand as perfectly elastic that is a horizontal line at the market price level. However, the industry demand curve is not perfectly elastic. The demand curve is perfectly elastic for individual firms because they are price takers regardless of the quantities they produce. This explains why the demand curve for firms in a competitive market is a horizontal line at the market price (Stackelberg, 2011). The demand curve of firms in a monopolistic market is highly elastic, but not perfectly elastic. The demand curve is more elastic than the monopoly’s demand curve as sellers have many competitors producing close substitutes. However, the demand curve is less elastic than perfect competition demand curve because products are differentiated (Stackelberg, 2011). The monopoly demand is the industry demand and is downward sloping. Prices exceed marginal revenues because the monopolist firm must reduce price to increase sales. The additional revenue is the price of the last unit minus the sum of the price cuts, which firms take on all previous units of output. The marginal revenue curve of a monopolist is below the demand curve (Norman, 2000). Due to competition from rival firms who have a considerable market share, price rises are unmatched while rivals match price cuts. Firms in an oligopolistic market view their demands as elastic for price increase and inelastic for price cuts. Firms in this market face a kinked demand curves. This examination clarifies the fact that in some oligopolistic markets prices tend to be inflexible (Stackelberg, 2011). Profit Maximizing Output In a perfectly competitive market, there are two analysis of the profit maximizing output. In the short run, a firm in a competitive market has fixed resources and minimizes loss or maximizes profit by adjusting output. Firms should produce if the venture is profitable, that is the total revenue should be greater than total costs or if the loss does not exceed fixed costs. If the loss exceeds the fixed costs, then the firm should shut down (Robson, 2011). In a perfectly competitive market, we compare marginal cost and marginal revenue to determine the profit-maximizing output of the firm. If marginal revenue is greater than marginal cost, a firm should progress with production. However, if marginal revenue equals marginal cost, it should stop the production of the additional unit. This is the profit maximizing level of output for firms in a competitive environment. If marginal revenue is less than marginal cost, then the firm should reduce its output (Townsend, 2002). Therefore, in the short run, if Price is less than the minimum average cost, then the firm needs to shut down. On the other hand, if price exceeds minimum average cost, then the firm should produce. Marginal cost and Price are used to find the loss minimizing or profit maximizing output level. The supply curve of firms in a perfectly competitive market would be the portion of the marginal cost curve above the minimum average cost curve (Triffin, 2004). Three assumptions are made when carrying out long run analysis. Firstly, the only adjustments in the long run are entry and exit of firms in the market. Secondly, firms in the industry have similar cost curves. Finally, there are constant returns to scale in the industry (Robson, 2011). In long run, economic profits attract firms, which enter the industry increasing market supply. Consequently, the increase in supply drives prices down. If firms incur losses in the short run, they will exit the industry in the process decreasing the market supply. This causes prices to rise until losses disappear. In the competitive markets model, economic profits are zero in long run. Long run equilibrium is achieved at a point where price equals the minimum average total cost (Robson, 2011). The MC = MR rule gives firms in a monopolistic competition the profit – maximizing output. The price that firms charge is on the demand curve. In the long run, firms tend to breakeven. Existence of economic profits leads to firms entering the industry. Consequently, entry of new firms in the industry shifts down the demand curve of individual firms as some buyers purchase from the new firms. The demand shifts down up to a breakeven point. In the long run, some firms will exit the industry when the demand shifts below the breakeven point. Theoretically, most firms in monopolistic competition should experience break-even in the long run. However, some firms earn profit as they able to distinguish themselves from other firms and build a loyal customer base (Norman, 2000). The MC=MR rule determines the monopolist’s profit – maximizing output. Monopolists maximize profit where total revenue minus total cost is greatest. This is dependent on the price as well as the quantity sold. A monopolist charges a price that consumers are willing to pay given an output level. Therefore, the price of a monopolist is on the demand curve. Monopolies will charge higher prices by producing smaller output than competitive producers would sell in the same market (Stackelberg, 2011). Economic Efficiency; Perfect Competition vs Monopoly Productive Efficiency Productive efficiency occurs where price equals the minimum average total cost. Firms in a perfectly competitive market achieve productive efficiency as they must use the least-cost technology or they will be driven out of the market. On the other hand, firms in a monopoly market do not achieve productive efficiency as they produce an output level that is less than the output of minimum average total cost. X-inefficiency occurs because firms do not face competitive pressure to produce at minimum costs (Norman, 2000). Allocative efficiency Allocative efficiency occurs where Price equals marginal cost. Price denotes the benefit that society get from additional units of a commodity while marginal cost denotes the opportunity cost to society of producing that particular commodity. Contrarily, Monopolists do not achieve allocative efficiency because they charge prices that are more than the marginal cost (Norman, 2000). Conclusion Even though both productive and allocative efficiencies are achieved in a perfect competition system, consumers face standard products. Consumers receive the highest consumer surplus as the long run market price is at the minimum average total cost. Producers receive lowest producer surplus as customers can easily purchase substitutes. Monopoly firms can be more efficient than many small firms can. In some industries, economies of scale may make monopoly the most efficient market model. However, rent seeking and X-inefficiency entails substantial costs leading to inefficiency. Firms in a perfect competition market are price takers. Contrary, firms in a monopoly market are price makers. On the other hand, firms in a monopolistic competition have partial control over the price. In an oligopoly market, firms prefer sticking to their prices to avoid any price wars (Robson, 2011). The demand curve of firms in a perfectly competitive environment is perfectly elastic. Monopoly and monopolistic firms face a downward sloping demand curve. On the other hand, oligopoly firms face a demand curve that is indeterminate as the market behavior of producers is uncertain (Stackelberg, 2011). Each firm in a perfect competition environment is small and as such, individual firms cannot influence the decisions of other market players. In a monopoly market, there is no question of other firms’ reaction since there is only one firm in the industry. In a monopolistic competition, there are many market players and as such, the behavior of an individual firm has less impact on the behavior of other firms. On the other hand, there are a few market players in an oligopoly market and behavior of each firm has significant impact on how other firms behave (Stackelberg, 2011). References Chioveanu, I. (2005). Strategic pricing in oligopoly markets. Bellaterra: Universidad Autònoma de Barcelona. Top of Form Bottom of Form Norman, G. (2000). Market structure and competition policy game theoretic approaches. Oxford, UK: Cambridge University Press. Top of Form Bottom of Form Robson, A. (2011). Law and Markets. Basingstoke: Palgrave Macmillan. Stackelberg, H., & Bazin, D. (2011). Market Structure and equilibrium. Berlin: Springer. Townsend, H. (2002). Foundations of business economics markets and prices. London: Routledge. Top of Form Bottom of Form Triffin, R. (2004). Monopolistic competition and general equilibrium theory. Cambridge: Harvard University Press. Top of FormBottom of Form Read More