Comparison between Markets - Example

Comparison between Markets I. Introduction The structure of the market in which a firm operates can have great influence on the success and long term sustainability of the firm. Therefore, investors specifically consider market structures in order to make sound investment decisions and to earn potential returns on their investments. Mainly there are four market structures such as perfect competition, monopolistic competition, monopoly, and oligopoly on the ground of type of competition. In reality, the concept of perfect competition does not exist. Monopolistic competition is very common in the modern market environment. Governments seek ways to discourage monopoly so as to deliver competitive services to people at affordable rates. This paper will evaluate the characteristics of each of these markets and contrast the economic efficiency of the outcomes under perfect competition and monopoly. II. Characteristics of Different Markets Generally, market structures have been classified into four categories such as perfect competition, monopolistic competition, monopoly, and oligopoly based on the type and intensity of competition. These four market structures have unique characteristics, and they are described below. i. Characteristics of perfect competition Perfect competition is a market structure or a situation prevailing in the market where there are numerous buyers and sellers who are informed that all elements of monopoly are absent. In a market where perfect competition exists, a commodity’s market price is beyond the control of individual buyers and sellers (Chapter 8, slide 4). The concept of perfect competition is sometimes referred to as pure competition. One of the major characteristics of a perfectly competitive market is that there will be a large number of consumers who are willing and able to buy the product at a certain price and a large number of producers who are willing and able to supply the product at a certain price. Since there are no barriers of entry and exist, it is really easy for firms to enter or exist a perfectively competitive market (Chapter 8, slide 20). Factors of production are perfectly mobile in this type of market in the long run, facilitating free long term changes to varying market conditions. Under this type of market structure, all stakeholders including producers and consumers are assumed to have perfect knowledge of various product details such as price, utility, quality, and production methods. Zero transaction cost is another major characteristic feature of perfect competition. More clearly, exchange of goods between sellers and buyers in a perfectly competitive market does not involve any cost. In addition, buyers are able to make rational purchases in this type of market based on the information provided. Finally, qualities and characteristics of goods/services would not vary between different suppliers in a perfectly competitive market. The effects of new market entry on economic profits are illustrated below. (Source: Chapter 8, Slide 20) ii. Characteristics of monopolistic competition Monopolistic competition can be simply referred to a type of imperfect competition where many sellers offer products that are differentiated from one another and hence are not perfect substitutes (Chapter 9, slide 3). One of the most notable characteristics of the monopolistically competitive market is that it is comprised of many producers, and many consumers and businesses have no perfect control over the market price. However, producers enjoy a degree of control over the price. In this type of market structure, consumers hold the view that non-price differences exist among the competitors’ products. In addition, there are few barriers to entry and exist in a monopolistically competitive market. Product differentiation is often cited as the most important characteristic of monopolistic competition (Chapter 9, slide 12). Monopolistically competitive firms offer products that have real or perceived non-price differences. However, the difference is not very significant as to eliminate other products as substitutes. In case of monopolistic competition, there is no entry and exit cost in the long run. Any monopolistically competitive firm that fails to cover its costs is free to leave the market without incurring liquidation costs. Independent decision making is another prime feature of monopolistic competition. Here, firms do not give any consideration to what effect its decisions can have on competitors. Monopolistically competitive firms have some degree of market power and they enjoy control over the terms and conditions of exchange. It is important to note that no buyers or sellers have perfect market knowledge such as market demand or supply. It seems that long-run characteristics of monopolistic competition are almost the same as the perfect competition. A major point of difference between monopolistic competition and perfect competition is that the former produces heterogeneous products whereas the latter produces homogeneous products. iii. Characteristics of monopoly Monopoly is a market condition where a particular person or enterprise is the only supplier of a specific commodity (Chapter 11, slide 3). In monopoly market, there will be absence of competition and a lack of viable substitute goods. Monopolies may be established naturally, by a government, or by integration. Profit maximization is a major characteristic of monopolies because there is no economic competition to produce goods or services in this market structure, and therefore monopolies can enjoy continuously growing or constant profits without losing market share to competitors. Monopolies have perfect control over the price as they can fearlessly determine the price of the good or product to be sold because there are no competitors to challenge their pricing decision. High barriers to entry represent another characteristic of monopolies. Here, other sellers cannot enter the market due to several reasons such as high entry costs and lack of market knowledge, technology, or expertise. As mentioned already, there is a single seller of the good/service that produces all the output. Hence, the whole market is controlled and served by a single person or enterprise. For practical purposes, the company is often regarded the same as the industry in a monopoly market. Price discrimination is also a prime feature of monopolies that are free to change the price and quantity of the product according to their interests. A monopolist generally sells higher quantities and sets lower price in a very elastic market whereas he/she sells lower quantities and fixes higher price in a less elastic market (Chapter 11, slide 12). iv. Characteristics of oligopoly Monopoly is a market structure where a small number of sellers (oligopolists) dominate the market or industry (Chapter 10, slide 3). In an oligopolistic market, firms can easily maximize their profits because there is no stiff market competition. It is important to note that oligopolists are price setters rather than price takers because they generally set common prices to avoid unwanted market competition. High barriers to entry and exist constitute a significant characteristic of oligopoly. The key barriers include economies of scale, government licenses, patents, and access to latest and expensive technology. Often, government regulations favoring the existing companies become a potential barrier for new entrants (Chapter 10, slide 4). Since there is only a small number of firms operating in an oligopolistic market environment, actions and policies of one firm can significantly influence the operations of the others. Since high barriers to entry exist in an oligopolistic market environment, oligopolies are able to retain abnormal profits in the long term. Product differentiation is a key characteristic of oligopolies although sometimes they may produce homogenous products. Oligopolies maintain perfect knowledge of their operating costs and demand functions but they do not have complete inter-firm information. Interdependence is one of the most significant and distinctive features of an oligopoly. Since a firm’s actions can have great impacts on other firms, each firm in a oligopolistic market would be concerned about the possible reactions of all competing firms and their countermoves. Another characteristic feature of oligopolies is that they do not wish to compete on price so as to avoid unhealthy price wars (Chapter 10, slide 15). III. Perfect competition Vs Monopoly As discussed already, a perfectively competitive market is characterized with many producers and consumers, perfectly homogeneous goods, perfect information, no barriers to entry and exist, and well-defined property rights. In this market environment, no single economic actor can influence the price of a good. In other words, producers in a perfectly competitive market are price takers that determine how much to produce, but not the price at which they can sell their items. In reality there are few industries that fall under the category of perfect competition but some are very close to this concept. For instance, there are many buyers and multiple sellers in commodity markets such as coal and copper. As the differences in quality between providers are negligible in a perfectly competitive market, goods can be easily substituted. In addition, both the buyers and sellers have complete information about the transaction so that no individual producer could set his prices above the market rate and still find a buyer for his product. Hence, perfect competition can be regarded as a buyer-friendly market system where sellers have little bargaining power over buyers, because there are numerous potential producers. In terms of economic efficiency of outcomes, the perfect competition is effective to better serve the needs of customers. In contrast to perfect competition, a monopoly exists when there is only one producer and many consumers. As a monopoly is characterized with a lack of viable substitute goods, the single producer has the perfect control over the price of a commodity. Public utility companies generally tend to be monopolies. One of the major similarities between perfectly competitive firms and monopoly firms is that both perform the same cost and production functions and seek to maximize the profit. In addition, shutdown decisions are the same under both these market structures. The key point of difference between these two is that price equals marginal cost and firms earn a zero economic profit in a perfectly competitive market whereas the price is set above the marginal cost and firms earn a positive economic profit in a monopoly. According to Mukherjee (2002), perfect competition creates an equilibrium where a good’s price and quality are economically efficient. In contrast, monopolies produce equilibrium where a good’s price is higher, and the quality is lower, than is economically efficient (p.440). Hence, governments often try to regulate the growth of monopolies and encourage healthy market competition. IV. Conclusion I total, there are mainly four types of market structures namely perfect competition, monopolistic competition, monopoly, and oligopoly based on the nature of competition. In a perfectly competitive market, there will be numerous producers and customers who have a perfect knowledge of the market and the producers are price takers here. Under monopolistic competition, many sellers offer products that differentiated from one another and hence are not perfect substitutes. In a monopoly market, a single person or enterprise is the only supplier of a specific commodity and he/it is a price maker. In case of an oligopoly market, a small number of sellers dominate the market or industry. The major difference between perfect competition and monopoly is that the former is characterized with an economic profit of zero whereas the latter is characterized with a positive economic profit. References Mukherjee, S. (2002). Modern Economic Theory. New Age International. Book Chapters. 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