Three Different Market Structures: Oligopoly, Monopoly, Perfect Competition - Essay Example

1. Discuss how powerful the consumer and the producer are in a monopoly and in perfect competition. Monopoly Monopoly is a case of persistent market situation where there is only one seller or provider of a product or service. In microeconomics, monopolies are defined as organizations that do not have upward sloping supply curves. Such organizations do not have any competition from competitors or substitute products. The businesses that these monopolies are into also have significant barriers of entry making it difficult for other competitors to offer a similar service. As can be understood from above, in a monopolistic organization, the company is king, while the powers of the consumer are limited. This can be further elaborated as under, Power of the consumer As the monopoly dictates the market, the consumer has little powers. ‘A monopoly will sell fewer goods at a higher price as compared to firms that operate in a purely competitive environment’1. While competition brings down the prices in competitive organizations and buyers have the power of choice, in a monopoly buyers are left with no option but to purchase from the monopoly. The single firm controls the entire supply of products and dictates prices in the market. However if the company offers supracompetitive prices, the buyers do have the power to look for supplementary options or substitutes, which may bring down the monopoly. It is the fear of competition from new markets that often regulates prices in a monopoly. The buyer has little control over the quality of the product he receives. The monopoly faces minimal competition and has a ready market for its products, the quality setting for its products and services are often much lower than they would be in the case of perfect competition. With a ready demand and a ready market, such companies have lower requirements for innovation and product/service enhancement. Popular theories dictate that as the quality setting is often in the hands of the companies rather than customers, the innovation and efficiency levels of such organizations decrease over time. Power of the producer The producer is all-powerful in the case of a monopoly and has unprecedented powers in the market. With no other company producing similar goods, the producer enjoys the powers to control the price and may hike it much more than it would have done in normal competitive conditions. While these companies do have high marginal profits, they too face pressure from potential competition that may arise if monopolies offer supracompetitive prices2. Thus while monopolies can make large profits in the short run, the profits become normal in the long run. The major chunk of information on markets is in the hands of the monopoly and this information is asymmetrically distributed as per the interests of the monopoly. The barriers to entry are high, and being the leader in the market, the producer can increase the barriers to entry further. Unregulated monopolies with no connections with the government ties have an undisputed upper hand and can work as they please. With on other organization offering products or services like the monopoly, it becomes the king and dictates the market. Perfect competition While the basic aspect of any micro economy is competitiveness among players, in the case of perfect competition, economic forces work uninterrupted by any other force. A perfect competition on the other hand is more of a hypothetical condition where neither the producer nor the consumer has the market powers to influence the prices of products or services. This kind of a competition arises when products are of similar kind (homogeneous), the market has various small sellers and small buyers (atomic market), the information on prices of all players is completely known to everyone, all firms have equal access to all technologies and the buyers and sellers operate independently with no threat of them coming together as groups. It can thus be safely derived that in a perfect competition, buyers and sellers have little control over the market price as they function as independent entities. Alternatively, it can be said that in such a market, the consumer and producer are equally powerful which can be judged through the following parameters. Power of the producer The producer only produces a small percentage of the total market output. In order to profit, the producer’s marginal costs and the cost of additional units produced must equal marginal revenue. Thus while the company profits with low production, if the production is higher, it costs more than it earns. The producer also has little control over the market price and earns the amount specified by the market. Also the company cannot restrict the output hoping that it will force up existing market prices. The producer in a perfect competition cannot earn unusually huge profits in the long run. This is because as the firm earns abnormal profits in the short run, it would trigger other firms to enter the market. This would increase the competition and drive the prices of the markets down. Also such markets do not make abnormally low profits also. This is because, once profits decrease, certain players go out of the market and reduce the supply. This in turn increases the demand for the product. Power of the consumer Also as the products are homogeneous and the prices are almost equal customers are equally spread out among the sellers. This showcases that even customers are unable to drive the prices of products in such markets. They too take the price as is given. There is no monopsony power either, and no individual buyer has any control over the prices. This is because the demand curve of the market is the sum total of demand curves of individual consumers. Thus buyers are also in the background and have no role to play in bringing down prices. (952 words) 2. Is an oligopoly market closer to monopoly or perfect competition? Try to include ‘real-world’ examples of these three different market structures. Why is this difficult for perfect competition? An oligopoly market is a common market form, which is seen to have more in common with a monopoly rather than a perfect competition. In many countries, oligopolies exist as four firm concentrations3 and can also be considered as collective monopolies where a few firms dominate the market. This can be further understood as under. Imperfect market conditions: Unlike markets in perfect competition, firms in an oligopoly market operate under imperfect market competition. This means that there are formidable barriers to entry into the business, which may occur through requirement of major financial investments or huge technical know-how. Information is not freely and equally accessible and only the market owners are aware of how the industry operates. Finally, the market is not in an atomic structure with only a handful of oligopolies. Price makers: Like monopolies, oligopolies are also price makers rather than price takers. Whereas in a case of perfect competition, neither the producers nor consumers have any power in controlling market prices, in an oligopoly, the producers together have an upper hand in pricing. Thus oligopolies often collude or collaborate for obtaining monopoly profits at monopoly pricing. This happens because of their high levels of product differentiation. The advertising efforts of the firms are thus non-price competitions and are based on packaging, quality, service and product development rather than low prices. Collective monopolies: In perfect competition, there are many buyers and sellers who operate as individual entities and there is no threat of them coming together as groups. However oligopolies are limited in number (often being referred to as the Big two or Big five). These organizations collectively dominate the market, often working as a single monopoly. These firms thus interact with each other and their planning involves ideas and plans of all oligopolies collectively. In some cases, oligopolies even collude as Cartels4 where they formally agree to control the price and output of a product like in a monopoly. Higher profits: Finally just as in the case of monopoly markets, prices charged in oligopoly conditions are much higher than what they would be in the case of perfect competition. This is so because decisions on pricing are taken collectively by the firms that together maximize their profits. While there are many similarities between monopolies and oligopolies, in certain cases oligopolies can be closer to perfect competition also. This may happen when organizations in an oligopoly setup compete against each other rather than colluding together. Competition can become fierce and thus bring down prices and increase quality. This in turn leads to perfect competition and a stable market. Examples of monopoly, oligopoly and perfect competition Today’s business markets are diverse, and one can see the diverse structures of markets operate. Monopoly markets do exist and so do oligopoly market structures. However perfect competition is a more hypothetical case, as it is difficult for all parameter to coexist. There are markets that operate close to perfect competition conditions. Given below are examples of such markets. Example of monopoly: Microsoft A good case of monopoly markets is that of Microsoft in the area of PC operating systems. This can be judged based on the following parameters. The company enjoys undisputed power in the market, so much so that if it exercises its power solely in terms of price then it could charge amounts that are much higher than in competitive conditions. The Windows software offered by the company is used to power most applications in personal computers across the world. As typical of a monopoly, the company has been alleged that it uses this market dominance to push its other products like the Internet explorer web browser to its customers. It has also been alleged that the company has misused its monopoly powers to prevent other software companies5 from innovating. Market conditions also show that with the scale of operations Microsoft currently has, the company can afford to hike its prices and continue doing business for a considerable period of time without any threat from outside. Even with many software firms, Microsoft has a monopoly in the market due to its huge size and scale of technology offerings. A perfect competition market structure: EBay A perfect market is more of a hypothetical condition and all its parameters seldom exist. This happens because; in real time market conditions one or more aspects are always seen wanting. If the market is atomic with various large sellers, information may be asymmetrically distributed. However, there are a few markets that come close to perfect competition. One of them is EBay. This is because it fulfils the criteria of perfectly competitive organization to a large extent as under, The market is atomic in nature with a large number of small sellers and small buyers. Not one seller or buyer can dominate the market scenario. The barriers to entry into ebay are very low. This comes through from the fact that anybody can sell or purchase a product on Ebay. Prices are openly disclosed so almost all buyers and sellers know the prices at which certain products are offered. A wide range of homogeneous products is available thus perfect substitutes to products are also available. An oligopoly market structure: Wireless communications The industry of wireless communications is a good example of an oligopoly market. This is because this sector matches parameters of an oligopoly market structure. Any state typically provides license to three or four providers of cellular service only. Thus there are few players in this sector that collectively dominate the market scenario. Entry into the business of wireless communications is difficult as the requirements for financial investment and infrastructure are high. Given the competitive nature of the market, decisions on price6 and features are taken collectively by the firms so they do not lose business. With little differentiation between the offerings of the various service providers, advertising and product development mainly determine the market share. Finally the prices are influenced more by market powers than by production and providers of the service get a large share of the profits. (1021 words) References used http://en.wikipedia.org/wiki/Monopoly http://news.com.com/2100-1040-232565.html http://www.tutor2u.net/economics/content/topics/monopoly/perfect_competition.htm International Journal of Industrial organization, 1999 Read More