Characteristics of Monopolistic and Competitive Markets - Coursework Example

Running Head: РRОFIT MАХIMIZАTIОN АND MАRKЕT STRUСTURЕ Student’s Name: Course Code: Lecture’s Name: Date of presentation: A. Characteristics of monopolistic and competitive markets Monopolies refer to a market situation whereby a particular individual or enterprise is the only seller or supplier of a particular commodity. The basic characteristic of this monopoly is lack of trade competition in the supply of both goods and services and consequently lack of a viable substitute commodity. Indeed the term monopoly refers to the action of an enterprise to achieve the ability to exclude competitors or raise prices of particular goods and services. In microeconomics, a monopoly can be termed as a single seller. In economics, a business entity that possesses significant market share and power, to be exact, market power- to increase commodity prices. Although most of monopolistic business entities are large business and firms, side is not a key characteristic of a monopoly. Smaller and medium businesses can still enjoy monopolistic power to determine market prices in a lesser market industry. Monopolies can either be established by governments through legislation or, naturally through market integration. Although most government establishment restricts the creation of monopolies, it is not illegal for a business entity to hold a monopoly of market dominant position. A legal or government created monopoly is sanctioned by the government, mostly in the provision of key services to the economy, or in giving incentives to a risky investment venture through granting of copyrights, patents, and trademarks. Other services could be offered by the state itself, and thus government monopoly. Characteristics of Monopoly Monopoly is basically refers to market situation with a single seller and a large number of sellers with the following characteristics: Single seller: in monopoly economy, there is only a single seller that produces all the output of both goods and services. This means that that the entire market is served by the single business entity, and thus for practical reasons, the company enterprise is equivalent to the business industry. Large numbers of firms Profit optimizer: Monopoly market allows the single or less sellers to maximize on their net profit returns Discrimination of price: a monopolist is at liberty to alter both the quantity and price of their commodities. In a very elastic market, a monopolist sells larger quantities at a lower price and sells lesser quantities at a higher price during lower elastic market. Price decider: the business enterprise in a monopoly economy is responsible for making decision on the price of commodities regardless of the market forces. Increased barriers to market entry: in a monopolistic market set up, other business competitions find it hard to penetrate the market which is heavily owned by the single firm Causes of a monopoly market power Monopoly market emanates from barriers to entry of the entire market by ac competitor. Such barriers can be grouped as; legal, economic, and deliberate. a) Economic barriers These include economies of scale, cost disadvantages, technological supremacy and capital requirements. i. Economies of scale: this refers to monopolies characterized reduced costs for a significantly large production range. Reduced costs combined with high initial costs offer monopolies an edge over potential competitors. They are often in a capacity to lower prices to less than the operating cost of a new market entrant enterprise thus hindering them from venturing into the market. In addition, the volume of the industry in respect to the minimum efficient scale may prohibit the number of potential competitor companies within the industry. This equally means that such companies that operate in a less minimum efficient scale will eventually suffer more operating cost relative to practical commodity costs. ii. Technological supremacy: a monopolist company is practically in a better position to produce goods cheaply. They can be ably to acquire, use and integrate up-to –date technology in production of commodities better than new entrants who often may lack capacity and capital to acquire this new and advanced efficient technology. iii. Capital ingredients: Capital investments that require huge capital to establish, both in terms of sunk costs, and increased research and development, often favor large and well financed enterprises at the expense of small upcoming firms. This naturally establishes monopoly to the advantage of such big corporate. iv. Lack of substitute goods: Monopolists flourish in markets which lack competitor commodities. The absence of these substitutes leads to inelastic demand enabling the monopolists to reap optimum profits v. Network externalities: the use of a commodity is dependent on the number of people using the product at that particular time. A good example is the supremacy of Microsoft Corporation in the provision of PCs software. vi. Control of vital natural resources: the main source of monopoly environment is the ability of some companies to control the main resources responsible for the production of final market commodity. b) Legal Barriers This refers to exclusive rights enjoyed by monopolists to exercise their monopolistic control. These rights include; copy rights, patents, and intellectual property rights which give them exclusive privileges to both demand and utilization of such products. c) Deliberate efforts This refers to action taken by a company that wishes to exercise monopoly, by actively eliminating or excluding competition. These actions include lobbying through state agencies, and collusion. Competitive Markets Competitive markets refer to market types characterized by huge numbers of producers who compete amongst themselves to meet the needs and wants of a large number of consumers. Ideally in this form of market structure, there is no single seller or producer, single consumer, group of producers or consumers, with the exclusive ability to control and manipulate the market. The price of goods and services is therefore not determined by individuals but rather through the effects of market forces. Competitive markets arise and prevail under certain conditions such as: Profit motive Free and competitive markets occur in situations where there are prospects of making profits if a firm enters the market. Market barriers A competitive market offer lees or no barriers to both entry and exit of the market players. Homogenous commodities Perfectly competitive markets offer homogenous products which make the market players to enjoy little or no bargaining power. The more the products become differentiated, the less competitive the market is and this eventually leads to monopoly market. Equilibrium between Marginal Cost and Marginal revenue Marginal revenue refers to the revenue generated when a unit measure of an item is sold while marginal cost of a product refers to the cost incurred by a producer in producing an extra unit cost. In a competitive market, marginal revenue tends to reduce as production increases, while marginal cost is more likely to increase as production volume increases. This means that, under a perfect competitive market, firms tend to function at the optimum point where marginal revenue equals marginal cost: break-even point on the last unit volume produced Comparison between monopoly and competitive markets Although both competitive and monopoly market situations appear on opposite extremes of a market configuration, there do exists some commonalities between the two. Both markets strive to maximize profits through the reduction of cost of production and operation. There are however some distinctions as described below. i. Marginal price and revenue: in monopoly market, prices are always above the marginal cost incurred by the monopoly firms. However, in a competitive market, commodity prices always equal the marginal cost of production and operation. ii. Product differentiation: in a perfect competitive market, each product is entirely homogenous, thus zero differentiation of a product. However, in a monopoly market, there is some extent or even absolute differentiation of a product leading to little or no product substitution of the monopolized commodity. The rules of trade are therefore stated by the supplier and thus the consumer has no choice, but to either buy the monopolized good; or leave it. iii. Level of competition: Basically monopoly markets involve a single trader, while in a perfect competitive market involves an infinite number of traders dealing with the homogenous commodity. iv. Elasticity of demand: the price elasticity of demand refers to the rate of change of demand as a result of a unit change of relative price. A low elasticity coefficient is an indicator of presence of barriers of entry into the market. Consequently, a perfect monopoly will always have an inelastic demand curve, while in a perfect competitive market the demand curve is infinite. v. Profit margins: A perfect competitive market is likely to make abnormal profits in the short run which consequently attract competitors. However, monopolists can preserve these abnormal profit margins as the market barriers keep away potential competitors. vi. Supply Curve: A well defined supply function exists in perfectly competitive market as a result of market forces of price and quantity. However, such supply- price interaction does not exist in a monopolistic market. B. Diagram of Monopoly and Competitive markets Monopoly Price vs. Output Diagram Demand Curve The figure above shows the demand curve of a monopoly market situation. As shown above the demand line slopes downwards. This means that a monopolist will not choose both output to be sold and also the respective selling price. He has to actively demand one of these parameters. If he opts for higher price P1 he has to equally contend with the respective lower quantities of sale Q1. Larger quantities call for an equivalent reduction of price. Since a monopolist is the sole seller of a commodity in the market, he can assume the market demand curve to be his own demand curve. He therefore faces a downward sloping line AR which is half the gradient of MR. this means that the firm has the liberty to set product prices as well as regulating output. A monopolist however, cannot set a price that the consumers can hardly afford. This consequently means that the pricing behavior in a monopolist market is depends on the elasticity and position of the demand curve. A monopolist will maximize profits at the point where MR=MC; thus establishing the short run equilibrium. P1 give the commodity price at maximum profit at output Q1 above average cost of production Q1 as shown in the figure above. Assumptions of a monopoly i. There is only one seller that is; absolute monopoly case where the firm has the overall capacity to alter prices and affect commodity supply- the individual is assumed to be the price maker ii. There exist trade barriers in the market- that prevent entry of competitors in the market. iii. No substitute goods on which the monopolist is dealing in iv. As the sole seller, the monopolist also reserves them to have exclusive access to resources, technology and other factors responsible in production of the monopolized goods or services.  Diagram of Competitive markets A perfect competitive market consists of an infinite number small independent enterprise firms dealing with perfect identical (homogenous) products to an infinite number of consumers. The demand curve of perfect competitive market is perfectly price elastic since and firm that increases prices experiences fall of demand to almost zero. This is due to the fact that consumers with adequate market knowledge switch to other sellers offering similar products. From the diagram above, Q1 refers to the output and at market price P1. The price is therefore common in all firms dealing with that particular commodity. AR, Average Revenue is the demand curve of the individual firm. The market price is same for the entire unit produced and therefore it shows the Marginal Revenue curve (MR). Q2 indicates the profit maximizing unit, where MC= Mr. The total output generated at maximum revenue point is P1Q2. This is a case of a firm getting abnormal profit margins and holds much in the short run. C. Basic assumptions in the diagram of a competitive market i. Perfect freedom of market entry and exit: it is assumed that firms do not suffer sunk costs. The firms exit from the market is feasible in the business long run. This assumption takes into consideration that the firms are making profits in the long run. ii. Homogenous products: It is assumed that firms are dealing with homogenous products with perfect substitutes of each other. This consequently renders the individual firms passive in determination of commodity prices. iii. Many sellers in the market, each with insignificant market share. This ensures that each seller is too insignificant to affect supply or change the commodity prices. iv. All industry players as well as new market entrants are assumed to have equal access to business privileges such as technology and other factors responsible for production and operational improvement. v. It is assumed that consumers have perfect information concerning the prices of all sellers in the market charge. If certain firms decide to increase item prices, the consumers will most likely make large substitution to other identical products. a) Circumstances under which monopoly may lower prices and increase output In a standard model, a monopolist sets single price for the entire consumer base. He will sell lower quantities at a higher unit price that perfect competition. With time monopolists tend to become less innovative and less efficient over long run thus leading to reduced sales and thus lower profit margin. Such reduced psychological innovativeness and efficiency may boost the potential competitor’s value in the quest of overcoming the trade and market barriers. The only way that the monopolist can regain the market supremacy is to encourage more consumers by lowering price thus increasing output. References Arrow, K. J. (1959). "Toward a theory of price adjustment", in M. Abramovitz . The Allocation of Economic Resources, Stanford University Press. Binger, B. (1998). Microeconomics with Calculus. New York: Addison-Wesley. Roberts, J. (1987). "Perfectly and imperfectly competitive markets". The New Palgrave: A Dictionary of Economics, pp. 837–41. S, A. (2002). Monopoly" (paperback). Microeconomics: Principles and Policy. Thomson South-Western, p. 212. Read More