Monopolistic Competition - Essay Example

Running header: markets Student’s name: Instructor’s name: Subject code: Date of submission: Markets Generally, the market structures in our economy today can be divided into four i.e. perfect competition, monopolistic competition, oligopolies and monopolies. The different types of markets are differentiated by the level of competition in a particular market as well as the number of players in the market. Monopolies and oligopolies are all markets where one or few companies (entities) have market power and hence must interact with their customers (monopoles)and other firms(oligopoly) in a manner similar to games theory implying that expectations about their behavior will affect other firms choice of strategy and vice versa (Findlay, 2003). This is unlike the case of perfect competition where the entities are price takers and have no market power. This paper aims at explaining the various types of markets using various businesses as examples to demonstrate whether the market for their products or services represent perfect competition, monopoly, monopolistic competition or oligopoly. Monopoly A monopoly is established when a specific firm (entity) acquires sufficient control over production of a specific product or service and hence determines significantly the terms on which other firms (individuals) shall access it (Fuller, 2005). It is a market structure where there is a single supplier in an industry who produces and sells the product and there lacks close substitutes for the goods it produces. Other characteristics of a monopoly include; -Market power- A monopoly has the ability to affect terms and conditions of exchange and hence the prices are set by the firm and not the market forces of supply and demand. -Product differentiation- there is very high level of product differentiation in a monopoly since there are no substitutes for a monopolized good or service. -Elasticity of demand – a monopoly faces a relatively inelastic demand curve due to the barriers to entry, exit or competition. -Supernormal profits –these are excess profits above the normal expected returns on investments. A monopoly usually makes supernormal profits due to the barriers of entry that prevent competitors from venturing into the market. -Profit maximization – a monopoly maximizes profits by producing where its marginal revenue equal marginal cost i.e. MR= MC. This is illustrated in the graph below; The Government owned Australian postal corporation (Australia post) is a good example of a business whose market for its products represents a monopoly. This is because it has numerous characteristics that qualify it to be a monopoly. The characteristics include; Australia post is a service provider that operates in three core markets which include letters and associated services, agency services and retail merchandise as well as parcel and logistic services. It is on the delivery of letters where the government has granted a monopoly to Australia post for letters up to 250 grams although other firms can offer they services provided they charge four times the basic postage rate (Gans, 2006). In essence, the company is the single provider of the letter delivery service in Australia as the price discrimination serves as a legal barrier to entry for other firms that would be interested in offering the same services. The Australia post has been increasing the basic postage rate for letters over the years without significantly affecting the demand. For example, it increased the rate from 55 cents in 2008 to 60 cents this year. Although the management blamed the increase on inflation, the often increases are obviously as a result of Australia post’s monopoly over small items. Also, there is no available substitute for Australian post letter delivery services and hence a customer has no choice but to use the services of Australia post. Due to lack of competition and the postal charges barriers, the Australia post can be able to make supernormal profits by charging high prices. This is because the elasticity of demand for its products is almost inelastic owing to the fact that Australians willing to send letters have no option but use its services. Perfect competition This describes a market structure where no participants are big enough as to have the market power to set the prices of a homogenous product. However, perfectly competitive markets are few (rarely exist) due to the fact that the conditions for perfect competition are extremely strict. A perfectly competitive market can only exist where the participants are price takers and no firm has the ability to influence the price of the commodities it offers in the market. Perfectly competitive markets are characterized by the following features. -Existence of infinite buyers and sellers- there exist infinite buyers in the market who have the willingness to buy the products or services offered at a particular price and infinite suppliers with willingness and ability to supply their commodities at a particular price. The price prevailing in the market is therefore determined by the forces of supply and demand (Layton and Tucker, 2002). -No entry and exit barriers- in the market, it is relatively easy for a firm to enter or leave the market since no barriers exist. -Perfect mobility of factors of production- there is perfect mobility of factors of production in a perfectly competitive market in the long run which allow for free long term adjustments to the changing market conditions. -Existence of perfect information- in a perfectly competitive market, it is assumed that the buyers and sellers have perfect information regarding the prices and quality of goods. -No (zero) transaction costs-buyers and sellers in a perfectly competitive market incur no costs in making an exchange. -Profit maximization- firms in a perfectly competitive market maximize their profits by selling at the point where marginal cost is equal to marginal revenue . This can be best illustrated by the graph below where the straight line represents the point of maximum profit. NB: TR =total revenue and TC = total cost -Homogenous products- unlike in monopoly, there is no product differentiation in a perfectly competitive market. The characteristics of any market goods or services do not vary across different suppliers. -Existence of constant returns to scale that ensures that there are sufficient firms in the industry. The best example of a business whose market for its products represents perfect competition is that of fish market and the vegetable and fruit vendors selling at the same place. This is because the market for their products posses most of the characteristics of a perfect market such as the following. a) There are a very large number of sellers offering the same commodities (i.e. fish, vegetable or fruits) and very many buyers looking for the same commodities. b) There exists no barriers to entry or exit in such a market and hence any body willing to venture the market can do so without encountering much difficulty. c) There exists perfect mobility of all the factors implying that the buyers can easily change (switch) from one seller to another if they deem it necessary. d) There is no product differentiation in such a market as all the products offered are homogeneous (e.g. the fruits are the same) Oligopoly This is a market structure that is dominated by a small number of sellers (oligopolists). Due to the existence of a few numbers of sellers, each seller is aware of the actions of the competitors and hence the decisions of a firm may influence and be influenced by the decisions of other firms (Pindyck, 2003). The characteristics of oligopoly include the following. -Profit maximization –an oligopoly usually maximize profits by producing where their marginal revenue (MR) is equal to marginal cost (MC) i.e. MR= MC. This can best be illustrated by the graph below where the firm produces at point E to maximize profits. -Pricing- due to the existence of a small number of firms that control the market, oligopolies are price setters unlike the participants in the perfect competitive market who are price takers. -Barriers to entry and exit- there exists very high barriers to entry in the market. Such barriers include economies of scale, patents, access to expensive and complex technology as well as strategic actions by incumbent firms designed to discourage entrance. -Supernormal profits – oligopolies are able to make supernormal profits in the long run since the numerous barriers to entry discourage new firms from venturing the market to capture the high profits. -Products differentiation – in this market, the products may be standardized or differentiated. -Perfect knowledge – in the market, knowledge of different economic actors is generally selective. The firms have perfect knowledge of their own cost and demand functions although inter-firm information is incomplete. The buyers on the other hand have imperfect knowledge as to price, cost as well as product quality. Interdependence- this is the distinctive feature of oligopoly. The firms in this market are relatively large such that their actions affect the market conditions. Competing firms always become aware of market actions and respond appropriately implying that before a firm takes an action, it must take into consideration the counter reactions by competing firms. The best example of a business whose market for its products represents oligopoly is that of the Australian media companies. This is due to the fact that most media outlets in Australia are either owned by News Corporation, Fairfax media or by Time Warner. As such, these companies are able to decide on the prices they will offer their products and hence they can sell their products at relatively high prices and hence make super normal profits. Furthermore, there exists barrier to entry in the industry due to the high capital requirements which discourage other firms from entering the market. An action by one of these companies also greatly influences the actions of the other companies. Therefore, if one of the companies decided to lower its prices, the other firms are also compelled to lower their prices. Monopolistic competition This is a market structure where there are many competing producers selling products which are differentiated from one another. In this market, firms can behave like monopolies in the short run. However, in the long run, other firms enter the market and competition increases thus the market becomes like perfect competition where firms do not get supernormal profits (Quayle, Robinson and McEachern, 2004). Characteristics of monopolistic competition include the following; -Product differentiation-Although the products are differentiated, the differences are not so great to eliminate goods as substitutes i.e. the goods are imperfect substitutes. The differences are in quality and circumstances e.g. style, quality, reputation, appearance etc. -Many firms-In this market, there are many firms and many firms in the sidelines prepared to enter the market. Each firm is therefore able to set its prices without necessarily affecting the entire market. -Free entry and exit-There is free entry and exit in the long run. Firms can enter the market freely and leave the market without encountering significant liquidation costs. -Independent decision making-In this market, each firm sets the terms of exchange independently for its product without considering the counter reactions by competitors. -Market power-Firms in this market have considerable market power as they are able to alter their conditions of exchange without loosing all their customers and without fearing the effects of heightened competition. -Perfect competition- buyers are aware of the goods being offered, where they are sold, and the differentiating characteristics of the goods and the pricing of the goods. -Profit maximization- firms in this market will maximize profit by selling their products where their marginal cost equals the marginal revenue. The graphs below show how the firms maximize profit both in the short run and in the long run a) Short run profit maximization b) Long run profit maximization The restaurants in Brisbane provide a very good example of a monopolistic industry due to the following reasons. There are a large number of restaurants where no restaurant can influence the market outcome but a single restaurant is able to set its prices higher than those of rival restaurants without fearing loss of customers. This is as a result of product differentiation as the restaurants offer services of differing qualities and customers choose the quality they want. New entrants into the restaurant business also face barriers of high capital requirements as well as licensing. Although this is a low barrier to entry, the fact that the restaurants sell differentiated products makes it hard for new firms to venture the market. It is for this reason that the restaurants are said to operate under monopolistic competition and not perfect competition since the goods they offer are differentiated and restaurants are able to make individual decisions without losing customers (affecting the entire market). References: Findlay, C 2003, Economics, Australia, Addison Wesley. Fuller, N 2005, Basic concepts in microeconomics, London, checkmate publication. Gans, J 2006, Principles of microeconomics, Brisbane, Thompson. Layton, A & Tucker, I 2002, Economics for today, Brisbane Thompson. Pindyck, R 2003, Microeconomics, Oxford, Oxford university press. Quayle, M Robinson, T & McEachern, W 2004, Microeconomics: A contemporary introduction, Australia, southwestern publishing company. Read More