Course name and number
Understanding market structures
Description of market structures
Market structures are generally described as the number of firms in the market producing similar goods and services. Because of interrelationships and interdependency in the market, market structures greatly influence the different behaviors of individual firms in the market. They help to determine how a firm can price its goods and services. These include four basic market structures that are namely, perfect competition, monopolistic competition, oligopoly and the monopoly structure.
In perfect competition, the market structure is characterized by existence of several players i.e. several buyers and several sellers. Since the players are very many in the market, no one seller can make a decision that can have an impact on the market. The market deals with products that are similar and undifferentiated. The industry thus has products that are homogenous in nature with pure standardization, so that all players sell identical goods and services. The market is so large that the activities of an individual buyer or seller do not affect the market. The pricing and the production levels in this market depends on the demand and supply of the market. These make all the industry players to be price takers. This market structure together with its partner market monopoly is called the extreme forms of market. In this market the products are similar and several and that is the reason why there are several substitutes in the market. This is the reason why when a single firm in the industry raises its price, customers or consumers will shift to the rivals for a better price for a similar service. Therefore the firm loses its share of the market by a slight increase of the prices (Clement, 2013). It also has free entry and exit features as no entry barrier exist. Pure/perfect market structures are generally rare in real world situation. The model is used in the analysis of industries where players exhibit pure competition.
This is a very unique market structure where the producers cannot maintain spare capacity. By spare capacity the economists mean that the firms have ability to exploit the resources in the industry but not to exhaust them one hundred percent. But in the case of perfect market where profitability is critical to the firms ensure that they don’t work with spare capacity and hence utilize the resources fully.
Some markets are described as pure monopoly. In this scenario, the industry has only one producer whose products lack close substitutes. These are mainly firms that offer public utilities or professional sport championships. The market thus has only one seller, making the seller to be synonymous with the industry. In monopoly, there is a single supplier in the whole market. For the purposes of regulation, for instance, in America a monopoly exists when a single firm has a control of more than twenty five percent to itself. Monopolies form due to a variety of reasons that includes; exclusive ownership of resources that are scarce is by one supplier, for instance, windows are Microsoft’s brand with which they have monopoly power. Producers may have patents and copyrights over ideas and designs that last for very many years. During this time the exclusive use of ideas and design is with the inventor. The major characteristics of monopoly are that they can be able to maintain supernormal profits in the long run. For all the firm’s profits are maximized when MC=MR. Secondly we can say that with no close substitutes the monopolists can derive super normal profits all the year (Clement, 2013).
The product of a pure monopolist is very unique making it difficult to get a close substitute. This makes the firm to dictate prices- price maker. This make the firm to have unlimited control of the industry, quantity produced and supplied and prices. The market has barriers to entry due to low pricing and efficiency that come from economy of scale. Entry can only be restricted by legal restrictions such as state control of media. Ownership or complete control of the key resources such as players’ contracts in professional leagues may hamper entry. Since the demand of the market (industry) is actually the demand of the monopolist, the demand curve slopes downward. Due to difficulty in price discrimination and ability to lower prices at will, prices do exceed the monopolists’ marginal revenue.
In monopolistic competition, there exists an imperfect competition that has both characteristics of a perfect market and a monopoly. In the market, there is relatively large amount of firms that offer similar products that are not identical. All players have small percentages of market share. This market structure is related to a monopoly in that the goods can be differentiated and be sold at a price determined by the producer. It is also related to a perfect market since the market allows for free entry and exit; there are several players in terms of buyers and sellers. In short run, the companies in this market structure just like monopoly have the power to generate profits. In the long run, other companies will enter the markets and benefit from part of the profit through differentiation. The firm later becomes more of a perfect competition where they cannot dictate profit or make super normal profit. At complete lack of government intervention this market structure falls under a natural monopoly. The presence of a coercive government monopolistic competition will fall under government granted monopoly. According to Edward Hastings, in his book theory of monopolistic competition, there are many producers and consumers but no single firm has control over the market price. There are few barriers to entry (Kelly, 2013). This situation makes the firms to have very elastic demand curves, though not perfectly elastic. The high level of elasticity is based on the fact that the many market rivals produce goods with very close substitutes. However, the products are more differentiated from each rival’s commodities.
In an oligopoly, there are only few firms that make up an industry. The firms have control over the price just like a monopoly. Every oligopoly all over the world has control over the prices and high barriers to entry. The firms in this market structures are independent and produce nearly identical products, the independence comes about due to the market forces. Three conditions for oligopoly were established by early economists. First, for a market to be oligopolistic, it must have few firms that are large in nature. This is a condition that is essential in distinguishing oligopoly from other market structures. Secondly, for a market to be oligopolistic there must be high barriers to entry as it distinguishes oligopoly from perfect market and monopolistic competition. Thirdly oligopolistic firms can produce products that are similar in nature or are differentiated (Clement, 2013).
Discuss two characteristics of each the market structures
Monopolistic competition market structure has got several characteristics, but in this paper we basically look at two crucial characteristics that have enormously shaped the market structure. The characteristics include existence of differentiated products whereby unlike perfect competition where the products are exclusively similar, in monopolistic competition, the products are highly differentiated. Differentiation means that though the products are substitutes of one another, they have been made to look different from that of other competing firms through different packaging and branding. Therefore for a firm to be able to sell its products they have to do a lot of advertising in order to create market awareness (Kelly, 2013).
Secondly, there is free entry and exit in the market. This is a kind of market structure that is similar to perfect market in this regard, several players both the buyers and sellers are allowed to enter and exit the market at will. When a firm is making supernormal profits other firms will be attracted to join the industry and benefit from this lucrative business and by doing so the monopolistic firms will start to realize normal profit which continues as more and more firms enter the market. When the market is saturated, the firms will start to realize loses hence other firms will start to exit the market until the firms that remain start realizing normal profits (Levy, 2011).
In Oligopoly there are few large firms in the industry and this is one of the most important characteristic of this market structure. The industry deals in products that are difficult to differentiate and the activities of one firm affect the other firm. The firms are few that the information pertaining one firm is known by the other. The prices of the goods are determined by the firm yet an increase or decrease of the prices by a firm is countered by similar reaction by the competitor, therefore it is worthless to increase or reduce prices in order to raise revenue.
Secondly, there are high barriers to entry for other firms to enter the industry; they have to face the several barriers that are created by the other players in the industry. Such barriers include legal barriers, legislative barriers and economic barriers. Legal barriers include the patents and the copyrights yet legislative barriers are attached to state corporations that are created by acts of parliament. On the other hand economic barrier are created by the large amounts of capital required to start the business (Kelly, 2013).
Based on the characteristics of the oligopoly, the industry is very conducive for technical advancements. The oligopolists can use their large sizes and economic profits, to carry out innovations. This situation can be enhanced by the existence of many market barriers that control new entries. Investment in research and development promote oligopolists’ grip in the market.
In Monopoly, there is existence of a Single firm in the industry. In this market structure, the firm is also the industry. There is only one producer who serves several consumers. The firm being the only producers they make supernormal profits in the long run. The firm enjoys monopoly due to the several barriers that exist either due to economic reasons or legal reasons. There is also the determination of the price. Here, the firm determines the market prices but for a firm to sell an extra unit of the product the firm has to reduce the prices and attract more buyers. The prices do not change due to the market forces of demand and supply but if the prices go high the buyers usually panic and avoid purchasing the goods (Levy, 2011).
In Perfect competition, there are several buyers and sellers. This is due to the free entry and exit in the market. The activities of individual buyers and sellers do not affect the market, the price of goods and services are determined by the market forces of demand and supply. There is also existence of non-differentiated goods. In perfect market, the goods and services are similar and are not different from the competitor’s product. The goods are direct substitute of one another and for one to sell an extra unit more than the competitor; they have to establish a customer base of loyal buyers.
In analyzing the demand features of perfect market, focus is made on the demand curve behaviors. The demand curve in the industry, for the individual firms is perfectly elastic. That is, the demand curve is exhibited as a horizontal curve at price. However, for the industry, demand curve does not shoe perfect elasticity feature since all firms are price takers. With the constant prices, increases in the Total revenues due to production of an extra unit would be equal to the industry price. This makes P=MR.
Identify one real life example of market structure
In a Perfect Market an example of the firm that belongs to this category is the aviation industry where there exists different airline companies like the British airways, Qatar airways, emirates airline, jet airways, virgin blue airlines , air Canada and the air china are the major examples in the aviation industry that help illustrate a situation where there are different players in the market and at the same time there are many users of the various services provided in the industry.(Mudida, 2013).
In Monopolistic Competition, an example of firm in this market structure is the Mc Donald’s food stores. They belong under this category of market since they sell highly differentiated food products to a market with several buyers and sellers. The fact that Mc Donald’s can dictate the prices in which they can sell their products without affecting the demand for their goods puts them under the monopolistic market.
An example of firm that falls under the Oligopoly market structure is the British Petroleum company. It trades in the market with few players and competitors such as the shell BP and Kenol/Kobil. They change prices depending on the prices of the other and sometimes they can even form a merger (Mudida, 2013). In Monopoly, an example of a company under the monopoly market is the cable company in India that faces no competition and is characterized by poor quality and poor service delivery to Indian citizens. This is due to its monopolistic nature as compared to the perfect market scenario where it would be challenged to offer better service. (Levy, 2011).
Clement, D. (2013). Introduction to economics, New York NY, McGraw Hill
Hastings, E. (2012). Advanced Micro economics, London, Sage
Kelly, G. (2013). Economics and its modern perspectives, New York NY, McGraw Hill
Levy, S. (2011). Economic Theory and Practice, New Jersey, Prentice Hall
Mudida, G. (2013). Modern Economics, Nairobi, Strathmore University Press