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Table of Contents
Chapter 1 2 2.1 2.2 2.3 2.4 2.5 2.6 3 3.1 3.2 3.3 3.4 4 4.1 4.2 4.3 4.4 4.5 5 5.1 5.2 5.3 5.5 5.6 6 7 Introduction Monopoly Market Features of Monopoly Reasons Demand and Revenue Short run production Advantages of Monopoly Disadvantages of Monopoly Oligopoly Features of Oligopoly Behavior of oligopoly Advantages of Oligopoly Disadvantages of Oligopoly Perfect Competition Characteristics of Perfect Competition Demand and revenue Advantages of Perfect Competition disadvantages of Perfect Competition Short Run production Monopolistic Competition Characteristics Of Monopolistic market Demand and Revenue Advantages of Monopolistic Market structure Disadvantages of Monopolistic Market Short-Run Production Comparison of market structure Conclusion Topic Page 1 1 2 3 4 5 6 7 8 8 10 11 11 12 13 14 15 16 16 18 18 20 21 21 22 23 24
1. Introduction
Market structure is the manner in which markets or industries are organized, based largely on the number of participants in the market or industry and the extent of market control of each participant. The structure of a market primarily depends on the number of firms operating in the market. In Economics there are four general market structures. They are: 1. Monopoly 2. Oligopoly 3. Monopolistic Competition & 4. Perfect Competition These types of market structured are described below:
2. Monopoly Market
A monopoly is a market structure in which there is only one producer/seller for a product. In other words, the single business is the industry. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers against entry into a monopolistic industry is that oftentimes, one entity has the exclusive rights to a natural resource. For example, in Saudi Arabia the government has sole control over the oil industry. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market. Monopoly power is an example of market breakdown that occurs when the member has the ability to control the price or other outcomes in a particular market.
position held and exhibit of illegal and abusive behavior. This is, however, milder in the case of a government- granted monopoly. Such a legal monopoly is offered as an incentive to a risky, domestic venture. Predatory Pricing: This feature of monopoly benefits the consumers. These are short term market gains when prices drop to meet scarce demand for the product. The suppliers and direct consumers benefit from the monopolizing company's attempt to increase sale for business marketing. This kind of pricing also helps the government to step in and address any unregulated monopoly. If the predatory pricing is not managed efficiently, the monopoly environment could be split. Price Elasticity: With regards to the demand of the prod uct or service offered by the monopolizing company or individual, the price elasticity to absolute value ratio is dictated by price increase and market demand. It is not uncommon to see surplus and/or a loss categorized as 'dead-weight' within a monopoly. The latter refers to gain that evades both, the consumer and the monopolist. Lack of Innovation: On account of absolute market control, monopolies display a tendency to lose efficiency over a period of time. With a one-product-shelf- life, innovative designing and marketing techniques take a back seat. Lack of Competition: When the market is designed to serve a monopoly, the lack of business competition or the absence of viable goods and products shrinks the scope for 'perfect competition'. Monopoly Litigation: Lack of competition does not eliminate consumer dissatisfaction. High market share results in consumers defying increased prices and welcome new entrants to the seller's market. Competition law dictates are designed to pronounce a monopoly illegal, if found to be abusing market power via practices of exclusionary nature. The law addresses abusive conduct in the form of product tying, supply cuts, price discrimination and exploitative deals.
2.3 Reasons
Monopolies achieve their single-seller status for three interrelated reasons: i. economies of scale, ii. government decree, iii. And resource ownership. While a monopoly can emerge and persist for any one of these reasons, most monopolies rely on two or all three.
Market Structure Analysis
Economies of Scale: Many real world monopolies emerge due to economies of scale and decreasing average cost. If average cost decreases over the entire range of demand, then a single seller can provide the good at lower per unit cost and more efficiently than multiple sellers. This often leads to what is termed a natural monopoly. The market might start with more than one seller, but it naturally ends up with a single seller that can best take advantage of decreasing average cost. Many public utilities (such as electricity distribution, natural gas dis tribution, garbage collection) have this natural monopoly inclination. Government Decree: The monopoly status of a firm can be established by the mandate of government. Government simply gives one and only one firm the legal authority to supply a particular good. Such single seller legal status is usually justified on economic grounds, such as an electric company that naturally tends to monopolize a market. However, it might also result from political forces, such as mandating monopoly status to a firm controlled by a campaign donor or close political associate. Resource Ownership: A monopoly is likely to arise if a firm has complete control over a key input or resource used in production. If the firm controls the input, then it controls the output. Monopolies have arisen over the years due to control over material resources (petroleum and bauxite ore), labor resources (talented entertainers and skilled athletes), or information resources (patents and copyrights).
For this reason, the marginal revenue generated from selling extra output is less than price. While the price of the second unit sold is $9.50, the marginal revenue generated by selling the second unit is only $9. While the $9.50 price means the monopoly gains $9.50 from selling the second unit, it loses $0.50 due to the lower price on the first unit ($10 to $9.50). The net gain in revenue, that is marginal revenue, is thus only $9 (= $9.50 - $0.50).
Charge higher prices to suppliers: Monopolies may use their supernormal profits to charge higher prices to suppliers. Unequal distribution of income: The high profits of monopolists may be considered by many as unfair. The scale of this problem depends upon the size of the monopoly and the degree of its power. The monopoly profits of a village store may seem of little consequence when compared to that of a giant national or international company. Other disadvantages are: exploitation of consumers restriction of consumers choice Exploitation of labor i.e. when price is greater than marginal cost.
3. Oligopoly
When the whole market structure of several firms controls the major share of market sales, then the resulting structure is referred as Oligopoly. Oligopoly is a market structure characterized by a small number of relatively large firms that dominate an industry. The market can be dominated by as few as two firms or as many as twenty, and still be considered oligopoly. Because an oligopolistic firm is relatively large compared to the overall market, it has a substantial degree of market control. It does not have the total control over the supply side as exhibited by monopoly, but its capital is significantly greater than that of a monopolistically competitive firm. Relative size and extent of market control means that interdependence among firms in an industry is a key feature of oligopoly. The actions of one firm depend on and influence the actions of another. Such interdependence creates a number of interesting economic issues. One is the tendency for competing oligopolistic firms to turn into cooperating oligopolistic firms. When they do, inefficiency worsens, and they tend to come under the scrutiny of government. Alternatively, oligopolistic firms tend to be a prime source of innovations, innovations that promote technological advances and economic growth.
case, advertising and marketing is the major feature of competition in case of such markets and so, there is also no obstruction to other entries. The four most important characteristics of oligopoly are:
Small Number of Large Firms: An oligopolistic industry is dominated by a small number of large firms, each of which is relatively large compared to the overall size of the market. This generates substantial market control, the extent of market control depending on the number and size of the firms.
Identical or Differentiated Products: Some oligopolistic industries produce identical products, while others produce differentiated products. Identical produc t oligopolies tend to process raw materials or intermediate goods that are used as inputs by other industries. Notable examples are petroleum, steel, and aluminum. Differentiated product oligopolies tend to focus on consumer goods that satisfy the wide variety of consumer wants and needs. A few examples of differentiated oligopolistic industries include automobiles, household detergents, and computers.
Barriers to Entry: Firms in a oligopolistic industry attain and retain market control through barriers to entry. The most common barriers to entry include patents, resource ownership, government franchises, start-up cost, brand name recognition, and decreasing average cost. Each of these makes it extremely difficult, if not impossible, for potential firms to enter an industry.
Inter-dependence of firms: Another important feature of an oligopoly is the dependence between two firms. This is nothing but, that each firm should always take into account the possible reactions of other firms in the market when they are making pricing and investment decisions. This may generate improbability in such markets. The behavior of firms in perfect case, in monopoly concept can be treated as a simple optimization. Some other characteristics of Oligopoly are: Some of the firms are selling product with similarity. The production of each firms branded products. To make the barriers to enter into the market in the long run that allows firms to make supernormal profits. High Barriers to entry Goods could be homogeneous or highly differentiated Branding or Brand loyalty may be a potent source of competitive advantages
3.2 Behavior
Although oligopolistic industries tend to be diverse, they also tend to exhibit several behavioral tendencies: Interdependence: Each oligopolistic firm keeps a close eye on the activities of other firms in the industry. Decisions made by one firm invariably affect others and are invariably affected by others. Competition among interdependent oligopoly firms is comparable to a game or an athletic contest. One team's success depends not only on its own actions but on the actions of its competitor. Oligopolistic firms engage in competition among the few. Rigid Prices: Many oligopolistic industries (not all, but many) tend to keep prices relatively constant, preferring to compete in ways that do not involve changing the price. The prime reason for rigid prices is that competitors are likely to match price decreases, but not price increases. As such, a firm has little to gain from changing prices. Non price Competition: Because oligopolistic firms have little to gain through price competition, they generally rely on non price methods of competition. Three of the more common methods of non price competition are: i. ii. iii. Advertising, Product differentiation, and Barriers to entry.
The goal for most oligopolistic firms is to attract buyers and increase market share, while holding the line on price. Mergers: Oligopolistic firms perpetually balance competition against cooperation. One way to pursue cooperation is through merger--legally combining two separate firms into a single firm. Because oligopolistic industries have a small number of firms, the incentive to merge is quite high. Doing so then gives the resulting firm greater market control. Collusion: Another common method of cooperation is through collusion--two or more firms that secretly agree to control prices, production, or other aspects of the market. When done right, collusion means that the firms behave as if they are one firm, a monopoly. As such they can set a monopoly price, produce a monopoly quantity, and allocate resources as inefficiently as a monopoly. A formal method of collusion, usually found among international produces is a cartel.
microeconomic goal of equity. While the concentration of wealth is not bad unto itself, such wealth can then be used (or abused) to exert influence over the economy, the political system, and society, which might not be beneficial for society as a whole. The other disadvantages of the oligopoly are: Firms have extensive amounts of power and may even collude to set prices, which is illegal. For the consumer this means high prices accompanied by the possibility of a low quality product. It could be argued that it ends up being a less competitive market as smaller firms find it impossible to compete with these brands established firms. less innovation and hiring because competition is limited
4. Perfect Competition:
Market for a homogeneous product in which there are many producers and consumers, none of which are large enough to have any individual effect upon the market on their own. In theory such a market produces the largest output at the lowest price. There are few, if any, real- world markets of this nature; probably the closest is markets for farm products. An ideal market structure characterized by a large number of small firms, identical products sold by all firms, freedom of entry into and exit out of the industry, and perfect knowledge of prices and technology. This is one of four basic market structures which is pure or perfect competition. Perfect competition is an idealized market structure that is not observed in the real world. While unrealistic, it does provide an excellent benchmark that can be used to analyze real world market structures. In particular, perfect competition efficiently allocates resources. Perfect competition a market structure characterized by a large number of firms so small relative to the overall size of the market, such that no single firm can affect the market price or quantity exchanged. Perfectly competitive firms are price takers. They set a production level based on the price determined in the market. If the market price changes, then the firm re-evaluates its production decision. This means that the short-run marginal cost curve of the firm is its short-run supply curve. Examples: If a bakery set the market price for bread is tk10, charging more of that of other bakeries of that area than no one will buy bread from that bakery as the customers can buy bread at a cheaper rate. This policy is applicable for agricultural products like wheat, rice, potato and spices for many fruit and flower market.
Free entry and exit: There are no legal, technological, financial, or other obstacles that prevent firms from entering or leaving a competitive market. It is easy for firms to enter or exit the industry. This is only possible in a purely competitive market because firms in this type of market are "price takers," and the number of firms does not affect the price of a product. Perfectly elastic demand: A perfectly elastic demand means that the firm can produce as much as they want at that price and it will still be sold. Purchasers will be willing to buy any quantity at that price. In this market structure perfectly elastic demand is seen.
Demand Curve, Perfect Competition Each firm in a perfectly competitive market is a price taker and can sell all of the output that it wants at the going market price, in this case tk2.5. A firm is able to do this because it is a relatively small part of the market and its output is identical to that of every other firm. As a price taker, the firm has no ability to charge a higher price and no reason to charge a lower one. Because it can sell all of the output it wants at the going market price, it has no reason to charge less. If it tries to charge more than the going market price, then buyers can simply buy output from any of the large number of perfect substitutes produced by other firms.
Because the price facing a perfectly competitive firm is unrelated to the quantity of output produced and sold, this price is also equal to the marginal revenue and average revenue generated by the firm. If a firm is able to sell any quantity of output for tk250 each, then the average revenue, revenue per unit sold, is also tk2.5 Moreover, each additiona l unit of output sold, marginal revenue, generates an extra tk2.5.
line. The curved red line is total cost. The shape of the total cost curve is based on increasing then decreasing marginal returns. The difference between total revenue and total cost is profit, which is illustrated by the lower panel as the brown line.
A firm maximizes profit by selecting the quantity of output that generates the greatest gap between the total revenue line and the total cost line in the upper panel or at the peak of the profit curve in the lower panel. In this example, the profit maximizing output quantity is 7. A ny other level of production generates less profit.
5. Monopolistic Competition:
Monopolistic competition is a market structure characterized by a large number of relatively small firms. While the goods produced by the firms in the industry are similar, s light differences often exist. As such, firms operating in monopolistic competition are extremely competitive but each has a small degree of market control. In effect, monopolistic competition is something of a hybrid between perfect competition and monopoly. Comparable to perfect competition, monopolistic competition contains a large number of extremely competitive firms. However, comparable to monopoly, each firm has market control and faces a negatively-sloped demand curve. The real world is widely populated by monopolistic competition. Perhaps half of the economy's total production comes from monopolistically competitive firms. The best examples of monopolistic competition come from retail trade, including restaurants, clothing stores, and convenience stores. Monopolistic Competitive Industries: Shoes -Nike, Addidas, Reebok Jewelry Asphalt paving Signs Bottled water ice cream- Breyers, Tom & Jerry Mobile Phone- Nokia, Samsung, Sony Ericcson
might only be perceived different by the buyers. Whatever the reason, buyers treat the goods as similar, but different. Relative Resource Mobility: Monopolistically competitive firms are relatively free to enter and exit an industry. There might be a few restrictions, but not many. These firms are not "perfectly" mobile as with perfect competition, but they are largely unrestricted by government rules and regulations, start-up cost, or other substantial barriers to entry. Extensive Knowledge: In monopolistic competition, buyers do not know everything, but they have relatively complete information about alternative prices. They also have relatively complete information about product differences, brand names, etc. Each seller also has relatively complete information about production techniques and the prices charged by their competitors. Price maker: A monopolistically competitive firm is a price maker, with some degree of control over price. Once again, unlike perfect competition, a monopolistically competitive firm has the ability to raise or lower the price a little, not much, but a little. And like monopoly, the price received by a monopolistically competitive firm which is also the firm's average revenue is greater than its marginal revenue. Product Differentiation: The goods produced by firms operating in a monopolistically competitive market are subject to product differentiation. The goods are essentially the same, but they have slight differences. Product differentiation is usually achieved in one of three ways: physical differences, perceived differences, and Support services.
Physical Differences: In some cases the product of one firm is physically different form the product of other firms. One good is chocolate, the other is vanilla. One good uses plastic, the other aluminum. Perceived Differences: In other cases goods are only perceived to be different by the buyers, even though no physical differences exist. Such differences are often created by brand names, where the only difference is the packaging. Support Services: In still other cases, products that are physically identical and perceived to be identical are differentiated by support services. Even though the products purchased are identical, one retail store might offer "service with a smile," while another provides express checkout. Product differentiation is the primary reason that each firm operating in a monopolistically competitive market is able to create a little monopoly all to itself.
Market Structure Analysis
Advertising: A unique feature of a monopolistic competitive market is that there are product differentiations. Therefore, companies rely on advertising to flaunt their products and try to get consumers to buy their product over another.
Demand Curve, Monopolistic Competition Each firm in a monopolistically competitive market can sell a wide range of output within a relatively narrow range of prices. Demand is relatively elastic in monopolistic competition because each firm faces competition from a large number of very, very close substitutes. However, demand is not perfectly elastic (as in perfect competition) because the output of each firm is slightly different from that of other firms. Monopolistically competitive goods are close substitutes, but not perfect substitutes.
Short-Run Production, Monopolistic Competition A firm maximizes profit by selecting the quantity of output that generates the greatest gap between the total revenue line and the total cost line in the upper panel or at the peak of the profit curve in the lower panel. In this example, the profit maximizing output quantity is 6. Any other level of production generates less profit.
Market Structure Analysis
Type of product
Products could be highly differentiated branding or homogenous High barriers to entry In Oligopoly sellers are price maker
Products differentiated
Profit maximization
Free entry and exit to industry Large number of buyers and sellers no individual seller can influence price. Sellers are price takers have to accept the market price Always
Relatively free entry and exit Firm has some control over price
Not always
Not always
Usually, but not always In monopoly economic efficiency is Low Potentially strong
Economic efficiency
Innovative behavior
7. Conclusion:
The graphs and models can be used as a comparison of structures. When looking at real world examples, focus on the behaviour of the firm in relation to what the model predicts would happen that gives the basis for analysis and evaluation of the real world situation. Regulation or the threat of regulation may well affect the way a firm behaves. Remember that these models are based on certain assumptions in the real world some of these assumptions may not be valid, this allows us to draw comparisons and contrasts. The way that governments deal with firms may be based on a general assumption that more competition is better than less.