Maximizing Profits in Market Structures

Maximizing Profits in Market Structures Charlotte Scheese Principles of Economics February 11, 2012 Nicholas Kuzmich Axia College of University of Phoenix

Maximizing Profits in Market Structures Competitive markets, monopolies, and oligopolies all play their own roles in an economy by providing goods or services to the people who need them Economic freedom, competition, limited government, economic incentives, and private ownership are characteristics of a competitive market structure. Economic freedom gives people the freedom to make choices as to what

products to produce, what services to offer, and which of these to purchase. According to businessdictionary.com (2012), economic freedom is defined as the freedom to prosper without intervention from government or economic authority. It is the freedom to secure and protect resources, labor, and private property. In a competitive market businesses are trying to maximize profits. Profit equals total revenue minus total cost. Marginal revenue is the revenue realized with each unit of additional output. Marginal cost is an increase or decrease in costs associate with an increase or decrease of each unit of output. When marginal revenue is greater than marginal cost, a company should increase output until marginal revenue and marginal cost are equal. When marginal cost is greater than marginal revenue, a company should decrease output until marginal cost and marginal revenue are equal. When marginal cost and marginal revenue are equal, output levels are maximizing profit. In a competitive market there are few if any barriers. Because there can be an unlimited number of producers and consumers, the demand curve is elastic. If one producer raises prices, consumers can find a producer that offers a lower price for a pretty much identical item. A competitive market does not allow any one buyer or seller to control the market or price. This forces sellers to charge only a minimum price or buyers will turn to the

Maximizing Profits in Market Structures competition. A competitive market helps the economy because there are many buyers and sellers. People buy products, producers output products and pay wages, people buy more products. Unlike competitive markets that have many sellers, a monopoly is the single provider of a good or service with no substitutes readily available. Monopolies exist because of barriers to entry. Other companies cannot easily enter the market and provide the good.

Barriers to entry come in three main categories: a single owner of a key resource bars entry, government policy allowing for a single provider of a good or service bars entry, or a single producer is more cost efficient than multiple producers. Resource monopolies, such as suppliers of water and natural gas, rarely exist. Consumers can dig wells to provide a water source or purchase natural gas from someone other than a local provider. Technological or economical barriers to entry that raise the cost to enter the market over the costs of an existing provider make entry difficult. With no competition, the seller can set the price and output of the product or service. Because some monopolies hurt consumers, the government often breaks them up. When it is in the best interest of the public and for public good the government can create a monopoly. One example from the text book and other readings is pharmaceutical companies. These companies are allowed by the government to patent their products. This allows the company to charge what it wants for the product (which is usually high). High prices paid by consumers often fund research which aids in the creation of products that benefit the company.

Maximizing Profits in Market Structures The government does not always encourage entrants to monopolies, however. Such is the case with distribution of electricity. Multiple power lines would increase overall costs which make a natural monopoly make more sense. When one company can provide a good or service to an entire market at a lower cost than multiple providers, a natural monopoly exists. A resource monopoly can be a natural monopoly as in the example of a water company. If consumers are not able to dig wells that supply water it must be purchased from a water company. For the market to become competitive, other companies would have to set up a network of pipes to supply the water making costs rise. In the case of a water company, the price is lower when one company supplies to the market.

Since a monopoly is the sole provider of a good or service it can change price by changing output. A monopolist cannot be sure what consumers are willing to pay for a good or service so it must experiment to find the price where marginal cost and marginal revenue are equal and output levels maximize profit. A monopoly then uses the demand curve to fix the price of the good or service. Monopolies are generally bad for the economy since the lack of competition restricts fair trade. This allows the market to set the price of the good or service. Monopolies also accumulate massive amounts of money that allow them to become dominant in an economy. In turn, this allows a monopoly to glean political support which it uses for the good of the monopoly and not the economy or society. A third market structure that falls between competitive markets and monopolies is an oligopoly. Oligopoly comes from two Greek words: Olegs which means a few and

Maximizing Profits in Market Structures Pollen which means to sell thus. Oligopolies supply goods that are close substitutes of each other. An oligopoly has six essential characteristics; interdependence, importance of advertising and selling, group behavior, interdeterminateness of demand curves, elements of monopoly, and price rigidity. Oligopolies are interdependent because changes in price and product affect competition. A company must take into account market demand and the reaction of other companies that supply to the market. Money spent on advertising and selling goods is very important in an oligopoly. An oligopolistic company engages in aggressive and defensive marketing sales. Therefore, a good deal of resources are used on advertising and promoting the good. Group behavior in an oligopoly is unpredictable since the companies in an oligopoly may not have the same objectives. Also, the group may have a dominate leader. Since the quantity that will be sold is uncertain the demand curve is uncertain. No one company knows the effect of its price-output. There is no guarantee that competitors will keep their price unchanged if one company makes changes in its own price. There is some element of monopoly in oligopoly. In an oligopoly there is some

difference in product that allows it to control a part of the market. In this case price and output can allow it to act as a monopoly.

Maximizing Profits in Market Structures Prices in an oligopoly tend to be rigid. If one company cuts prices, the

competition generally follow suit resulting in price-war conditions. Hence, one company will not make price cuts without discussing price-output with other firms. In oligopolies companies use non-price competition to increase revenue and market share. This lets a profit maximizing producer to set marginal costs to equal marginal revenue. A change in marginal costs or marginal revenue is reflected in new price and/or quantity sold. Oligopolies have high barriers to entry. Since they tend to offer specialized products, costs for location or specialized machinery may be very high. Oligopolies dominate the economic landscape supplying about half of all the output. They do not have total control as with monopolies, but do enjoy a large degree of market control. Oligopolies tend to be innovative and promote economic growth. The success or failure of any company in any market relies heavily on supply and demand. Knowing how to maximize profits to stay in business is important to any company. Profitable, growing companies are the backbone of a healthy economy.

Maximizing Profits in Market Structures References http://www.businessdictionary.com http://www.enotes.com http://www.investopedia.com http://www.preservearticles.com