The term “market structures” describes how the industries in a locality, region or country are organized. It is of four types – perfect competition, oligopoly, monopolistic competition and monopoly (O’Connor, 2004). They are differentiated by the number of players or firms involved, the kind of products, the barriers to entry or exit, power of the market and the amount of intervention from theside of the government.
It is that condition under which there are many firms (thousands) producing a standardized or homogenous product. There are a number of buyers and sellers. The barriers to entry in this market structure are low to non-existent and hence, firms can easily enter or exit the market. Since all the firms are perfectly competitive, they do not wield any market power. Thus, all these firms are price takers i.e. it is not possible for them to sell above the market price of the product (O’Connor, 2004). The price of output is therefore decided by the forces that determine demand and supply for the entire market.
In a perfectly competitive market there is negligible intervention of the government as there is no risk of firms engaging in anticompetitive practices such as restricting output or raising prices through conspiracy. There is no advertising in a perfectly competitive market as the product and price are homogenous. An example of perfectly competitive industries in the U.S. economy is that of the agriculture industries such as that of corn or wheat. There are several firms in these industries, which produce the standardized corn or wheat for the domestic as well as international markets.
Example Of Perfect Competition
At the local level, an example of perfect competition would be the weekend flee market. The market has a large number of sellers of the same products and also a large number of buyers. The prices are therefore very competitive and nothing is sold above a certain fixed price in the market. The prices may however be lower than this fixed upper limit due to competition. Neither is there any advertising used for the local flee market nor are the prices or products governed by the government regulations. This is because the products are homogenous and there are no brand loyalties providing any sort of market power to the players.
It is that market structure in which several firms (say up to 100) producing differentiated products, exist. The products are only somewhat differentiated and are largely similar. Firms can easily enter or exit these markets as the barriers to entry are low. There is intense competition among the firms. However, they maintain price differentiation based on product differentiation (O’Connor, 2004). Local advertising is utilized to create differentiation in customer mind and thus, demand the price they want. It is also used to create brand loyalty whereby firms in a monopolistic competitive market have some market power to govern their own prices.
However, the price difference between products is not very high as the competition is intense. Due to high competition and lesser chance of manipulation of prices by competitors, the level of government intervention in such a market is very low (O’Connor, 2004). This kind of market structure in the U.S. economy can be observed in the fast food industry. Several fast-food joints serve foods like pizzas, burgers, sandwiches, etc. which are basically very similar and yet each joint provides their own twist to the recipe, thereby differentiating it from the others and charging their own price.
Example of Monopolistic Competition
The FMCG market e.g. bread, butter, packaged milk, toothpaste etc. is an example of monopolistic competition at the local level. Though most big players are national level brands, there are often very popular local brands for such goods. These brands have association with the local populace and appeal to their choices. If we take the example of bread, all bread produced by the different players is almost the same. Different brands try to promote different health nutrients and thus price bread differently. People have a certain association with certain brands and that decides their preference. The prices, however, do not vary greatly and mostly all types of bread are available in similar price range (except certain exotic varients). There is little government intervention except for the food quality check in this case.
This is the kind of market structure where a few firms are the largest and key players of the industry. Mostly economists define an oligopoly as the market structure where about 4 to 5 firms constitute 40-50% of the market share. Two kinds of oligopolies exist – pure and differentiated (O’Connor, 2004). In a pure oligopoly, many firms produce a homogenous product. For example, in the U.S. economy, most industrial goods companies such as those manufacturing steel and aluminium operate in oligopolies. U.S. Steel, LTV and Bethlehem Steel are the top steel companies in the U.S. In a differentiated oligopoly, firms manufacture almost similar product with some differentiation. The automotive industry is an example of a differentiated oligopoly in the U.S. Ford Motor, General Motor and Chrysler are the top players of the automotive industry in the U.S. All produce automobiles which are differentiated by the make and model.
An oligopoly is characterized by high barriers to entry which include high entry costs for capital, R&D costs and costs for advertising nationally. Moreover, oligopolies have greater brand loyalties associated with the major players and this acts as another barrier to entry. The key players thus wield greater market power and control their pricing decisions. However, the price changes are interdependent and a price change by one firm impacts a change in price by the others. Overall, the competition is non-price and is based on advertising, product differentiation and loyalty benefits.
Another characteristic of oligopolies is price leadership, a major player decides the price change through a legal pricing strategy and the other firms follow in the footsteps. A possible drawback of major oligopolists, however, is collusion. There is a high possibility at all times of oligopolists to indulge in anticompetitive practices through collusion by fixing prices and dividing market share. Such practices create a false barrier to entry for new entrants. Thus, governments closely monitor oligopolies to prevent such unfair trade practices. Federal Trade Commission in the U.S., for example, protects general public interest by monitoring oligopolies for collusion and other malpractices.
Example of Oligopoly
At the local level, a few major mobile service operators have the major market share. These are companies like Verizon Wireless, Sprint Nextel, T-Mobile and AT & T Mobility. They control almost 80-90 per cent of the mobile service market. The competition among these companies is mostly non-price and is based on product differentiation, reward schemes for loyal customers and advertising. The government intervenes to keep the mobile service prices under check through the Federal Communications Commission (FCC) and The Wireless Association (CTIA).
This is the type of market structure which is dominated one major player who accounts for almost 80 to 90 per cent of the market share (O’Connor, 2004). The product of a monopolist firm does not have a close substitute. The barriers to entry in such a market are very high. These include high entry cost of capital expenditure, high R&D costs and costs associated with patented technology as well as economies of scale.
Since there is one major producer of goods in a monopoly, the government usually restricts the market power wielded by the producer. This is because there is no competition which can restrict the price and profits of a monopolist. There are government regulations for the pricing, quality and availability of product which bind a monopolist and keep its practices under check. There are four different kinds of monopolies viz. natural, geographic, government and technological.
Example of Monopoly
At the local level, we can observe government monopoly in the water treatment and provision as well as in sewerage services. These are basic services required by the community at the mass level and to provide these services at affordable prices and in requisite quantities, the government takes charge. This is because it would be difficult to provide these services at the reasonable rates and quantities by small private firms. Another example could be the production of electricity or collection of trash, which are also services provided solely by the government at the local level.
Impact Of High Entry Barriers To Long-Term Profitability
Both, perfect competition and monopolistic competition are characterized by low to non-existent barriers to entry. Hence, for the purpose of this discussion on the impact of high barriers to entry, only monopoly and oligopoly shall be considered. Since, for both monopoly and oligopoly, barriers to entry are high, the threat of new entrants is controlled. Short run profits for both these market structures are above those of open market structures. In the case of a monopoly, the product is offered such that the marginal revenue is equal to the marginal cost, thus maximizing profit.
In the case of an oligopoly, the pricing is set between that of a monopoly (maximized profit) and the open competition (prices lowered to the unit cost of production). Thus, both oligopoly and monopoly tend to enjoy long term abnormal profits because the high barriers to entry prevent new firms from entering. However, firms with deep pockets and those that develop a certain product differentiation, e.g. the FIOS fiber optic innovation of Verizon allowed it to enter the satellite television market, competing in the satellite and cable television market. Hence, long term profitability of oligopolies and monopolies can be termed temporary or long-term until the barriers to entry are transcended. Also, just the threat of new entrants may trigger the reduction of profitability of the oligopoly or monopoly (Heger& Kraft, 2008).
Competitive Pressures Of Markets With High Barriers To Entry
It is observed that in a monopoly there are no competitive pressures owing to the high barriers to entry and absence of other major players. Thus, a monopolist wields sufficient market power and can enjoy maximized profitability over a long period (Heger& Kraft, 2008). However, in order to curtail unusually high prices and to protect general public interest, government intervenes through regulations on product pricing, quality and quantity available in the market. Moreover, the government may threaten the monopolist (usually providers of utility goods and services) of opening up the markets; thus, keeping the prices under check.
In an oligopoly, price inter-relationship and inter-dependency is observed. Thus, competitive pressures can be observed in an oligopoly. Though there are high barriers to entry and new entrants might be restricted from entering the market, the players already competing in the market follow price leadership of the most dominant player. Thus, if the prices are altered by one of the players of an oligopoly, the other players in the market will follow suit. Hence, if prices are reduced by one player, others cannot keep their prices higher, they have to reduce prices.
Similarly, if the product offering is altered by a player, other players have to respond to the change in product offering. An example of this is the shift of mobile service providers away from providing the handset to just providing the service. This was triggered by the shift of T-Mobile from sales of handsets along with service to just service. This was because of the comparative disadvantage they would have suffered especially with respect to services specific to certain brands such as those of Apple’s iPhone. The shift meant that those customers who wanted to retain the handsets could keep them or buy handsets from any of the vendors.
Price Elasticity Of Demand And Its Effect On Pricing Of Its Products In Each Market
Price elasticity of demand refers to the price sensitivity i.e. the change in quantity demanded for a given change in price. The formula used for calculating this is as follows.
Price Elasticity of Demand = Per cent change in demand of quantity / Per cent change in price
Perfect competition is characterized by a perfectly elastic demand curve. In the above equation it would be explained by a value of price elasticity of demand greater than 1. This means that when the price of the commodity changes, there is a substantial consequent change in demand. In a perfectly competitive market no individual firm can affect the price of the market, however, the change in market price affects the overall demand and thus demand for each individual firm. Firms in a perfectly competitive market have zero economic profit in the long term.
Monopolistic competition is characterized by high elasticity of demand. Since firms in this market are price setters, prices are set such that the marginal revenue = marginal cost. In the monopolistic competition also a firm can break even only in the long term when the average total cost increases and demand decreases. This implies, like in perfect competition, in monopolistic competition also, firms generate zero economic profit in the long run.
Oligopoly is characterized by the kinked demand curve. Hence, if a firm raises its prices in an oligopoly, its demand would decrease followed by its revenues because other firms in the oligopoly will mostly not increase their prices. However, if a firm reduces its prices, other firms in the oligopoly will follow suit and adjust their prices; thus, off-setting any increase in demand. Thus, a change in price does not have a substantial change in the demand, making the demand in an oligopoly inelastic.
Monopolies are characterized by an inelastic demand. Monopolists are likely to set the prices such that the marginal revenue = marginal cost since monopolies are price setters. However, an increase in price will show a very little change in demand. Thus, no firm will be ready to produce any extra units when it involves losing money due to the inelastic demand curve (Russell & Bolton, 1988).
Role of Government in Market Structure’s Ability To Price Its Products
Mostly there is little to no government intervention in a perfect competition as the prices, quality and quantity are all regulated by the existing competition. In a monopolistic competition, there is very little government intervention due to the competitive nature of the market. However, government does apply certain regulations for monopolistic competition whereby it restricts indulgence of the firms in negotiated profits through division of supply and price setting (Stiglitz, 1989).
Oligopolies are closely monitored by government for collusion and other anticompetitive practices that create artificial barriers to entry for new firms (O’Connor, 2004). Thus, the government regulations control an oligopoly in terms of pricing as well as hording stocks. Monopolies are entirely overseen and regulated by government. This is especially since monopolies are either government provided services or such utility services that are of much value to the general public. Hence, a cap on pricing is created by the government regulations.
Effect of International Trade On Market Structure
Free international trade increases supply of goods and also offers complete substitutes to existing products. The impact of international trade is reduction in prices due to increase in supply. Governments often push international trade through subsidies for two purposes, as follows.
- To establish or increase demand in the market and
- To drive away unsubsidized producers of goods.
Perfectly competitive firms remain unperturbed by increase in number of suppliers. Since the demand curve is perfectly elastic, it means that no individual seller can change the price of the market (Arnold, 2007). The lower cost of the international goods only affects the sales of their own products and do not affect the entire market. For monopolistic competition, international trade is again not a big threat as long as product differentiation and customer loyalty are maintained. The new offering can make the cut with the loyal customers only when they see a substantially superior product.
In an oligopoly, introduction of international trade would mean introduction of players as big as or bigger than the existing players since the barriers to entry are high. As such, the new entrant would spur a reduction in prices for the oligopoly and thus reduce profits for the existing members (Bagwell &Staiger, 1994). This may likely eliminate an incompetent oligopolist. Later, once a certain level of brand loyalty is established by the new entrant (international player), the prices will again increase and this new entrant would become a member of the oligopoly.
Monopolies are faced with international trade when governments open up the markets. In this case, the barriers to entry are reduced as are the prices due to increased supply. Also, as a new entrant, most international products are offered at a cheaper price, thus providing an alternative to the buyer. Governments support the reduced price offerings to reduce the overall prices in the market and thus, spur product differentiation strategies.
Arnold, L. G. (2007). Existence of Equilibrium in Models of International Trade with Perfect or Imperfect Competition.RegensburgerDiskussionsbeiträgezurWirtschaftswissenschaft, 424.
Bagwell, K., &Staiger, R. W. (1994). The sensitivity of strategic and corrective R&D policy in oligopolistic industries.Journal of International Economics, 36(1), 133-150.
Heger, D., & Kraft, K. (2008). Barriers to Entry and Profitability.ZEW-Centre for European Economic Research Discussion Paper, 08-071.
O’Connor, D. E. (2004). The Basics of Economics. Greenwood Publishing Group.
Russell, G. J., & Bolton, R. N. (1988). Implications of market structure for elasticity structure.Journal of Marketing Research, 229-241.
Stiglitz, J. E. (1989). Markets, market failures, and development.The American Economic Review, 197-203.
You have been hired as a consultant by your local mayor to look at the various market structures. Your role is to provide analysis and answers to these important questions that will help the mayor understand the structures of many of the businesses in his city: Describe each market structure discussed in the course (perfect competition, monopolistic competition, oligopoly, and monopoly) and discuss two of the market characteristics of each market structure. Identify one real-life example of a market structure in your local city and relate your example to each of the characteristics of the market. Describe how high entry barriers into a market will influence long-run profitability of the firms. Explain the competitive pressures that are present in markets with high barriers to entry. Explain the price elasticity of demand in each market structure and its effect on pricing of its products in each market. Describe how the role of the government affects each market structure’s ability to price its products. Discuss the effect of international trade on each market structure. Your paper will need to include a title page, a reference page, and in-text citations properly formatted according to the APA style guide. Also, your content should be eight to ten pages, which does not include your reference or title page. You will need to include at least five scholarly sources from the Ashford Library in your paper as part of your research to support your analysis. Writing the Final Paper The Final Paper:
Must be eight to ten double-spaced pages in length and formatted according to APA style as outlined in the approved APA style guide.
Must include a cover page that includes:
Title of paper
Course name and number
Must include an introductory paragraph with a succinct thesis statement.
Must address the topic of the paper with critical thought.
Must conclude with a restatement of the thesis and a conclusion paragraph.
Must use at least five scholarly resources from the Ashford University Library.
Must use APA style as outlined in the approved APA style guide to document all sources.
Must include, on the final page, a Reference Page that is completed according to APA style as outlined in the approved APA style guide.