Market Structures

Introduction

There exist different types of market structures. A market structure can be described as the number of firms that produce identical and homogenous goods. There are some market structures within an economy such as oligopolies, monopolies, perfect competition and monopolistic competition. The following paper discusses market structures with an in-depth analysis of the various market structures.

Oligopoly

An oligopoly is a market structure, in which the market is dominated by a few firms. In the oligopoly market structure, there are only a few firms dominating the market but there are also other smaller players within the market (Hamilton, Bontems, & Lepore, 2015). An oligopoly can be formed as the result of collusion between large market shareholders to reduce competition.

Characteristics

There are several characteristics of an oligopoly market. Among them is that an oligopoly market has no barriers to entry and exit to the market but, in the long run, there are some barriers that restrain firms from entering the market. Some of these barriers include economies of scale enjoyed by very large firms, ownership of specialized inputs necessary for production, and ownership of patent rights. Other barriers include large capital requirements as well as the unutilized capacity that makes the market look less attractive (Hamilton, Bontems, & Lepore, 2015). These barriers to entry will scare away potential investors since the market looks less lucrative. In an oligopoly market structure, firms are normally dependent on each other. Any action by a firm within the oligopoly market structure prompts a counter move by the other firms. For example, if a firm decides to undertake rigorous advertisement, other firms may opt to advertise too or make another move that would counter the effect of advertising.

The diagram above shows a kinked demand curve. It shows the rigidity of prices in an oligopoly market structure. A kinked demand curve has two parts representing a price increase that is more elastic and a price decrease that is more inelastic. If an oligopolistic firm increases its price, other smaller firms will not increase their prices. An increase in price leads to a drastic loss in the quantity demanded as buyers will buy from the cheaper sellers (Bloch, Eaton, & Rothschild, 2014). On the other hand, if an oligopolistic firm reduces its price, the other smaller firms will match the decrease. The firm will not gain market share through a reduction in market prices. This effect is represented by the two different MR curves.

Within an oligopoly market structure, collusion occurs very easily; hence, the government’s intervention is required to avoid exploitation of the public by these firms. The firms may collude to hike the price or, in turn, hoard goods so that demand may rise causing the price to rise. However, the government should not over-engage in regulation because it may kill off competition within that market. The government should also provide an environment to harbor competition. Competition can be promoted by the government offering subsidies or tax holidays to new entrants within the market. New firms will enter the market, making it more competitive and harder to collude. When there are many firms within a market structure, competition is rarely based on prices; hence, the public cannot be easily exploited.

At times, the government can employ the tactic of price control. There are two types of price control, namely a price ceiling and a price floor. A price ceiling is a regulation that limits the maximum price that can be charged on a good. A price ceiling is a maximum amount a good can be charged by a firm, it is put in place to avoid exploitation of the public. On the other hand, a price floor is a regulation that sets the minimum amount that a good can be charged at any given time. In many cases, this price floor is set to protect the producing firm if the equilibrium price is below the cost of producing a good.

Effects of Barriers to Entry on Profitability

 A new firm within the market has an uphill task of competing with already established market brands, which requires a very large capital outlay (Hamilton, Bontems, & Lepore, 2015). The oligopoly industry may experience long-run super normal profits as the result of these natural and artificial barriers. When it comes to competition in this market structure, a few firms have market power but they cannot price their goods above a certain level. Due to the kinked demand curve, an increase in price will lead to a decrease in output level sold.

Monopoly

Another form of market structure is the monopoly. A monopoly market structure has a single seller with a unique product (Braido & Shalders, 2015). This product has no close substitutes. A monopoly has no competition since it operates alone on the market. A monopoly can form due to the exclusive ownership of a scarce resource used for production. Another source of monopoly power is being granted monopoly status by the government. Purchasing a patent also leads to the monopoly power as well as copyrights and other property rights. The owners of the content being patented have monopoly power over their material. The merging of firms within the same market could lead to a monopoly since there is the elimination of competition.

Characteristics

A monopoly achieves its status by selling a unique product that has no close substitutes. A monopoly is the only supplier of the good; hence, if a buyer wants to purchase the good, he or she has to purchase it from the monopoly. A monopoly can form due to the economies of scale. In some cases, it is advisable to avoid engaging in a business venture because economies of scale can only be enjoyed when there is only one supplier. If a new party enters the market, then both firms may suffer loss. Levels of profit depend on competition within the market but, in this case, there are no competitors, and this ensures that the firms can enjoy super-normal profits in the short run and long run (Braido & Shalders, 2015).

In a monopoly, the demand curve appears to be straight but it has different levels of elasticity on it. Between point A and C, the demand curve is elastic but from point C to E, the curve is inelastic. There is the MR curve showing marginal revenue that is the extra revenue earned by selling an extra unit. Firms cannot sell beyond level C because marginal revenue will be negative, and firms cannot accept to lose money. Hence, a monopoly will operate when the demand curve is elastic.

Monopoly prices can be regulated by regulatory bodies. The regulatory bodies limit the maximum amount that can be charged for a given good or service. The government can also come up with a merger policy where firms that merge are not allowed to control more than 25% of the market share. If firms merge and they control more than 25% of the market share, they are referred to the competition commission to decide whether the merger will be allowed or turned down. International trade enables people from an economy of one country to buy goods from another economy. Within an economy, when people engage in international trade, they can buy goods provided by a monopolist within the country from outside the country or they can buy already purchased goods. The public might opt to buy the imported goods since they are cheaper than those being produced by the local firms. Monopolies suffer from international trade since the goods they produce may be produced in a different country at a lower price and brought to the local market at lower prices.

Effects of Barriers to Entry on Profitability

In a monopoly setting, there exist very high barriers to entry. A monopolist does not operate on the inelastic part of the demand curve because they will strive to reduce prices and increase output. A monopolist can increase output up to a point where MR=MC. Due to this fact, firms continue to enjoy profits while keeping competition away.

Competitive Pressure

In a monopoly, if there is a risk of potential competition, the monopolist will opt to lower prices and increase output to repel any competition. If there is no risk of competition, he will set a price that will maximize his profits.

Perfect Competition

Perfect competition is a hypothetical market, under which competition is at the highest level. Characteristics of this market are that the public and society are the main beneficiaries. In perfect competition, all the parties have complete and adequate knowledge on the market (Lennartz, 2014). In this market, risk-taking is minimal; hence, entrepreneurship is limited. Perfect knowledge of the market ensures that consumers and producers maximize utility and profit respectively. Within perfect competition, there are no barriers to entry or exit. The lack of barriers ensures there is competition within the market, making it better suited for the consumers as firms engage in price wars. Firms only enjoy enough profits to keep them in business and nothing more. If firms in perfect competition experience more than normal profits, more firms would join due to no barriers, and they would drive profits back down. In the perfect competition market structure, there is limited or no government intervention.

In the above diagram, the market demand curve is different from that of the firm. The market demand curve slopes downward while that of the firm is a straight line. The straight line is equal to the equilibrium price of the market. If a firm sells its product above the market price, it will not make any sales, and if it sells below the market price, it will make losses. Firms in perfect competition have to follow the equilibrium price.

International trade is the exchange of goods from one economy to another. Perfect competition would not be greatly affected by international trade since the prices of goods in this market is determined by the forces of demand and supply.

Effects of Barriers to Entry on Profitability

In perfect competition, barriers to entry are rare. Hence, anyone with the view of entering the market can start production. When producers are few, they can experience economic profit but as firms increase, the profit reduces because supply is increased and price reduces.

Monopolistic Competition

Monopolistic competition is a market where there are many producers selling differentiated products. The goods produced in this market are not close substitutes.

Characteristics of this market structure are that firms in this type of market do not take into consideration the prices of the goods of rival firms. Competition within this type of market is based on differentiation. Differentiation of the goods is done but not so much to eliminate the good as a substitute. The goods are supposed to perform the same functions, but differentiation is done to improve other qualities such as texture or quality. In this type of market, goods will exhibit physical differences such as the materials they use in production. For example, one firm may decide to use plastic when making its product while the other may use wood. Another way that goods are differentiated is by the brand name. Some buyers trust in some brands more than others and this comes forth as a form of differentiation. Lastly, a good may be differentiated by the type of service that comes with the purchase of the good. For example, a firm may decide to deliver goods to buyers, offer discounts on goods, or even award prizes for a certain level of sales. 

In the long run, monopolistic competition is almost the same as perfect competitive market structures (Caputo, 2014). In the monopolistic market structures, there a large number of buyers and a large number of sellers, which means that no firm has full control over the market. Firms in monopolistic competition can lower their prices without the fear of reaction from rivals in the market. Price changes in the monopolistic competition have a negligible impact on the market. Because a price change is negligible, the firm can make an independent decision without taking into consideration the reaction of other firms.

In some cases, firms are inefficient in monopolistic competition. Profit maximization normally occurs at the point where marginal cost is equal to marginal revenue (MR=MC). When the market is inefficient, the firm charges a higher price than the marginal cost at the optimum output. At the point where (MR=MC), which is when a firm maximizes its profit, there is a likelihood of it losing part of market share due to an increase in the price of its good. Another source of inefficiency is that firms in monopolistic competition operate at a point where there is excess capacity. Excess capacity implies that the profit maximizing output is at a level that is less than the level of output associated with minimum average cost. In this monopolistic competition, buyers do not have complete knowledge of all the aspects of the goods available in this market but they do have extensive knowledge of the prices of other goods. Firms in a monopolistic competition have complete knowledge of the techniques of production as well as the pricing of goods by other rivals.

There are limited barriers in this type of market structure, and this makes it easier for firms to enter the market. When the number of firms increases, the range of products increases and as a result, profitability goes down (Caputo, 2014). Profitability goes down because the firms fight for the same number of buyers whereas the products have increased. Monopolistic competition firms have some form of market power, and this happens because a firm can raise its prices without it and still make sales.

In monopolistic competition, demand is relatively elastic because goods are relatively close substitutes. The diagram shows that the range of prices within this market is limited. The range of prices is limited because a large increase in price would mean a huge loss in the number of buyers because the demand is elastic.

Effects of Barriers to Entry on Profitability

In the short run, firms in the monopolistic competition may enjoy supernormal profits. However, there are low barriers in this type of market. Hence, new firms can enter the market. When new firms enter the market, the profitability reduces.

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Real-Life Example of a Market Structure

For a long time, the casino strip in Las Vegas has acted as a monopoly within the market. In the past, gambling had not been embraced and it was seen as a vice in society. The public have come to accept gambling in the wake of the new century, seeing that it could pay bills as well as clear other bills such as school fees. Other casinos have been put up in other states, but Las Vegas remains the main gambling state. The gambling strip in Las Vegas acts as an oligopoly in the sense that it controls a large market share of the gambling trade. Entry into the gambling and entertainment industry requires a very large capital outlay, and this quantifies the Las Vegas strip as an oligopoly. Casinos on this strip have been constructed in such a way that they have a huge space, usually twice the normal size and this makes them enjoy economies of scale. These casinos also have a variety of facilities that make it more attractive to the public. The Las Vegas strip acts as an oligopoly since some of the casinos have already merged to control more of the market.

Conclusion

This paper has shown that there are four distinct market structures. They are oligopoly, monopoly, perfect competition, and monopolistic competition. An oligopoly is a case in which one firm controls the majority of the market share of its market. There are limited barriers to entry and government regulation is present. In the case of a monopoly, there is only one seller and many buyers. Here, the monopolist sets his or her price since there is no competition. A monopoly lacks competition because there are very many barriers to entry to the market. One of the barriers includes a large initial capital layout. In monopoly market structure, the government has to intervene to ensure that the public are not exploited by these firms. Monopolies normally experience supernormal profits in the long run. The other market structure is the monopolistic competition where firms in the industry engage in the differentiation of their goods to find an edge to compete. There are very few barriers to the entry of firms into this kind of market structure. Firms in this market structure do not experience supernormal profits. In monopolistic competition, firms have their specific market share. Lastly, there is the perfect competition where all the firms sell similar products. In this market structure, there are no barriers at all to entry or exit. The government only regulates the environment but does not regulate price because the forces of demand and supply take care of that. In perfect competition, firms earn profits just enough to keep the firm in operation.