In order to come up with effective and efficient strategies, it is important to understand the dynamics of different market structures. Different market structures have different characteristics and features and operate differently. In this report, an attempt has been made to understand the different market structures and comments have been made on the different features and characteristics of these market structures.
A market is a group of individuals, firms and economic agents, who have interaction with each other as a buyer and seller. In economics market structures are defined into four main types, and that are perfect competition, monopolistic competition, monopoly, and oligopoly. Each market’s characteristics differ from other. Each market has a different number of sellers, barriers to entry, types of products, types of non-price competition, and power to affect the price (Arnold, 2008).
Perfect competition is consistently used by many organizations as a benchmark for the purpose of comparison in term of efficiency, output, price and profitability. But in economic sense this is not perfect essentially. In such market structure firms are price takers and all products are sold at same price throughout the country. There are five major characteristics of perfect competition (Arnold, 2008).
- Buyers and sellers:
The main characteristic of the structure is that it has many buyers and sellers. Both of them – buyer and seller – are responsible for doing some buying and selling of total output. The purpose of this buying and selling of the small portion is that nobody is capable of having any control over the price of the market.
- Products are standardized or homogeneous:
All firms must be manufacturing indistinguishable products, and the example is skimmed milk.
- No barriers to entry:
There is free entry and free exit in the market which shows that there are no barriers for new entrants. Due to the no barrier characteristic old firms have a benefit over the new one.
- Perfect understanding:
Firms and consumers of the firms’ products must have all information that is relevant to market such as information related to the products
- No cost of transportation:
In perfect competition, there is a zero cost of transportation, which shows that firms do not have to pay any cost to bring goods in the market.
Monopoly refers the sort of market structure in which there is one supplier of the product and close substitute is not available; such as electricity firm. Supplier has control on the product or service supply and therefore also has the power to influence market price. The two main features that differentiate the monopoly from other market systems are single producer and supplier of product or service and no other close substitute is available. A monopolist firm has the ability to earn irregular gains in long-run, due to the absence of competitors. It is considered that monopolist firm cannot face losses, but it is not true at some extent. For example if a monopolist firm produce and supply those kind of products that are not used mostly; then firm have to suffer from losses, and these losses can lead firm towards closure. Monopolist firm is not a price taker because price-taker firms are those that are in competition; in monopoly firms are price makers. The characteristics of monopoly are that only one seller exists in the market and is liable to provide all outcomes in market, product is single, entry barriers are too high, and there is specific information about the techniques of production. Monopoly has vast control over market (Froyen, 2009). Below is the explanation of two characteristics of monopoly (Gartner, 2009):
- Single Seller:
Only one seller of the product and service exist in the market. There is no close substitute available in market and supplier has full control over the market because he does not have to compete with anyone and he does have a fear to lose the market share.
- Much High Entry Barriers:
The entry barriers are too high for the new firm. Monopolist system cannot continue if another firm enters in the market because monopolist firm will lose its control over the supply.
In oligopoly market, there are few firms that dominate the whole market or industry, but buyers are many. In this structure firms have the option to produce either differentiated products or standardize products. Firms have greater efficiency and try to innovate. Examples of oligopoly are chemical, steel, electronic and car. The distinguishing feature of the system is that; firms are interdependent. There is an amount of heterogeneity that cannot be avoided. In oligopoly, firms make collision due to which these firms are able to reduce competition and cause for the higher cost for consumers. Decision of one firm influence other firms in the market. In oligopoly wide range of numerous outcomes can be seen due to the competition and firms may also concern trade practices that are restrictive - in some situations not always – in order to increase prices and control production. There are some characteristics of oligopoly such as few numbers of sellers, standardized or differentiated, high barriers to entry, medium power to affect the price, and heavy advertising and product differentiation (Leamer, 2009). Explanation of two is below:
- Barriers of entrance and exit:
Entry barriers are high in oligopoly and barriers that are considered most important include access to complex and expensive technology, economic of scale, strategic actions that are taken by existing firms to discourage the nascent organizations, and patents. Government regulations are also important and create hurdles for the new entrants.
- Product differentiation:
In oligopoly firms have the option to produce homogeneous products like steel, wheat and milk; or they can produce differentiated products like automobiles and cosmetics.
It is a form of imperfect competition in which some features of the competitive market are discussed. Everyone can set his own quantity and price without having any effect on the whole market. Consumers prefer one product to another on the basis of a single feature and buy it even on the high price that give the supplier little market power. It is common in all open markets. This structure is more realistic that perfect competition. There are some characteristics of monopolistic competition and that are; numbers of sellers are many, products are differentiated, low barriers of entry, low power to effect price, and advertising and product differentiation (Mankiw, 2009).
- Low entry barriers:
In monopolistic market structure firms have an opportunity to enter easily in the market due to the low entry barriers. In monopolistic competition, new participants produce new product brand with certain variations in the product, and therefore; the new entrants have to face competition from the existing one.
- Differentiated products:
Monopolistic competition describes that firms produce differentiated goods and these goods can be comparable; however not identical. For example, all firms produce similar products but differentiate them by labeling, advertising, setting different price, and providing different quality. The example of monopolistic competition is cosmetic companies that produce similar products, but differentiate them by color, labeling, fragrance, price and quality. This market structure is like perfect competition but has little difference due to the differentiated products. Firms provide close substitutes but not perfect and due to this feature prices are close to the level to average cost which is also the feature of perfect competition.
MARKET STRUCTURE OF BEVERAGE INDUSTRY
The beverage industry has features of oligopoly because there are few firms that produce beverages, but differentiate by setting little dissimilar price, by labeling and advertising. The products are almost homogeneous with slight taste difference. The Coke and Pepsi are offering perfect substitute products. Another important feature of oligopoly is the interdependence among the firms. Both Pepsi and Coke offer similar prices all across the globe. The entry barriers are high because of the high initial investment. It is not easy to enter in this market because people prefer these two brands for their taste.
HIGH ENTRY BARRIERS AND LONG-RUN PROFITABILITY
Firms operating in the industry with high entry barriers (oligopoly) have an opportunity to make a profit in short and long-run; sometimes firm with high barriers makes excess profit, but it is not possible all the time. The profitability of the firm depends upon the production cost and demand of the product; high cost procedures may cause to weaken the profits. Due to high barriers firm may not have many competitors but still it cannot charge high price if it does so; then company has to face losses or lower profit, and same in oligopoly. However, firms can make long-run profit by creating a difference in their products and enjoy super normal profits. In a monopoly, there is no substitute due to which the firm’s demand curve is the demand curve of market. If firms cover variable cost of the product; profit can be maximized easily (Brickley and Zimmerman, 2009). In order to maximize the profit firm’s marginal cost and marginal revenue should be equal in oligopoly.
Market with high barriers to entry has very fewer firms that compete with each other and this competition cause to increase the different outcomes. Firm restrict their production in order to raise prices. Firms fix their prices, production and marketing through agreements, and the example is an agreement (OPEC) on oil prices. But in other situation the competition can be violent. Firms do advertising and differentiate its products through labeling, quality and quantity, but they do not have much pressure of competition due to the identical production. For example; if there are 3 companies in the market and they all make identical products like computers; in case one firm reduce its price the market share of this lower price firm will increase and this step will compel others to reduce their price (O'Sullivan & Sheffrin, 2003). Companies compete on non-price factors. However, these markets are dynamic, and characterization is not easy. Rapid technical changes from global competitors may cause vigorous competition (Wessels, 2000).
PRICE ELASTICITY OF DEMAND
Each market has different price elasticity of demand such as in monopoly; there are no substitute and one supplier in the market, and it is considered that these sort of firms can charge any price but it is not true in real life. If monopolies firm charge too high price people may not buy the product (Arnold, 2008).
The price elasticity demand curve shows that price and demand have an inverse relation if the price will increase the demand of the product will decrease (Williamson, 2008). Same in oligopoly because if the firm increase its price it will become uncompetitive and will lose its market share. In contrast; if the firm decrease its price it can enhance the market share and enlarge the profitability but other firms will do the same in order to have profit. In oligopoly firms compete on non-price factors (Arnold, 2008).
In perfect competition, there are many suppliers in the market, and they cannot charge high prices. Firms are price takers not price makers. They have to sell products on constant cost (Arnold, 2008).
In perfect competition, sellers can sell all their output but they cannot charge higher prices than the market price. Price has no impact on demand and vice versa because all firms are selling goods at constant price (Williamson, 2008).
In monopolistic competition firms are price makers they can charge any price for their products. They can charge higher price for innovative products and can lower price as compared to their rival (Arnold, 2008).
The price elastic demand curve is downward sloping in monopolistic competition. This shows that when price of the product increase the demanded quantity increase. The demand curve is elastic (Williamson, 2008). Due to innovative products demand increase and the price of the product also increase. For example in the mobile market, each mobile with innovative features has a high price but the demand of these new mobiles is also high.
GOVERNMENT’S ROLE IN PRICING OF PRODUCT
In any sort of market structure; government can have great influence on the price of products and government can influence the prices of different market structures through making legislation and regulations. Government can pass the price fixing cartels. Some regulators are appointed to impose rules in order to control the prices of some major utilities such as rail transport, gas, telecommunication and electricity (examples of monopoly). Government can use indirect taxes to raise the prices of goods and services. Sometimes government provides subsidies and gives tax reliefs due to which suppliers are able to reduce the prices of their products and can make higher profits than normal. The purpose of the government is to maintain social equity and efficiency (Arnold, 2008). By making the marginal benefits equal to marginal cost of either consumption or production. Sometimes government use lump sum taxes to reduce the monopoly profit without changing the price of the outcome (Mankiw, 2009). The impact of government steps has on each market if the government will give subsidy it will be beneficial for all, and if impose taxes all market structures’ cost of production will increase and due to this price will to (Arnold, 2008).
EFFECTS OF INTERNATIONAL TRADE
When there is an international trade; comparative advantages like price differentiation do not play any role consumers have substitutes, firms have an advantage of economy of scale. Due to the international trade firms are able to reduce the prices. In order to be competitive, organizations can place their operating activities in lower cost countries and can make high profits. This is also a restriction for monopoly markets; even in some countries international trade eliminated the concept of monopoly (Arnold, 2008). Due to international trade the average cost increased because suppliers are many, and each is liable to produce less. In contrast; the large sales of industry tend to lower down the average cost due to the massive production (Arkolakis, 2008). In monopolistic competition firms can influence the price of their products, they can sell more, and each firm behaves as a price setter. Companies in any market either monopoly, oligopoly, perfect competition, monopolistic can also lower the average price due to the economics of scale. Due to international trade oligopoly markets have a large number of sellers and competition has increased (Arkolakis, 2008).
The report presents an overview of the different types of market structures. At the same time, the report highlights the long run profitability of the firms and the competitive pressures that are prevalent in the market with high entry barriers. Along with this the report outlines the pricing decisions of firms operating in different types of market. All this allows to comprehend and understand the dynamics and characteristics of different market structures.
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