MARKET
STRUCTURE
MARKET STRUCTURE
refers to the competitive environment in which buyers and
sellers operate. It refers to the characteristics of a market
such as the number of and size of buyers and sellers,
similarity or type of product bought and sold, degree of
mobility or resources, entry and exit of firms and input
owners and degree of knowledge of economic agents
regarding prices, costs, demand and supply conditions.
Market structures may be classified as either perfect competition, monopoly,
monopolistic competition and oligopoly.
A.PERFECT COMPETITION CHARACTERISTICS:
1. Large number of small firms In perfect competition, there are a large number of
small firms each with a small market share.
2. Homogeneous products In perfect competition, firms sell homogeneous products
that are perfect substitutes.
3. Perfect knowledge In perfect competition, consumers and firms have perfect
knowledge about the price, quality, availability and production technology of the
product.
4. Price-takers Due to small market share, product homogeneity and perfect
knowledge, perfectly competitive firms are price-takers in the sense that they are
unable to influence the market price by changing their output levels.
5. No Barriers to Entry In perfect competition, there are no barriers to entry which
means that firms can make only normal profit in the long run.
The Profit-maximizing Condition
A firm will maximize profit when it produces the output level where marginal
cost is equal to marginal revenue.
Equilibrium of a Perfectly Competitive Market
A perfectly competitive market is in short-run equilibrium when all the firms in
the market are producing the profit-maximizing output level.
A perfectly competitive market is in long-run equilibrium when firms that wish
to leave the market and potential firms that wish to enter the market have done
so. In other words, a perfectly competitive market is in long-run equilibrium
when the number of firms in the market is constant.
The Shut-down Condition
If a firm is making subnormal profit (i.e. negative economic profit or economic
loss) which means that the total revenue is less than the total cost, it does not
mean that it should shut down production. In the short run, a firm should
continue production so long as the total revenue is greater than or equal to the
total variable cost.
Supply curve in Perfect Competition
Recall that the supply of a good is the quantity of the good that firms are able
and willing to sell at each price over a period of time, ceteris paribus, and the
supply curve shows the quantity supplied at each price. The portion of the
marginal cost curve above the average variable cost curve of a perfectly
competitive firm is the supply curve. As the supply curve shows the quantity
supplied at each price, this means that given the price of a good, the quantity
supplied is determined entirely by the supply curve.
Advantages of Perfect Competition
1. Firms always achieve efficient allocation
Efficient allocation happen when the price of the goods is equal to the marginal
cost that produce the goods.
2. Firms always achieve efficient production
Firm production efficiency refers to the ability of firms to produce goods at the
minimum average cost.
In the long run, perfectly competitive firms earn only normal profit at the
equilibrium point
3. Non-price competition cost savings
In a perfectly competitive market, the goods produced are homogeneous and
consumers have perfect knowledge of the market. Hence, the firm does not
need
to allocate resources such as advertising and sales promotion in non-price
competition.
Non-price competition cost saving production cost and thus benefit consumers
in the form of lower selling prices.
4. Freedom to choose and act
In a perfectly competitive market, the individual is free to make choices about
the kind of economic activity that is to be made and the type of goods to be
purchased. Production factors easily and move freely to get the best returns.
Manufacturers are also free to determine the type and quantity of goods to be
Produced.
Disadvantages of Perfect Competition
1. No encouragement of research and Innovation
In the long run firms only normal profit only. Firms do not have sufficient
resources and incentives to conduct research to improve product quality.
Market driven to innovation in creating new products because without
restrictions such as patents and copyrights.
2. Limited consumer choice
Perfect competition does not take account the vagaries of various
consumer preferences for goods produced are homogeneous.
Consumers in a perfectly competitive market cannot enjoy the pleasure of
buying things different patterns in terms of design brand and packaging
design according to the taste.
3.Create social costs
Pursuit of production efficiency and resource allocation may create a
variety of adverse social costs society. For example, environmental pollution
and neglect the welfare of workers.
4.Not enjoy economies of scale
Inability of firms producing massive lead firm cannot enjoy the benefits of
economies of scale that can lower production costs. Therefore, the cost of
production and selling price perfectly competitive firm may be higher than the
monopolistic benefit of economies of scale when conducting large-scale operations.
A. MONOPOLY
Characteristics:
1. Single Large Firm
In monopoly, there is a single large firm which dominates the whole
market.
2. Unique Product
A monopoly sells a unique product that has no close substitutes.
3. Price-setter
A monopoly is a price-setter in the sense that it is able to set its price
by setting its output level. In other words, a monopoly faces a downward
sloping demand curve.
4. High Barriers to Entry
In monopoly, there are high barriers to entry which means that the firm
can make supernormal profit in the long run.
Barriers to Entry
1. Economies of Scale
A monopoly may emerge naturally if it can reap very substantial economies
of scale due to very high capital costs such that the market can
accommodate only one firm.
2. Financial Barriers
Some industries have high start-up costs which are difficult to finance.
These high start-up costs which make it difficult for potential firms to enter
the industries may be due to expensive capital goods. They may also be due
to heavy advertising which is costly especially when there are established
brand names in the market.
3. Legal Barriers
A firm may have obtained its monopoly position through the acquisition of
a patent or copyright.
4. Control of Key Factor Inputs or Wholesale and Retail Outlets
If a firm controls the supply of some key factor inputs, it can deny access
to these factor inputs to potential firms which will make it difficult for them
to enter the market.
Equilibrium of a Monopolistic Market
A monopolistic market is in short-run equilibrium when the monopoly is
producing the profit-maximizing output level. However, this does not necessarily
mean that it is making positive economic profit
Advantages of Monopoly
1. Monopoly avoids duplication and hence avoids wastage of resources.
2. A monopoly enjoys economies of scale as it is the only supplier of product or
service in the market.
3. Due to the fact that monopolies make lots of profits, it can be used for
research and development and to maintain their status as a monopoly.
4. Monopolies may use price discrimination which benefits the economically
weaker sections of the society.
5. Monopolies can afford to invest in latest technology and machinery in order to
be efficient and to avoid competition.
6. Source of revenue for the government – the government gets revenue in form
of taxation from monopoly firms.
Disadvantages of Monopoly
1. Poor level of service
2. No consumer sovereignty. A monopoly market is the best known for
consumer exploitation. There are indeed no competing products and as a
result
the consumer gets a raw deal in terms of quantity, quality and pricing.
3. Consumers may be charged high prices for low quality of goods and
services.
4. Lack of competition may lead to low quality and out dated goods and
services.
MONOPOLISTIC COMPETITION
Characteristics:
1. Large Number of Small Firms
In monopolistic competition, there are a large number of small firms each
with a small market share.
2. Differentiated Products
In monopolistic competition, firms sell differentiated products that are
close substitutes. Differentiated products are products that are sufficiently
similar to be distinguished as a group from other products. An example is
restaurant foods.
3. Price-setters
Monopolistically competitive firms are price-setters in the sense that they
are able to set their prices by setting their output levels. In other words,
monopolistically competitive firms face a downward sloping demand curve.
4. Low Barriers to Entry
In monopolistic, there are low barriers to entry which means that firms can
make only normal profit in the long run. An example of monopolistic
competition is the restaurant market
Equilibrium of a Monopolistically Competitive Market
A monopolistically competitive market is in short-run equilibrium when the
firms in the market are producing the profit-maximizing output level.
Advantages of Monopolistic Competition
1. There are no significant barriers to entry, therefore markets are relatively
contestable.
2. Differentiation brings greater consumer choice and variety
This provides greater choice and variety of products and services for
consumers to purchase. 3. Product and Service Quality – Development
4.Consumers become more knowledgeable of products
They can gain an understanding of the unique features and aspects that
certain products have compared to that of others.
Disadvantages of Monopolistic Competition
1. They can be wasteful – liable of excess capacity
They don’t produce enough output to efficiently lower the average cost and
benefit from economies of scale.
2. Allocatively Inefficient
As the demand curve is one which is downward sloping this then implies the
price has to be greater than the marginal cost for a monopolistically competitive
firm. Hence, it is allocatively inefficient as not enough of the product gets
produced for society to benefit however this would force the company to lose
money.
2. Higher Prices
Is that as a result of firms having some market power, they can extenuate a
mark-up on the marginal cost of revenue.
B.OLIGOPOLY
Characteristics:
1. Small Number of Large Firms
In oligopoly, there are a small number of large firms each with a large
market share.
2. Differentiated Products
Oligopolists generally sell differentiated products such as cars and
electrical appliances. Some oligopolists, however, sell homogeneous products
such as cement and steel.
3. Price-setters
Oligopolists are price-setters in the sense that they are able to set their
prices by setting their output levels. In other words, oligopolists face a
downward sloping demand curve.
4. High Barriers to Entry
In oligopoly, there are high barriers to entry which means that firms
can
make supernormal profit in the long run.
5. Strategic Interdependence (also known as Mutual
Interdependence)
In oligopoly, due to the small number of large firms and hence the
large
market share of each firm, the actions of one firm affect and are
affected by
the actions of the other firms in the market, and this is known as
strategic
interdependence.
Advantages of Oligopoly
1. High Profits
Since there is such little competition, the companies that are involved in the
market have the potential to bring a large amount of profits.
2. Simple Choices
Having only a few companies that offer the goods or service that you are
looking for makes it easy to compare between them and choose the best
option for you.
3. Competitive Prices
Being able to easily compare prices force these companies to keep their
prices in competition
with the other companies.
4. Better information and goods
This also goes with the advertising and amount of information and support
that they provide their customers.
Disadvantages of Oligopoly
1. Difficult to Forge a Spot
For small business and other people with creative ideas in a oligopoly
market, the outlook for the business is grim. Extremely large and companies
completely control the market, making it nearly impossible for small or new
businesses to break into the market place.
2. Higher concentration levels reduce consumer choice.
The higher concentration levels in society can reduce the amount of choice that
consumers receive.
3. It can lead to decision-making bias and irrational behavior.
Because an oligopoly removes the threat of competition from the market,
those who practice it are sometimes free to manipulate the consumer
decision-making process.
4. Deliberate barriers to entry can occur with an oligopoly.
5. There can be a potential loss of a economic welfare in an oligopoly.
Because consumers are given limited choices with an oligopoly, there can be
more saving activities in the economy than spending.
