Managerial Economics: Monopolies - Essay Example

Perfect competition according to some economists is the most desirable market model but it is also almost non-existent in the modern world today. Perfect competition can be defined as a market structure characterized by a large number of buyers and sellers in a market which consists of goods which are homogenous in nature (every good is a perfect substitute of the other good). Although perfect competition is almost never found, the closest thing to perfect competition is the small businesses which sell street food in developing countries. The reason why they are a part of perfect competition is that the cost of entry and exit are very low, so any person / firm who see the existence of profit in the market can enter the market with comparatively very low costs. There are numerous people who sell street food in developing countries and mostly the goods are homogenous is nature , each person will sell the exact same good which is going to be a perfect substitute to market competitors. A large number of producers is also going to determine that one producer or consumer cannot influence the market price. A producer who wishes to increase the price cannot do so as consumers are going to shift to the other business selling street food at cheaper rates. A single consumer cannot influence market price as well, they can signal to the producer as to how much to produce but one consumer cannot dictate market price. The producer has to keep equilibrium at the efficient output. The producer must minimize costs in order to sell at a competitive price in the market. Each producer has a small market share due to the perfectly competitive nature of the goods, one producer will not be able to secure a larger market share due to the same reason it will not be able to affect market price. All businesses will at the most have normal profits in the short run covered, when profits start decreasing from normal profits the street food businesses are going to leave the market and hence bringing the market back to equilibrium level. Lastly there will be no role of government in these businesses, as mostly people who sell street food do not are legally obliged to keep minimum and maximum prices. There are no influence on demand and supply by the the government so the market automatically goes to equilibrium due to the iron rule of demand and supply with no interference from the government. The reason why Street Food sellers in developing countries is an example of perfect competition is due to the fact that the business face the same characteristics of perfect competition and hence is declared to fall under that category. Monopoly – A monopoly is a market structure which is characterized by the domination of one firm in the market share of good producing differentiated goods with significant barriers to entry. An example of a monopoly business is South West Gas in Arizona which is a monopoly due to the reason that it falls under the same characteristics as that of a monopoly as it is shown below Since it is the only gas provider in the region the market is dominated by the business .Some characteristics include that there is an in-elastic demand for its product, for example if South West Gas decides that it is going to increase the price of its goods the consumption of that good will not decrease due to a lack of substitutes of that good. There are no or very few substitutes of gas, so the business can afford to charge high prices without the fear of the consumers shifting to an alternate good. There is no interdependence on other firms / competitors since it is the largest and only gas provider in the region it does not have to account for the competitor’s actions before devising a market strategy. There are numerous barriers to entry in the market , one due to the economies of scale enjoyed by the monopoly the new firm ( even if it enters the market) cannot rival South West Gas for prices as the monopoly has the advantages of lower costs. Another barrier to entry is the obvious utilization of gas resources in the land by the monopoly so the competitors cannot produce gas itself without the presence of raw material hence it new firms cannot enter the market. Another barrier to entry is that high cost associated with entering the market, to set up a gas plant requires substantial amount of capital so it is not a luxury available to any firm to set up a gas plant only a large multinational is able to enter the market and raise enough capital to rival the monopoly. Furthermore there are some legal obligations, some firms have agreements with the governments and the license providers not to allow any other firm into the market due to the power they enjoy they usually get their way. A monopoly has the authority in this case South West Gas to not produce at equilibrium level of output but at that output where the supernormal profit is going to be maximum. In order to raise the prices of the goods, the monopoly allows the demand to exceed the supply so there are always people willing to pay more for the same utilization of that commodity. In this case if gas is going to be reduced in supply such is the nature of the good that people will be willing to pay more to achieve the same quantity of good hence providing the firm with supernormal profit. The government has started to regulate monopolies in modern economies, if a company is trying to increase barriers to entry or discouraging competition then the monopolies have legal action taken against them but such is the nature of South West Gas in Arizona that selling a necessity plus having the control over natural resources even if the government does try to impose sanctions on them no firm will be willing enough to enter the market due to simple reason that it is almost impossible to compete with a natural monopoly and will have to leave the market soon. Monopolistic competition – Monopolistic competition is a market structure very much like a perfectly competitive market except for the product to be differentiated and not homogenous. An example to monopolistic competition is the toothpaste industry, the toothpaste consists of a number of brands and each substitute to each other but they are not perfect substitutes as they are all differentiated by one way or the other (Investopedia, 2012). There are a few dominant firms but a large number of smaller firms in the market. Even though there is an existence of dominant firms the market share they possess is not significant enough to bring about a big change in market price. The toothpaste industry has some dominant firms such as Close up and MacLean’s while there do exist many smaller industries in the market. All the substitutes are differentiated , such as the difference in Close Up and MacLean’s may be the color , the packing , the ingredients which causes each other to be slightly different than the other but essentially their purpose is the same and can be used as substitutes for each other. The barriers of entry and exit are less in a monopolistic market with no dominant firms now this may be true if there were no dominant firms in the toothpaste industry, the only cost of entry would be setting up of the industry but since dominant firms do exist the barriers to entry get more significant as economies of scale and legal obligations come into the picture. Although substitutes are available, the firms are going to make independent decisions. This is because of the concept of brand loyalty. A customer who has a likening for Close Up will continue to use it even if the cost is slightly more than its substitutes because the customer is loyal to the brand for various reasons. This allows each firm to make independent decisions but again monopoly prices and low quality products can override the effect of brand loyalty. Lastly in monopolistic competition mostly the firms can only charge normal profit in their prices, there are substitutes readily available for every product so the price level should be at a mean level. However with goods with a high level of brand loyalty higher prices may be charged for a higher profit margin. The tooth paste industry does have a mean level of prices among most of its goods but some more established brands have a higher price than those who may be relatively lesser known or new to the market. The toothpaste industry is a good example of monopolistic competition due to the fact that it has low barriers to entry, the products are differentiated, and the firms make independent decision and have a small leverage to charge higher prices due to brand loyalty. Oligopoly – It is a market structure in which the number of firms is small that the action of any one firm is likely to have noticeable impacts on the performance of other firms in the industry. An oligopoly business may be of cell phone network providers in Pakistan, since there are only five of them each of them have a degree of dependence upon the other when devising their market strategies. This is an example of an oligopoly due to the simple reason that it has oligopolistic characteristics (Colin, 2011). In an oligopoly the product differentiation is an important factor and the network providers in Pakistan sell differentiated products, which causes the demand of the product to be dependent on brand loyalty. In an oligopoly there are significant barriers to entry such as those in a monopoly, since there are dominant firms existing in the market, the network providers in Pakistan have paid the government a specific amount of money in order to ensure no business can legally become a part of the industry apart from the five existing license holders. Oligopolies compete with each other on non-price factors, such as advertisement, promotional packages etc. A decrease in price can lead to a price war in which firms will keep on decreasing the prices until one business declares bankruptcy and the dominant firms survives. The network providers in Pakistan are on the verge of a price war after having very low call and messaging rates compared to when there existed only one network provider in Pakistan. Another factor by which price of an oligopoly can be decided is by that of collusion in which firms make one market strategy and all of them follow the same price level as that which is profitable to the industry it is however illegal to do so in modern day economies as it discourages competition. Furthermore in oligopolies there is a profit motive and an existence of supernormal profit is to be found in these types of markets. Network providers in Pakistan still have the existence of super normal profit due to the fact that their market share is so huge that even with low prices their profit margins are more than that of any other market structure save monopoly. However in a price war the scenario may be reversed and the firms have to cut their losses by leaving the market. Hence evaluating that the most common found market structure in modern economies today is that of monopolistic competition, which has numerous examples to support its market structure. Perfect competition is the standard through which market structures are compared to but there are very rare examples which do fulfill the criteria. Monopolies have been regulated by the government and governments have tried to decrease their market share though oligopolies still exist but not a great extent. References McGuigan, James., Moyer, Charles. And B, Frederick. 2010. “Managerial Economics”. Cengage Learning. United States. Colin, Mang. 2011. “Managerial Economics”. Chapter 9: Oligopoly. Retrieved on 28th April 2012 from: http://faculty.nipissingu.ca/colinm/ECON2106/Lectures/Oligopoly.pdf Investopedia. 2011. “Monopolies.” Web. Retrieved on 28th April 2012 from: http://www.investopedia.com/university/economics/economics6.asp Read More