Monopoly and Perfect Competition - Report Example

Types of Markets ID Section Number: Introduction Firms operate in different markets depending on their sizes and the types of the commodities they offer in the market. Market in this aspect is a set of sellers and buyers whose operations affect the price at which a particular product or services is sold. Economists separate different kinds of competition in the market based on the number of firms and the variety of products that is whether the products are similar. They also consider entry strategy to the market, question will be asked, is it easy to enter the market or not? Monopoly and perfect competition are some markets available in the economy. On the other hand, there are a number of aspects that determines the profitability of the company. Competition is one thing that can determine the profits made by the firm. For example, a firm facing a serious competition will have to offer its products or services to customers at lower price. Additionally, the firm will also have to be more efficient as possible so as to survive in the market. A company facing one or two competitors will work as much as possible to see that the products they offer are unique so as to improve its market share. On the other hand, a firm facing less or no competition will control the price, meaning that the customer will have to pay more. Monopoly and perfect competition are some types of markets in the economy. In between the two forms of markets are monopolistic competition and oligopoly. This paper will review characteristics and differences of the four markets. Perfect competition Perfect competition is a market structure defined by large number of sellers and a significant number of buyers. The firms sell homogenous products meaning that firms in this industry do not engage themselves in advertising or branding of the products. New firms can enter the market easily; they can also exit the market anytime. However, firms can enter easily into the firm in the long run. Buyers and the Sellers are well aware of prices, costs and the market opportunities. Additionally, consumers have all the information regarding product quality, price and the availability of commodities. Those are some of the features of firms operating under perfect competition. However, not all the firms meet those conditions. Some, but a few like agricultural firms can operate closely to those conditions. For example, market of fresh vegetables mostly operates under perfect competition. Farmers selling vegetables such as potatoes cannot change the price because of many potato growers. In addition, potato farming can be easily set up by any farmer and so entry to the industry has no barriers. Additionally, each farmer can grow any variety of potatoes. This means that the potatoes grown by the farmer are not branded. Consumers and sellers are also well aware of the market, and that is, consumers know the price charged by the seller (Mankiw, 2014). Under perfect competition, price of a product cannot be charged or determined by the firm. The price is however determined by the industry. The figure below explains how the firm and industry behaves under perfect competition in the short run. a) Indusrty (Q millions) b) Firm Q (thousands ) As viewed from the figures above, each firm in an industry charges the same price determined by the intersection of demand and supply curve. All the firms must provide the products with price Pe and they cannot charge it. In addition, because the firm is a price taker, a single firm in an industry shows a horizontal demand curve whereby average revenue, AR equals to marginal revenue MR as indicated on figure b. A firm under perfect competition will always produce at a level whereby MR=MC. This means that a firm will produce to a level where MR curve intersects with MC curve. In short-run super normal profits arises when the average cost curve AC is below the average revenue curve AR. This is evident from the figure b above. Supernormal profits are indicated by region WXYZ in figure b (Mankiw, 2014). Monopoly Monopoly arises where there is only one firm in the industry. In this kind of market structure, a firm produces unique goods or services with no close substitutes. For example, some common firms operating under monopoly market structure are public utilities like water or electricity firms. Entry to this market is not easy because of barriers such as legal barriers. However, a firm cannot be always monopoly is specific places. For example, a rail industry can be a monopoly in between two cities; it is because it is the only firm offering rail services. This firm cannot however be a monopoly under public transport services because there are other forms of transport such as air and buses (Sloman et al. 2013). Barriers to entry Monopoly market exists because of various barriers to entry that prevent new firms from entering the industry. The following are some examples of barriers that prevent new firms from entering monopoly market: Economic scale This situation arises when monopolist costs falls to an extent that it only supports the whole market, and the industry might not be able to sustain more than one producer. The situation is also known as the natural monopoly. In addition, such cases happen when the markets are small. For example, two coach industries cannot operate in a small market because the market will be unprofitable for them. Network economy is another reason that prevents new entrants, in this sense, users share benefits of products and services used by every person in the market. This situation arises when there is a large network of market provided by a firm. For example, eBay has a large network of market that makes it quite difficult for new online users to enter the market. Therefore, the firm is a monopoly. Product differentiation and brand loyalty a new entrant to the industry will find it difficult to operate because the incumbent firm produces products that are unique. Another barrier is legal protection; a firm could be protected by legal patents, copyrights and various forms of licensing. Such protection could only allow one firm to operate in an industry. Monopoly is a price maker because it is the sole producer. This means that consumers will be forced to accept the price. The firm demand curve slopes downward unlike perfect competitive firms which are horizontal. The figure below shows the demand curve of monopolist and a firm under perfect competition. A competitive demand curve monopolist demand curve As it shown from the figures above, a competitive firm shows horizontal demand curve while the monopolist shows a downward sloping demand curve. Similarity and differences between monopoly and perfect competition The two firms are similar in the case that they both share elastic demand in the long run. In this case, consumer reduces the number of items he or she buys as price increases. This means that the need for the product decreases as the price goes up in the long run. On the other hand, perfect competitive firms face perfect elastic demand curve. Here, it shows that an increase in price of the product will force a customer to stop buying the product. This aspect is quite different in a firm under monopolistic industry. The demand curve is not perfectly inelastic. It is because they can increase the price of commodities without losing the customers (Sloman et al. 2013). Monopolistic competition Under this market structure, the firms have a freedom of entry to the industry and exit from it. This market structure is defined by a large number of firms having a small share of the market. The operation under a small share of market means that the actions of each firm have no effect on the rival firms. This also means that the firms act independently; their actions have no effect on other firms. Unlike oligopoly, actions made by one firm will affect the other firms. As stated above, there is freedom of entry and exit to and from the industry. This feature is also common on firms under perfect competition. However, the difference between a monopolist competition and perfect competition is product differentiation. While firms under perfect competition produce homogenous products, monopolistic firms make products that are quite different from its rivals. The product differentiation gives them the freedom to increase the prices without losing the customers. The demand curve of monopolistic firms is, therefore, downward sloping (Sexton, 2007). Equilibrium of the firm Under this market structure, profits are maximised where MC=MR. The firms under monopolistic market structure depict a curve like a monopolist firm. However, the only difference is that MR and AR curves are more elastic. The figure below indicates market structure of the monopolistic firm in the short run. Monopolistic firm in the short run On the diagram above, a monopolistic firm maximises profits in the short run at the point where MR=MC. The two curves intersect at point Z where quantity demand or sold is Q. The profit maximising price of an item is indicated by price P2. Price P2 is however more than ATC of price P. The profits made by the firm in the short run are indicated by rectangle P2OTP (Sloman et al. 2013). Oligopoly It is a market structure defined by small interdependent firm competing. This happens when small firms share a large share of the industry. Firms under oligopoly market structure have a significant difference; they also have significant behavioural difference. Oligopolistic firms may manufacture identical products such as chemicals, metals and petrol. However, quite a number of them produce differentiated products like soft drinks, airlines, cars (Sexton, 2007). Main features of oligopoly There are some characteristics of oligopolistic firms that make them far different from other market structures. Here are the features; Barriers to entry There are some barriers to entry to this market that makes it impossible for new firms to set up business. This makes it different from monopolistic markets that are easy to enter. Entry to this market is however similar to monopoly that has quite a number of barriers preventing new entrants. However, barriers to entry vary from one industry to another. At times, there are some industries that are easy to gain entry while others are quite impossible to enter (Sexton, 2007). Interdependence of firms This market is characterised by a few firms because of this feature, firms value each other. In other words, the firms are mutually dependent. Action done by one firm will affect the other firm. For example, the change of products’ price by one firm in the oligopoly market will affect the other firms. In a sense, the other firms will also have to change the price of the products (). Competition and collusion Oligopolies can behave in two ways in any industry; they can decide to work together or compete against each other. It is stated above that the firms are mutually dependent that is, they are independent. In order to maximize the profits, the firms will work together, and they will collude. Collusion will make them as one monopoly and they will maximise profits. OPEC is one industry that was known to fix the price of oil and controlled output. Conversely, the firms in this industry can decide to compete against each other using strategies like advertising so as to gain more market share (Sexton, 2007). Conclusion Some markets do occur because circumstances forced them. It is clear from the study that perfect competition is one market that no one has control over it. Additionally, products or services available in the market define such markets. On the other hand, markets such as monopoly have to be available because some commodities are scarce or more expensive to be offered by many firms. References Mankiw, N. (2014). Principles of Economics. Connecticut: Cengage Learning Sloman, J., Norris, K. & Garrett, D. (2013). Principles of Economics. UK: Pearson Higher Education AU. Sexton, R. (2007). Exploring Economics. Ohio: Cengage Learning. Read More