Oligopoly and Monopoly - Essay Example

Types of Markets Affiliation Introduction Any industry comprises of all the organizations that make identical or similar products. The industry in the market is dependent on the number of organizations and the manner in which they compete. The common types of market structures include perfect competition, oligopoly, monopoly and monopolistic competition. Firstly, a perfect competition situation comprises of a large number of small firms that compete with each other and produce at minimal costs for every unit. Secondly, a monopoly does not have rivals in the industry. It minimizes output to allow it raise its prices and profit. Thirdly, an oligopoly comprises of few firms. When these firms merge, they reduce output to allow them raise their profits as in the case of a monopoly. In doing so, they produce output that creates incentives for cheating in the case of collusive agreements, ending up competing with each other. Fourthly, a monopolistic competition entails many firms competing against each other, each producing a slightly different product. This paper will depict the traits of different types of market, their differences, similarities, and economic efficiency of outcomes under perfect competition and monopoly. Discussion Main Characteristics of Market Structures Perfect Competition The major traits of perfect competition include prevalence of many small firms, all organizations selling identical products, free entry and exit to the market, and perfect knowledge regarding the prices and technology in the market. These traits mean that it is not possible for a firm to exercise any form of control in the market. Since the large number of firms sell identical products, a broad range of perfect substitutes prevail based on the output of a given organization. As such, the demand curve for the firms in a perfectly competitive market is perfectly elastic (Dransfield, 2013). Since firms are free to enter the market, this means that resources such as capital are perfectly mobile. As such, it is not possible to impose barriers of entry into the market. With regard to the issue of perfect knowledge, it is true that organizations operate in a similar environment. As such, consumers are aware of the perfect substitutes prevalent in the market for a certain good, especially since firms produce matching products (Stackelberg, 2010). In a perfect competition market, the industry and market forces determine the prices and output. The price is set by the market forcing firms to adjust their prices based on equilibrium position of firms as shown by the figures below. Source: (Mukherjee, 2012) Source: (Mukherjee, 2012) In the first figure, the demand and supply curves interest at point E. This price determines the equilibrium point governing the industry as shown by OP and OQ. As price rises from P to P2, demand is shown at P2K while supply is at P2L, meaning the supply of goods is excess. In this case, price decreases at OP. On the contrary, as price drops from P to P1, excess demand is shown by the areas MN. This increases price OP meaning that the equilibrium price lies at OP. The firms accelerate the price in the market although they are capable of adjusting their output based on equilibrium price. In this case, a firm may realize supernormal profit, loss or normal profit. For instance, in the case of firm A as shown by the second figure, which produces output OQ1 at price OP, the organization is realizing supernormal profit Source (Mukherjee, 2012). . Monopolistic Competition The major traits governing a monopolistic industry are as follows. The firms in the market are large and small. They sell similar but not identical products. There is considerable freedom of entry as well as exit in the market. Moreover, there is broad knowledge regarding the prevailing prices and technology in the industry (Stackelberg, 2010). These major traits mean that a firm that is monopolistically competitive has some control towards its share of the market. The many small firms that produce closely identical products means that a broad range of close substitutes prevail in the market based on the output that a firm produces. As such, the demand curve for the output of a firm is relatively elastic. The freedom of market entry and exit means that resources such as capital are exceedingly mobile (Stackelberg, 2010). Moreover, barriers to entry that might prevail in the market are minimal. The barriers to entry make it possible for firms in the real world to acquire as well as sustain more than proportionate economic profit. The extensive knowledge reveals that firms operate in a similar environment, where consumers have considerable information regarding the possible substitutes for a given product. Furthermore, it is true that firms utilize similar production techniques (Wilkinson, 2005). In the case of monopolistic competition, a firm realizes an equilibrium position when marginal revenue matches with marginal cost. When marginal revenue is higher than marginal cost, a firm finds it possible to expand output. If marginal revenue is below marginal cost, a firm reduces output to a point that sees marginal revenue equivalent to marginal cost. As such, in the short run, a firm realizes an equilibrium position when maximizing profits (Dransfield, 2013). Source: (OConnor, 2004) From the above figure, the average cost in the short run is at MT while average revenue is MP. Since the AR curve is higher than AC curve, the profit is reflected at PT. PT reflects the supernormal profit realized by the firm for every unit of output. Overall supernormal profit is measured when supernormal profit is multiplied by overall output, that is, PT x OM. A firm may also realize loss during the short run when the AR curve goes below the AC curve (OConnor, 2004). In the long run, supernormal profit disappears as new firms enter the market. In this case, the AR curve shifts to the left meaning that supernormal profit is competed away making firms to realize normal profits. For the firms in the short run that incur losses, some disappear form the market in the long run. The AR curve becomes more elastic since more substitutes are availed in the long run. As such, an equilibrium is realized as firms start realizing normal profits when AR = AC as shown in the figure below (OConnor, 2004). Source: (OConnor, 2004) Oligopoly An oligopoly market has three major traits. The market is under the influence of small big firms, the firms sell differentiated or identical products, and the market has considerable entry barriers. With regard to the small big firms, each of them is proportionately large when compared to the market size. This makes it possible for firms to acquire an extensive control of the market. The extent to which firms control the market is dependent on the size and number of firms (Wilkinson, 2005). With regard to the issue of differentiated or identical products, some oligopolistic industries are noted to produce differentiated products, while others produce similar products. Oligopolies that produce identical products mostly process raw materials or intermediate goods, which other industries can use as inputs. Common examples of oligopolies include steel, petroleum, and aluminum firms. Firms that produce differentiated products mostly embark on the production of consumer goods, which address the needs and wants of consumers. Major examples of differentiated oligopolistic industries comprise of household detergents, automobiles, and computers (Wilkinson, 2005). For barriers to entry, firms present in an oligopolistic industry acquire and retain control of the market due to the prevalence of entry barriers. The common barriers of entry prevalent in this industry include resource ownership, patents, start-up costs, government franchises, brand name appreciation, and declining average costs. These pose significant challenges for other organizations trying to enter the market (Dransfield, 2013). The price and output determination in the case of an oligopoly is shown by the kinked demand curve. The demand curve assumes that the kink serves as the governing price in the market. This is because a firm in the industry supplies a considerable product share and has significant influence in the commodity price as shown by the following figure. Source: (Stackelberg, 2010) From the diagram, it is true that there is a discontinuity in the MR curve below the point that corresponds to the kink. The MR curve is drawn from the discontinuity. The reason for this is that the firm realizes an equilibrium at output ON at a point where MC curve intersects with the MR curve from below (Stackelberg, 2010). . Monopoly A monopoly market structure has four major traits. These include a single organization that sells all the products in the market, products are unique, high barriers to market entry and exit, and exclusive information regarding the production techniques, which is not available to potential producers. These traits reveal that a monopoly has significant control towards the market. A monopoly exercises control towards the selling side in the industry. In case an individual seeks to acquire the products being sold by a monopoly, he should purchase from the firm. In this case, it is true that a monopoly faces a market demand curve (Mukherjee, 2012). The traits of monopoly are directly opposite to those of a perfect competition. In the case of a perfect competitive market, a large number of small firms characterize the industry whereby each produces identical products. In this case, it is possible for firms to move in and out of the market freely as well as share information regarding the production techniques and market prices. In the case of a monopolized industry, on the other hand, the firm lacks the traits of perfect competition. Since there is one firm in each industry, the products produced lack close substitutes regardless of the identical products that other firms produce. A monopoly gains its status since various barriers prevent potential producers from entering the market. Since a monopoly market lacks freedom of entry and perfect competition, a firm has specific information including copyrights and patents, which are not possible for other producers to acquire. Since a monopolist serves as the only supplier in the industry, the firm takes the market demand curve. As such, the monopolist experiences AR that is downward sloping while the MR curve has a gradient that is twice that of the AR. The firm serves as the price maker and has significant power while setting output and price. A firm is not supposed to charge prices that consumers cannot accept. As such, the elasticity and position of the demand curve serves as a constraint to the monopolist’s pricing behavior. In this case, the output that maximizes profit is sold at price P1, which is higher than the AC curve at output Q1. The firm in this case realizes economic profits reflected by the yellow area. The area below ATC1 indicates overall cost of producing Qm output (Wilkinson, 2005). Source: (Wilkinson, 2005) Conclusion There are different types of market structures that govern the economic environment. These include perfect competition, monopolistic competition, oligopoly, and monopoly. These structures are influenced by different market forces, which govern the manner in which these firms operate in the market. As such, it is appropriate for a firm to determine the requirements of the market structures in order for it to operate in a competitive, profitable, and cost effective manner. References Dransfield, R. (2013). Business Economics. London: Routledge. Mukherjee, S. (2012). Modern Economic Theory. New Jersey: New Age International. OConnor, E. D. (2004). The Basics of Economics. New York: Greenwood Publishing Group. Stackelberg, H. (2010). Market Structure and Equilibrium. New York: Springer Science & Business Media. Wilkinson, N. (2005). Managerial Economics: A Problem-Solving Approach. Cambridge: Cambridge University Press. Read More