Perfect Competition, Monopolistic Competition, Oligopoly and Monopoly - Research Paper Example

? MICROECONOMICS – MARKET STRUCTURES INTRODUCTION: The purpose of this paper is to comprehensively analyze the characteristics of various market structures namely; perfect competition, monopolistic competition, oligopoly and monopoly. The paper also aims to answer critical questions related to the aforementioned market structures to establish which conditions and characteristics of a market structure make it suitable and most preferable for buying and selling of products. The paper follows the description of major market structures present in the study of economics based on factors such as number of firms, price elasticity of demand, barriers to entry and exit, profitability, cost efficiency, competition and several other aspects. PERFECT COMPETITION: Firms operating under perfect competition essentially rest upon four primary assumptions, the first of which is that since there are several firms operating under this model the significance of their output from a perspective of the entire industry supply is unimportant which means that such firms do not have the capability to influence the price of the product, therefore, at the market price perfect competition firms are said to experience perfectly elastic demand. Henceforth, this phenomenon postulates that perfect competition firms are price takers (Mankiw, 2011). The second assumption of the model of perfect competition relates to the freedom of entry into the industry or whether there is existence of any barriers to entry or exit. In this scenario, new firms do not face any lack of restrictions if they wish to enter the industry, however, the concept of freedom of entry is said to be applicable in the long-run owing to the period it takes to establish an organization (Sloman, 2006). A fundamental assumption of the model relates to product homogeneity within the industry, this concept is based upon the idea that all businesses supply products that are identical (Sloman, 2006). Lastly, it is supposed that buyers and sellers have perfect knowledge regarding the market such as price, quality and costs. The profit maximizing output of the firm occurs at the intersection of Marginal Cost and Marginal Revenue where, MC = MR (Sloman, 2006). Therefore, when P = MC firms in perfect competition are economically efficient, where allocative efficiency occurs when consumer as well as producer surplus is at its maximum and productive efficiency occurs because the firm’s equilibrium output in the long-run is established where the businesses’ average cost is the least. The quantity of firms in the short run varies as firms leave or come into the industry, if it is understood that the costs of the firms experience no change the exit of some firms will lead to generation of abnormal profit or supernormal profit where AR>AC. In the long-run however, the attraction of abnormal profits will cause firms to enter the industry because of no barriers to entry or exit thereby, bringing the state of the market back to equilibrium at a point on the LRAC curve which is the least, causing firms to make normal or zero economic profit such that the long-run equilibrium occurs where P = AR = LRAC = LRMC = MR (Stanlake & Grant, 2000). Due to obvious factors relating to the model of perfect competition it can be concluded that most firms are not audacious in terms of taking risks. The instability of demand therefore, causes perfectly competitive firms to diversify which leads to intra-industry trade and if the condition of elastic demand is fulfilled such exchange of identical commodities on an international scale proves to be beneficial for both the countries and firms involved (Cukrowski & Aksen, 2003). Hypothetically, the economic efficiency of perfectly competitive firms would indicate that government regulation is not required in such a model but in the short-run government intervention might be needed to control prices if firms are generating supernormal profits, however, the primary premise remains that in a perfectly competitive market the long-run equilibrium would be such that it allows for the accumulation of zero economic profit. Sloman (2006) believes that the relevance of the model of perfect competition is strictly limited to an ‘ideal’ representation primarily because of its stringent assumptions and in this scenario agricultural markets appear to be the closest example of the model however, a real-life instance of a perfectly competitive market could be that of the dairy market in New Zealand, which consists of 13000 farmers operating as a dairy co-operative in the country. The case in point fulfills assumptions such as large number of buyers and sellers, free entry and exit and that all dairy farmers are price takers such that no single farmer has the ability to influence the price of dairy products. MONOPOLISTIC COMPETITION: The key distinguishing factor between perfect competition and monopolistic competition is that firms enjoy a certain measure of power in the market, which means that a monopolistically competitive firm has some degree of autonomy over what price the product will be sold at. This control in comparison with perfect competition is a result of product differentiation in monopolistic competition, which means that several firms that are operation in such a market produce products that are distinguishable from that of the competitors which is why firms can afford to charge prices which they please therefore, monopolistically competitive firms face a downward sloping demand curve (Sloman, 2006). An important point to note, however, is that the existence of several sellers in the market provides consumers with the ability to switch between producers this phenomenon suggests that the demand curve for monopolistically competitive firms is relatively elastic (Mankiw, 2011). Other principles of the model include the freedom of entry and independence, the latter referring to the idea that monopolistically competitive firms must keep track of the actions of their competitors as choices taken by firms do affect each other (Sloman, 2006). The model follows the same rule as with other market structures when determining the profit-maximizing output which occurs at the intersection of marginal cost and marginal revenue (MC = MR). The elasticity of demand of products determines the profit earning capability of a firm in the short-run, which in turn is dependent upon the number of substitutes that are available in the market, certainly, if a firm’s products are highly distinguishable then it would be able to earn profit in the short-run. In the long-run, supernormal profit earning firms will increase the attractiveness of the market to encourage the entrance of competition. Once, more suppliers populate the market profits will be shared until the long-run equilibrium is established at AR = LRAC so that zero economic profit remains (Sloman, 2006). Grossman (1992) argued the an assessment of intra-industry trade should focus on the concept of imperfect competition and increasing returns to scale rather than perfect competition and constant returns to scale, as the former postulates that once a firm’s marginal cost is below its average cost losses would not be incurred as is the case with perfect competition. This indicates that the relationship between increasing returns to scale and perfect competition is incompatible which is why beneficial intra-industry trade can only be explained through the premise of monopolistic competition in order to increase overall national welfare. A real-life example of monopolistic competition could be of the American film industry, where several movies are produced by a number of production companies and studios. In some cases there is some degree of differentiation between movies, while the movies that truly succeed or generate short-run profit are those with a greater degree of differentiation such that the demand for the viewership of such movies (e.g. cinema tickets) is relatively inelastic in the short-run but in the long-run as more movies are opened to the audience supernormal profits are shared between production companies so that AR = LRAC and normal profit is earned. OLIGOPOLY: An oligopoly market is one which is dominated by few large firms. The model of oligopoly rests on two primary principles one of which is that potential entrants are faced with barriers to entry, the extent of which is relative. Secondly, oligopoly firms are interdependent rather than dependent upon each other with pertinence to choices related to price and output. Mankiw (2011) asserted that the homogeneity or differentiation of products in oligopoly markets is not fixed; such that some firms may be producing or supplying products that are exactly the same (e.g. oil) on the other hand oligopolistic firms also make use of non-price competition such as advertising to promote their products to consumers. High barriers to entry within the model postulate that rather than facing competitive pressure, oligopolistic firms wish to collude rather than compete. This occurs when participant firms decide to form a cartel in cases where the products that they are producing are identical (Mankiw, 2011). A cartel works upon such basis that participating firms merge their AR, MR and MC functions in order to arrive at an output and price that will collectively maximize profits. One way that a cartel operates is through the allocation of quotas which is share of the total output given to each member and a limit that cannot be exceeded (Sloman, 2006). High barriers to entry into an oligopolistic market safeguard the profitability of businesses to allow them to make abnormal profits in the long-run. Moreover, the economic efficiency in oligopolistic markets is inexistent because of the model’s failure to abide by the principals relating to efficiency, as oligopolistic firms produce at P > minimum ATC and where P > MC where both allocative and productive efficiency is not achieved. In a market with high barriers to entry, inefficient firms will not be able to survive, primarily because economies of scale enjoyed by large firms act as a significant barrier to entry that new firms cannot overcome. Moreover, oligopolistic as well as monopolistic firms can afford to lower their prices to drive the competition out as they earn supernormal profits in the long-run. Grossman (1992) argued that an international trade policy created under an oligopoly should be such that the firm existing in the country of origin and the international firm should be producers of a product which is perfectly substitutable that do not contend in either of the two countries’ markets but in another neutral market. Perhaps, the most popular and globally recognized example of an oligopolistic market is that of Pepsi and Coca-Cola in the carbonated soft drink market as both firms are observably interdependent on each other and their large stature helps them reap benefits of economies of scale to deter the entrance of competition into the market. MONOPOLY: According to Sloman (2006), a monopoly comes into existence when one firm exclusively supplies a specific commodity or commodities that have sizeable demand. This establishes the highlighting feature of a monopoly firm which faces no economic competition whatsoever due to which its product competes with no possible or likely substitutes in the market. The reason why a monopoly is able to maintain a hold of the market is by exercising its sources of power, the leading power being economies of scale that are characterized by a reduction in average cost as the firm expands its output scale (Sloman, 2006). Furthermore, another barrier to entry is legal rights that are owned by certain monopolies in form of various types of intellectual property rights. High barriers to entry, lack of competition and unavailability of substitutes in the market dictate that a monopolist’s demand curve is relatively inelastic (Mankiw, 2011). A monopolist’s ability to increase prices is reflective of the firm’s power in being a price maker. While, the profit maximizing output of a monopolist firm also occurs where MC = MR, MR < P in a monopoly when MR = P for a perfectly competitive firm. Furthermore, a monopoly may also exercise price discrimination by charging different prices to different customers based on their elasticity of demand. Henceforth, a monopolistic firm continues to make abnormal or supernormal profits in both short-run and the long-run since, new firms cannot enter the market because of the presence of barriers to entry. In a scenario where several firms are operating under intense competition, businesses are forced to adopt techniques that would lower their cost hence, making them as efficient as possible but in the case of a monopoly lack of competitive pressure does not leave room for such motivation. Even though, some economists suggest that cost-efficiency is an entirely positive concept as lowering costs would permit a monopolist firm to earn even more profit (Sloman, 2006), investment in research and development and cost saving methods in order to achieve efficiency often puts off monopolistic firms from doing so in a scenario in which they are already earning supernormal profits. An interesting study in this regard was conducted Nishimori and Ogawa (2002) to compare which of the market structure between an oligopoly and monopoly had a greater incentive to engage and invest in cost-efficiency the result of which turned out to be in favor of a monopoly firm which advocates the idea that cost-efficiency is a factor which should be considered and worked upon. Before trade liberalization, the monopoly will be able to charge a higher price for a lower output in its own country; however, in a foreign market the scenario would change in turn transforming the monopoly from a price maker to a price taker. This postulates that international trade would not be able to effect the firm’s monopoly position in its own country unless the imported products are viable substitutes of the monopoly’s products, however, in the foreign market a monopoly firm will behave like a perfectly competitive firm. Government regulations across the globe prevent the creation of monopolies to ensure that consumers are not exploited by the firm’s actions. Therefore, monopolies that are not owned by the government are now a rarity. An example, however, could be that of Deutsche Telekom which was previously owned entirely by the government in Germany but still holds considerable monopoly power in the telecommunications arena in the country. CONCLUSION: According to an understanding of the characteristics, assumptions and aspects related to the market structures that have been discussed in the paper, it can be concluded that the most preferable market structure for a seller to operate in would be a monopoly, so that a producer is able to benefit from having control over the prices which are set for the firm’s product and also practice price discrimination. Moreover, monopoly is a preferable situation also because lack of or inexistence of competition means that a monopoly firm does not have to engage in large investments to deter the entrance of potential sellers. From the point of view of a buyer, monopolistic competition is the most preferable market structure as it is able to provide differentiated products to the customers, which promotes variety and a range of choices for buyers. Moreover, freedom of entry means that in the long-run monopolistically competitive firms only make normal profit. Even though, perfect competition appears to favor buyers the most, its assumptions make it an impossible premise to exist completely in the real world and in a host of industries. REFERENCES Cukrowski, J., & Aksen, E. (2003). Perfect competition and intra-industry trade. Economics Letters, 78(1), 101-108. Grossman, G. M. (1992). Imperfect competition and international trade. The MIT Press. Mankiw, N. G. (2011). Principles of microeconomics. South-Western Pub. Nishimori, A., & Ogawa, H. (2002). Public monopoly, mixed oligopoly and productive efficiency. Australian Economic Papers, 41(2), 185-190. Sloman, J. (2006). Economics. Harlow (Essex: Pearson Education. Stanlake, G. F., & Grant, S. J. (2000). Introductory economics. Longman. Read More