ECO 204 Week 5 Final Paper: Market Structure

Market Structures

ECO 204: Principles of Microeconomics

Instructor Gordon, MA, BA, BS

Alexandria Wright-Walker

November 13, 2016

Market Structures

Market structure is best defined as the organizational and other characteristics of a market. The four major market structures of which I will be discussing throughout this paper are perfect competition, monopolistic competition, oligopoly, and monopoly. Within this paper, the characteristics of those market structures will be discussed in details, with examples of each. Also,I will discusshigh entrybarriers, competitive pressures, price elasticity, the government’s effect on market structures, andthe effect of international trade on each market structure.

Describe each market structure discussed in the course (perfect competition, monopolistic competition, oligopoly, and monopoly), provide a real-life example of each market. Perfect competition defined by Amacher & Pate (2013, Ch. 9) is the market structure in which there are many sellers and buyers, firms produce a homogeneous product, and there is free entry into and exit out of the industry. Perfect competition is characterized by the fact that similar products are produced. With this being the case consumers have no tendency to buy one product over the other because they are all the same. This structure is purely theoreticaland represents anend of the market structure. Secondly, monopolistic competitiondefined by Amacher & Pate (2013, Section 11.2) describes an industry composed of many sellers. Each of these sellers offers a differentiated product, which is a good or service that has real or imagined characteristics that are different from those other products or services.Monopolistic competition is similar to perfect competition and some economist regards it as more realistic because the products are differentiated. Oligopoly is defined by Amacher & Pate (2013, Section 11.2) as the market structure in which a few firms compete imperfectly. The scarcity of sellers is the key to firms’ behavior in oligopoly.When a few firms share a market, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market.Lastly, monopoly defined by Amacher & Pate (2013, Ch. 10) is the market structure in which a single seller of a product that has no close substitutes. A monopoly could be created following the merger of two or more firms. Given that this will reduce competition, such mergers are subject to close regulation and may be prevented if the two firms gain a combined market share of 25% or more.Also, if there is a single seller in a certain industry and there are no close substitutes for the goods being produced, then the market structure I that of a “pure monopoly.”

To illustrate a real-life example of perfect competition, I will use the popular burger restaurants such as; McDonald’s, Burger King, and Wendy’s. All three restaurants sell similar products and attempt to advertise their differences between them. In fact, all three restaurants have incorporated a value menu as a way of attracting more customers to their restaurant and boost their earnings. Dominos and Pizza Hut are real-life examples of monopolistic competition. Because of ingredients, recipes, and taste, they are differentiated. Companies within the industry can gain a monopoly over their competitors by offering superior products or better service. The auto industry is a real-life example of an oligopoly. The automobile industry consists mainly of three major firms, General Motors (GM), Ford, and Chrysler. Oligopoly influence this industry through price, development, and the introduction of new car models. Now, a real-life example of monopoly would be the electric company. When the fixed costs involved with power generation and power lines are paid, each additional unit of electricity does not cost much; the more units sold, the more the fixed costs can be spread, creating a reasonable price for the consumer. Having two electric companies split electricity production, each with their power source and power lines would lead to a near doubling of price.

Indicate how high entry barriers into a market structure influence long– run profitability of the firms, cost efficiency of the firms in the industry, likelihood that some inefficient firms will survive, and incentive of entrepreneurs to develop substitutes for the product supplied by the firms.High barriers to entry are obstacles that make it difficult to enter a market. In perfectly competitive markets, there are no barriers to entry or exit. Therefore, in the long-run firms cannot make an economic profit but can only break even.In other markets, such as monopoly and oligopoly, barriers do exist.The three major barriers to entry into a market are legal restrictions, economies of scale, and control of an essential resource.A profit-maximizing monopolist will lower price and expand output if marginal revenue exceeds marginal cost. Therefore, long-run economic profits for a monopoly are sometimes possible.Prices in oligopoly tend to be more rigid than in any other market structure.Oligopolies may earn anaverage or an economic profit in the long run. They will restrict output and charge a price more than marginal cost. The likelihood that firms will survive in an oligopolistic market depends on the amount of competition among rivals.Oligopolies are expected to be quite progressive since they usually face some competition or potential competition and have the means to engage actively in research and development. An actual monopolist is the only seller in its market, yet it competes with rivals in other markets, recognizes potential competition, and may be subject to government regulations. Also, large firms will be able to produce in large quantizes as a means of enjoying the economies of scale,therefore, enabling the firms to be able to earn more profit in the long run due to these barriers to entry. So, the likelihood that firms will survive in a monopolistic market depends on the economy of scale.

Are competitive pressures present in market with high barriers to entry? Explain.Yes, competitive pressures are present. However, those high entry barriers will protect monopolists from competitive pressures, such as new firms managing to access and establish a channel of distribution that will compete with existing firms in the industry. Another pressure in the industry is switch costs. This pressure would be costly for the buyers because most buyers prefer to be served by already existing firms than new ones. Finally, the last competitive pressure is the capital requirement. When entering a new industry, a high initial capital is required. Also, this entry barrier prevents new industries from accessing the market because they have no financiers like the already existing firms. Foster, J., McChesney, R., & Jonna R, (April 2011. Vol. 62, Issue 11, Para. 44) states, “Oligopolistic firms remained under “competitive pressure” from the outside in the sense that failure to continue to innovate could lead to a weakening of the barriers to entry, protecting them from potential competitors.”Most existing firms in the industry have already gained customer loyalty through brand differentiation through their previous advertisement. However, it would not be easy for an “infant firm” to compete with existing firms. It requires a lot of time to be able to differentiate its product to the customers in the market.

Describe which market structure you would prefer for buying product. Explain why and support your answer with the characteristics of that market.I would prefer buying product in a perfectly competitive market structure. As I have stated, there is no barriers to entering or exit this market structure. Therefore, firms will make average profit and prices will remain low because there is no competitive pressure.

Describe which market structure you would prefer for selling product. Explain why and support your answer with the characteristics of that market. I would prefer selling product in a monopolistic competitive market structure. This market structure, like perfectly competitive market structures, has the freedom of entry and exit. However, the firms can also differentiate their produce which will give them an inelastic demand.

How does each market structure respond to price changes of the products that they sell?Explain whether each market structure will be selling elastic or inelastic products and how thiswill affect the market price changed. In an oligopoly market structure, the direction of the price change will determine the respond. If prices are lowered, then all firms will lower their prices to prevent any loss of market share. This demand curve will then become inelastic. However, if the price rises then the demand curve will become elastic. Since the price has risen, this will cause consumers to buy from other firms. In a monopoly market structure, response to price change can be crucial to consumers if the direction of the price change goes up. Let’s take Swedish district heating company for example. Because of a price increase the consumers took to the streets protesting. “The protesters argued that the energy companies are taking advantage of the natural monopoly that the district heating systems constitute. The heating companies, on the other hand, argue that they are acting in a heating market, where they are competing with other heating systems, such a heating pumps” Karlsen, R., & Pettyfer, M. (2011. Chapter 1, Para. 1). In this case, demand is completely elastic. Therefore, each firm will maximize its profits by increasing production until marginal cost equals price. Monopolistic competition market structure is sensitive to price change making it elastic. Market powerallows firms to raise their price without losing all their customers. Also, as price decreases, the demand for their product increases. Now, in a perfectly competitive market structure, individual firms do not have any influence on the market price. These firms are considered “price takers.” Firms are forced to charge theequilibrium price of the market or consumers will purchase the product from another source. The demand curve in this market varies significantly making it perfectly elastic.

How does the role of the government affect each market structure’s ability to price their products?Each industry and firm in an economy is grouped into one of the different market structures to ensure efficiency and effectiveness in service delivery. Because there are an abundance of industries and firms, the government’s role in each market structure’s ability to price their product is based on institutional barriers. There are four types of institutional barriers. These barriers take on many forms, such as patents, licensing restrictions, exclusive franchise rights, and the use of tariffs and quotas. Canadian Journal of Economics (1999. Para. 11) stated, “As domestic firms earn more profit under quotas and tariffs when a market industry is constrained, quotas induce domestic firms to participate in the market under free entry and exit. An increase in the number of firms, however, does not necessarily lead to more efficient outcome under imperfect competition, since each firm must operate on such a small scale that the advantage of increasing returns to scales is left unexploited in the economy.” Moreover, the government is the price overseer under monopoly and monopolistic market structure. It ensures that there are price ceilings and price floor to prevent price exploitation from monopoly firms.

How does international trade affect each market structure?“Governments have long intervened in international trade by collecting taxes, or tariffs, on imported goods” Suranovic, S., (May 2010. Ch 7, Para. 1).Under perfect competition,the international trade increases competition. Besides, since this market structure provides homogeneous goods, consumers are also provided with a variety of products to choose.In monopolistic market structure, differentiated products produced are ensured by the international trade to be of high quality (Feenstra, 2004). According to Suranovic, S., (May 2010. Section 6.6 Para. 7). “In terms of Figure 6.4 “Firm Equilibrium in Monopolistic Competition,”trade will cause the demand curve of a representative firm to shift out because of the increase in foreign demand but will cause the demand curve to shift back in because of the reduction in domestic demand.”

Furthermore, under monopoly market structure, exploitative prices are eliminated by the international trade since firms with huge initial capital will invest in those expensive industries. Finally, the international trade ensures that the prices are a bit lower due to competition under oligopoly market structure.

In conclusion, after taking this course, I gained knowledge about the details and characteristics of the four market structures. As I have stated, those four markets are perfect competition, monopolistic competition, oligopoly, and monopoly. I can now identify those four markets in the real world. Over the past five weeks, I’ve gained an abundance of in-depth knowledge on what it takes to function within a market structure. I plan to harvest this new knowledge in its right season and efficiently apply it where needed.

Reference

Amacher, R., & Pate, J. (2013). Microeconomics Principles and Policies [Electronic version]. Retrieved from https://content.ashford.edu/

Canadian Journal of Economics (1999). Retrieved from http://library.ashford.edu/index.aspx

Feenstra, R. C. (2004). Advanced international trade: Theory and evidence. Princeton, N.J: Princeton University Press. Retrieved from https://phamtrung.wikispaces.com/file/view/Advanced+International+Trade+Theory+and+Evidence.pdf

Foster, J., McChesney, R. W., & Jona, J. (April 2011. Vol 62, Issue 11, Para 4) Monopoly and Competition in Twenty-First Century Capitalism Retrieved from http://monthlyreview.org/2011/04/01/monopoly-and-competition-in-twenty-first-century-capitalism/

Karlsen, R. W. & Pettyfer, M. A. (October 2011) Monopolies: Theory, Effectiveness, and Regulations Retrieved from http://library.ashford.edu/index.aspx

Suranovic, S. (2010) Policy and Theory of International Trade (V.1.0) Retrieved from https://phamtrung.wikispaces.com/file/view/Advanced+International+Trade+Theory+and+Evidence.pdf