CLA 2 Paper & PPT - Managerial Economics

Running head: MANAGERIAL ECONOMICS 1

MANAGERIAL ECONOMICS 9

Managerial Economics

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Institutional Affiliation

Managerial Economics

Introduction

The market structure describes the state of a market with respect to competition. The attractiveness and competitiveness of an industry can be analyzed by Porter’s five forces which consider the five forces in the market. According to this framework, the likelihood of an organization making a profit in a market depends on the barriers to entry and new entry threats, supplier power, buyer power, rivalry and threats from substitutes. This paper aims to identify the relationship between Porter’s five forces framework and the market structure.

Explain the Five Forces Framework and Industry Profitability of Michel Porter

Porter’s five forces is a framework used to analyze the competitive environment of a business. It is used to improve the progress of a business in different dimensions. Different businesses have utilized it to determine how they will improve, make profits and better competitive analysis. It is very useful, especially for a new business or a business that is venturing into a new sector (Dessain & Fishman, 2017). According to the framework, competitors are not the only source of competition; rather it depends on competition, new entrants, the threat of substitute services or products, power of customer and power of supply.

Competition

This force examines the intensity of the competition in the current market. It is dictated by the number of current competitors and what each competitor has to offer. Competition among businesses is high when the industry grows, and several businesses sell similar services or products. This makes it easy for a consumer to switch to a competitor offering goods or services at a lower rate. When the competition is high, businesses will be involved in adverts and price wars, which will hurt the bottom line of the businesses. Competition may be more intense if a business is unable to exit the industry even when profit margins are declining.

New Entrants

Markets that show profits tend to be attractive and will bring about new entrants, resulting in eroding profitability. This force shows the easiness or difficultness it is for new rivals to enter the business industry. It shows that the easier it is to gain entry for new competitors, then the greater the risk of depletion of an established business market share. Unless there are substantial entry barriers such as government policies, patents, and capital requirements, the rate of profits will reduce to a competitive rate. When the barriers of entry are high, they tend to favor existing players (Bedre-Defolie & Biglaiser, 2017).

Power of Supply

The supplier of a business has much power in controlling the potential rise in prices by a company which in turn lowers the profitability of the business. This force assesses the raw material, resources and the number of suppliers that are available. In a situation where there are fewer suppliers, then they tend to have more power. In cases where there are multiple suppliers, then businesses are in better positions and can make profits. Everything is dependent on how suppliers are able to bargain in an industry.

Power of Customers

This force analyses the power of a customer in influencing the market prices a company sets within the economy (Bruce L., 2019). The fewer the number of customers are, the more powerful they are, especially when there are numerous sellers and the consumers are able to switch from one to the other. In a situation where the customers buy products in small amounts, and the product from the seller is different from competitors, then the buying power tends to be lower.

The Threat of Substitute Services or Products

This force examines the existence of substitute products and services as well as how customers can effortlessly switch from one business to that of a competitor. This ends up in the reduction of the attractiveness of the market and the power of suppliers (Martin, 2019).

Describe the four market structures of Perfect Competition, Monopoly, Monopolistic Competition, and Oligopoly.

The classification of different industries and how they are differentiated is referred to as market structure. The market structure is based on the characteristics and how a business behaves and its outcomes in a specific market (Hossain, 2020). The market structure can be categorized into the perfect competition, monopoly, monopolistic competition and oligopoly. Market structures show different relationships, such as relations between sellers and other sellers and sellers and buyers.

Perfect Competition

In this market structure, there are numerous small companies, which are the sellers competing against each other and consumers who are the buyers. The sellers sell homogeneous products and do not have the power to influence the prices on the market because the small sellers are in competition with each other. The products sold in this market structure are of the same size, weight and shape. In addition, the market is not influenced because there is no one big seller. All the companies in this market structure tend to be price takers. Entering and exiting this market is easy for anyone, and it does not affect the market in any way. An example of such is the agricultural market, where the farmers grow similar crops to sell.

Monopoly

           In this structure, the industry is represented by only one organization. In the entire market, it is the only seller of the products and services and lacks any competitors. It is very difficult for other companies to enter this market due to different factors such as patent and copyright, sole claim to ownership of resources, high prices for initial setup, and government licenses. As a result, the organization remains a single seller in the market. Since the organization has all the market power, it can set the prices how it wishes. Consumers will be required to pay the set prices by the seller because they do not have an alternative. This is very undesirable to the consumers, and they tend to lose all their power. In this market structure, there are no substitutes.

Monopolistic Competition

This market structure has the characteristics of both monopoly and competitive market. The sellers in this structure compete among themselves or choose to collaborate. The buyers are far more than the competitors. All sellers sell similar products, which have slight differences. Price changes are considered in case competitors make changes. Monopolistic businesses tend to maximize profits when observed in the short term. But in the long term, companies face less profit because initially, the demand is high, and they produce more products. However, over time new businesses enter the market and affect demand. An example is company selling toothpaste.

Oligopoly

This market structure consists of a few organizations in the market. The sellers here sell identical or different products. Since the businesses in the market are limited, their competitive strategies depend on each other. In the case of pricing, if one company reduces the prices of their products, then this will trigger the other businesses to make reductions. However, an increase in prices may lead to others not taking any action with the home that the customers will choose their products. Businesses tend to create agreements in such a structure where they share the market by making restrictions on productions which leads to profits. Companies focus on the efficiency and quality of their products when competing.

Analyse the relation between the five forces and different market structures.

The different market structures validate different forces of the five forces framework (Dessain & Fishman, 2017). In perfect competition, the competition tends to be very high, and businesses have the freedom to enter and exit the market as they wish. This indicates that the organizations in this market have limited market power as well as profitability. This implies that the power of suppliers is very low. Under monopoly, the buyers have very low power compared to sellers who have significant power due to lack of availability of close substitutes and lack of competition. There is no threat of new entrants due to the sole organization having all the power. The market power in monopolistic competition is divided between the buyers and the sellers. Businesses are free to enter and exit the market at any time, and the competition is simply based on how a product is marketed. In oligopoly, the buyer has limited power compared to the seller. The competition is limited due to the limited number of businesses. Due to how it is structured, entry of new companies is difficult.

Apply your understanding in the evolution of the market in the computer industry.

In its early stages, the computer industry was a monopoly market. For a long time, the suppliers had power, and the competition was very limited. Also, the prices were very high. Over the years, there has been an increase in the upgrading of technology as well as the demand for computers. This led to the fall in the production cost of computers, which resulted in the benefit of economies of scale (Ray, 2017). With new entrants in the market, it led to an increase in the competition. In the current world, the computer industry can be referred to as an oligopoly market where there are a number of organizations in the market, and they focus on the efficiency and quality of their products when competing (Maisyarah, 2018).

Conclusion

Following the study of the market structure and the five force framework, an organization can create insights that are needed in the determination of the attractiveness in an industry to earn more profit on the invested capital. An organization should be aware that an industry without any potential of returns has low entry barriers, intense rivalry among the competitors and serious competitive threats from product substitutes.

References

Bedre-Defolie, Ö., & Biglaiser, G. (2017). Contracts as a barrier to entry in markets with Nonpivotal buyers. American Economic Review, 107(7), 2041-2071. https://doi.org/10.1257/aer.20151710

Bruce L., D. (2019). Business statistics and analytics in practice (9th ed.). McGraw-Hill.

Dessain, S., & Fishman, S. E. (2017). Porter’s Five Forces and the market for angel capital. Preserving the Promise, 49-62. https://doi.org/10.1016/b978-0-12-809216-3.00007-5

Greiner, M., & Julian, S. D. (2017). (PDF) An empirical test of the five forces model. ResearchGate. https://www.researchgate.net/publication/320787915_An_Empirical_Test_of_the_Five_Forces_Model

Hossain, B. (2020, May 27). Market structure in economics. ResearchGate. https://www.researchgate.net/publication/341671618_Market_structure_in_Economics

Maisyarah, R. (2018). Analysis of the determinants competition oligopoly market telecommunication industry in Indonesia. KnE Social Sciences, 3(10), 760. https://doi.org/10.18502/kss.v3i10.3170

Martin, M. (2019, December 3). Analyzing the competition with Porter's Five Forces - businessnewsdaily.com. Business News Daily. https://www.businessnewsdaily.com/5446-porters-five-forces.html

Ray, K. (2017). Market Structure of the Indian Computer Industry And Cynicism Layoff. International Journal of Business and Management Invention.