Market_Structures.pdf

Running head: MARKET STRUCTURES 1

Market Structures

Laura Coplai

Liberty University

BUSI 620-B01 LUO

February 28, 2015

MARKET STRUCTURES 2

Abstract

Market structures are either imperfect competition or perfect competition, referring to the

environment in which a firm competes in. These are monopolies, oligopolies,

monopolistic competitions, and perfect competitions. A monopoly is one market in

competition has elements of both a monopoly and a perfect competitor. With multiple

sellers and differentiated products, a monopolistic competitor is able to produce with

these advantages of both market structures. The final market structure is perfect

competition. Perfect competition occurs when there are many sellers and buyers,

identical products, mobility of resources, and complete knowledge of the market.

competitor must make sure it’s price strategy is suitable for the industry or they will stand

to lose profit. Perfect competition, however, “has never really existed” (Salvatore, 2012,

p. 374). Therefore, a firm faces a difficult task in deciding which market structure to

produce in and must base it on not only the possible consumer demand curves, but the

short and long run analysis of the market as well.

Keywords: market structures, monopoly, oligopoly, perfect competition, monopolistic

competition

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Market Structures

Market structures are prevalent in today’s economies. These market structures are

imperfect competitions, which include monopolies, oligopolies, monopolistic

competitions, and perfect competitions. “These types of market structures or

supply conditions” (Salvatore, 2012, p. 373). The short-run and long-run analyses are

examined to determine the equilibrium prices and quantities for all market structures.

With any economy, a firm must determine which market structure is the best to produce

in and where to earn the most profit.

Monopoly

substitutes, there must be barrier to entry of competing firms. The dominant firm effect

takes place when a monopoly is established. Based upon the early entry, cost advantages,

efficiency, and the barriers to entry, a monopoly market structure may be formed. If

smaller firms try to enter and are able to decrease the concentration between the dominant

firm and the market, this will reduce monopoly power. However, “if the dominant firms

are strengthened, then concentration and monopoly power will be increased” (Corden,

1997, p. 11).

Sources

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Monopolies exist when four situations occur. “First, the firm may control the

entire supply of raw materials required to produce the product” (Salvatore, 2012, p. 389).

This can occur when a monopoly can control a source of raw materials, such as gas, oil,

or minerals. Secondly, the firm may use patents, copyrights, or obtain other rights that

to innovations are the difference between the competitive and the monopoly returns

actually earned” (Meiners & Staaf, 1990). Third, a natural monopoly may occur. Natural

monopolies occur with economies of scale. An example of natural monopolies are public

utilities. When more than one firm in an industry would lead to higher costs and a

duplicate product or service, many “local governments allow a single firm to operate in

with regulation by the government. The government may require certain businesses to

carry licenses. Licenses for specific businesses ensure minimum standards, but also

restrict competition to only those with licenses.

Market Analysis

In order for a firm to determine if a monopoly market structure is the best

decision, the short-run and long-run demand would need to be determined. A

monopolistic firm is not a price taker, as they set the prices. The firm will face a

negatively sloped demand curve for the product they are selling. “This means that the

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monopolist can sell more units of the product only by lowering its price” (Salvatore,

2012, p. 390). In the short run, a monopolist is also able to incur losses or break even,

depending on the level of the average total costs at the best level of output. The

monopolistic firm should aim to maximize profits and minimize losses. Overall, a

where the marginal revenue curve equals the long-run marginal curve. The firm will also

not product at the lowest point on the long-run average cost curve. The barriers to entry

give rise to a monopoly earning economic profits in the long run. This is only true as

long as the demand and cost curves do not change.

Oligopoly

form of information costs, economies of scale, franchises, and patents appear to be

sufficient to keep out enough new competitors” (Ruffin, 2009). Oligopolists usually have

a characteristic to work interdependently, as each decision made will affect the other

firms in the industry. The high rivalry of this market structure causes a firm to think

about the pricing strategies and product differentiation.

Sources

Oligopolists have the relatively same sources as monopolies. These include

economies of scale, large capital investments, patents, loyal customers, control of the

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entire supply of raw materials, and the government may allow only a few firms to operate

in the market. “Oligopoly power is the power to restrain competition” (Scitovsky, 1950,

p. 48). The sources of this market structure are also indicative of barriers to entry. If a

firm has the ability to operate in economies of scale, collusion is created by keeping the

buy from the firm with the better advertising. As Scitovsky states, buyers will fall “prey

to the emotional suggestion of advertising” (1950, p. 49). This ignorance also creates a

source of power in the oligopoly market structure by fostering collusion, limiting price

competition, and creating a barrier to entry.

Market Analysis

the bargaining power of buyers, (4) the bargaining power of suppliers, and (5) the

intensity of rivalry among existing competitors” (Salvatore, 2012, p. 425). In the short-

run, when these five forces are considered, an oligopolist firm will be able to earn a

profit, break even, or incur a loss. In the long run, the firm will leave the industry unless

it earns profits or breaks even. However, in the long run it is more difficult to determine

the best level of output for an oligopoly.

Monopolistic Competition

Definition and Importance

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Monopolistic competition occurs when there are many sellers with a differentiated

product. “However, when the private good is supplied by a monopolistically competitive

industry and comes in a range of different varieties, consumers have a preference for both

quantity and variety” (Mondal, 2013, p. 394). The product differentiation can be based

However, there is some perfect competition element to the market structure as well.

There are many sellers of the heterogeneous products that are too small to affect the

others when prices are changed.

Market Analysis

A monopolistic competitor faces a highly price elastic demand curve, which

the population increase, the number of differentiated products will increase. This is

because the “marginal utility of income is inversely related to the aggregate expenditure

made on the private goods,” so it will lower the marginal utility of income (Mondal,

2013, p. 379). As with other market structures, the optimal level of output is where the

marginal revenue equals the marginal cost. In the short-run, a monopolistic firm can

achieve profit, loss, and break-even.

In the long run, more firms may enter the market if firms are earning profits in the

short run. There are no barriers to entry and exit into the industries in the long run.

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Shifting the demand curve to be more price elastic than in the short run, “each

monopolistic competitor is left with a smaller share of the market…because of the greater

range of competition that becomes available in the long run” (Salvatore, 2012, p. 399).

This may cause the firm to break even at the optimal point and incur losses at any other

There are four characteristics of a perfect competition to occur as a market

structure. These include the production of homogeneous products, many buyers and

sellers, perfect mobility of resources, and the knowledge of the market conditions are

known by all agents of the market (Salvatore, 2012, p. 373). The amount of buyers and

sellers are too great to affect the prices of the products and neutralizes any conflict. With

(Berta, Julien, & Tricou, 2012, p.11).

Market Analysis

In the short run of the market structure of perfect competition, the firm will stay

in business even if losses are incurred. This is because “the best level of output of the

firm in the short run is the one at which the firm maximizes profits or minimizes losses”

(Salvatore, 2012, p. 378). The losses, however, must not be greater than the fixed costs.

This usually occurs where the marginal cost equals the marginal revenue. In the short-

run, however, the perfectly competitive firm will have an infinitely inelastic demand

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curve. This is because the firm is a price taker, indicating that they cannot change the

market price or they will lose customers. Therefore, the optimal point for a perfectly

competitive firm is where the demand, which equals the marginal revenue and price,

equals the marginal costs.

more firms that enter because of the easy entry. While all inputs and costs are variable in

the long run, the new firms entering the market can diminish all profits from the market.

When this occurs, firms will break even and earn zero economic profits. “When a

competitive market is in long-run equilibrium, all firms produce at the lowest point on

their long-run average cost curve and break even” (Salvatore, 2012, p. 381).

each market structure, but there are also disadvantages to each. If a firm believes the

government will grant the ability to be a monopoly in the United States, they should

decide to produce in that market structure. An example of a monopoly currently in force

is that of the taxi industry in New York City, where licenses are required to operate. An

oligopoly is a better decision, however, it is hard for a firm to analyze the long run.

Monopolistic competition is common in the retail and service sectors, while perfect

competition has never really existed. Therefore, it is up to a firm and their pricing

strategies to determine in which market they should produce in.