Market Structures – Market Classification
Market
Structure refers to the characteristics of a market that influence the behavior
and performance of firms and describes the competition environment in the
market for any goods or services. Market Structures describe the important
features of a market, such as the number of suppliers, the product’s degree of
uniformity, the ease of entry into the market and the forms of competition
among firms. Based on the type of competition, markets are classified as perfectly
competitive and imperfectly competitive.
Perfect
Competition: Refers to market structure where competition
among the sellers and buyers prevails in its most perfect form. Depending of
the demand and supply of service or commodity, a single price exists for the
particular commodity in a perfectly competitive market.
Examples:
Most
agricultural products such as wheat, corn, and livestock; markets for basic
commodities such as gold, silver, and copper; markets for foreign exchange and
widely traded stock.
Features
of Perfect Competition:
Large number of buyers and sellers
Homogeneous product
Freedom to enter and exit
Perfect knowledge
No existence of transport costs
Perfect mobility of factors of production
Each firm a price taker
Demand
Curve for firm: Horizontal and elastic
Price =
Average Revenue = Marginal Revenue
Short
Run Profit Maximization or Minimizing short-run losses: The
firm maximizes economic profit by finding the quantity at which the total
revenue exceeds total cost by the greatest amount. To maximize profit or
minimize loss, a firm should produce the quantity at which marginal revenue
equals marginal cost; provided marginal cost cuts marginal revenue from below.
Perfect
Competition in the Long Run:
Ø Short-run
economic profit attracts new entrants in the long run and may cause existing
firms to expand. Market supply thereby increases, driving down the market price
until economic profit disappears.
Ø A short-run
loss, in the long run, forces some firms to leave the industry or to reduce
their scale of operation. In the long-run, departures and reductions in scale
shift the market supply curve to left, thereby increasing the market price
until remaining firms break even – that is earn, a normal profit.
Ø Perfect
competition guarantees both productive efficiency and allocative efficiency in
the long run.
Imperfect
Competition: When the conditions of perfect competition do
not exist in a given market, it is said to imperfect market. Based on the
number of buyers and sellers, the imperfect markets are classified as follows:
- Monopoly
- Monopolistic Competition
- Duopoly
- Oligopoly
- Monopsony
- Duopsony
- Oligospony
Monopoly:
Monopoly is the sole supplier of a product with no close substitutes.
Examples:
Patented Products, Some prescription drugs, Postage Stamps
Features
of Monopoly:
Single person or a firm
Large number of buyers
No close substitutes
Price Maker
Entry Barriers
Demand
Curve for a firm: Downward sloping Curve and Inelastic
Price:
Marginal Revenue<Average Revenue
Short
Run Profit Maximization or Minimizing short-run losses
- The monopolist chooses either the price or the quantity, but choosing one determines the other- they come in pairs.
- The profit maximizing firm produces where total revenue exceeds total cost by the greatest amount.
- If the price covers the average variable cost, the monopolist produces, at least in the short run, or else shuts down.
Long
Run Profit Maximization: If a monopoly is insulated from competition
by high barriers that block new entry, economic profit can persist into the
long run.
Monopolistic
competition: When there are many firms and each one produces
such goods and services that are close substitutes to each other but not
identical.
Examples:
Convenience stores
Features
of Monopolistic competition:
Existence of many firms
Product differentiation
Free entry and exit of firms
Selling costs-high
Imperfect knowledge
Short
Run Profit Maximization or Minimizing short-run losses:
- The monopolist chooses either the price or the quantity, but choosing one determines the other- they come in pairs.
- The profit maximizing firm produces where total revenue exceeds total cost by the greatest amount
- If the price covers the average variable cost, the monopolist produces, at least in the short run, or else shuts down.
Monopolistically
competitive firms earn zero economic profit in the long run because market
entry is easy.
Oligopoly: A
market structure characterized by so few firms that each behaves
interdependently
Examples:
Industries such as automobiles, oil, breakfast cereals, personal computers, etc
Varieties
of Oligopoly:
- Undifferentiated Oligopoly: Sells product that does not differ across suppliers
- Differentiated Oligopoly: Sells product that differ across suppliers
Features
of Oligopoly:
Existence of only few firms Product differentiation Interdependence among firms High advertising and selling costs Each firm knows that any changes in its
product’s quality, price, output, or advertising policy may prompt a reaction
from its rivals. Some forms of barriers to entry such as
economies of scale, legal restrictions, brand names built up by years of
advertising, or control over an essential resource exist.
Models
of Oligopoly:
Based
on the diversity of observed behavior, Oligopoly can be collusive or
non-collusive.
1) Collusive Oligopoly: It is
a way of reducing the uncertainty associated with oligopolistic interdependence.
There are two main types of collusive agreements.
- Price leadership or tacit collusion: This occurs when one firm has a clear dominant position in the market and the firms with lower market shares follow the pricing changes driven by the dominant firm.
- Cartels or overt collusion: This occurs when firms openly agree on price, output and other decisions aimed at achieving monopoly profits. A group of independent producers working in unison is called a cartel. This can be formed either based on sharing the market or maximizing profit jointly by non-price competition.
2) Non-collusive Oligopoly: Firms
assume that there will be a certain reaction from their competitors for any
action taken by them.
- Cournot Model – Augustin Cournot (1838): Each firm assumes that the other keeps the output constant. A reaction curve gives the relationship between how a duopolist reacts to the other duopolist’s action.
- Kinked Demand Curve Model or Price Rigidity Model – Paul Sweezy (1939): An oligopoly firm believes that if it reduces the price, the other firms will follow suit by matching the price cuts but if it increases the price, other firms will not follow. This led to a kink in the demand curve, which occurs in the existing price. In this model, oligopolists recognize their interdependence but act without collusion in keeping their price constant. Thus the oligopolists prefer to compete with others on the basis of non-price competition policies rather than price policies.
