Characteristics of Various Markets

CHARACTERISTICS OF VARIOUS MARKETS 20

Characteristicsof Various Markets

Thereare different market structures, which include oligopoly, monopoly,monopolistic competition, and perfect competition. These marketstructures have different characteristics that help in identifyingthem. The purpose of this report is to discuss characteristics ofthese market structures.

Oligopoly

Number of firms

Oligopoly market structure is dominated by a small number of firms that are usually large. The firms in the industry are relatively large compared to the overall market size.

Pricing Decisions

Every firm in an oligopolistic industry tries to keep a close eye on operations of other firms in the industry (Dwivedi, 2010). Since oligopolistic firms are in competition amid few firms, pricing decisions made by one firm affects other firms. In case an oligopolistic firm increases the price of its commodities, other firms in the industry do not follow the pricing decisions of such a firm. There are price rigidities in the oligopolistic market. Firms in the oligopolistic market are usually price setters instead of being price takers. In some other cases, firms in the oligopoly industry may cooperate in order to determine the price that they would sell their products.

Output Decisions

In oligopoly market structure, output decisions are indeterminate. Because there are few competitors in this market structure, firms have the capacity of setting price of commodities and services at a higher level such that the price of commodities and services are above marginal cost. Lowering or raising prices would imply that a firm in this industry would encounter revenue losses (Mankiw &amp Taylor, 2006). Thus marginal cost can decrease or increase without affecting the profit-maximizing output. Hence, the output decision is indeterminate in the oligopoly market structure.

Profit

In maximizing profit, firms in the oligopoly market maximize their profits, where marginal revenue is equal to marginal cost. Since lowering and increasing price may affect the profitability of firms in oligopoly, firms cooperate and determine the price that they would sell their commodities in order to realize profits. At times, the dominant firms in the industry determine the price that other firms in the industry would sell their commodities. In the long run, the ability of firms in the industry to make high profits is determined by the existence of high barriers to entry. When there are high barriers to entry in the market, oligopolistic firms can make supernormal profits. Under oligopoly market structure, firms are not only involved in profit maximization they also compete with one another for non-profit motive.

Demand Curve

The demand curve for an oligopoly is indeterminate. The demand curve under an oligopoly is unknown because of the different behavior patterns exhibited by organizations in this market. In oligopolistic market structure, every firm checks the actions of competitors and makes strategies depending on the actions of other oligopolistic firms. Thus, the demand curve for an oligopoly is not stable and shifts depending on the actions of rivals (Sexton, 2008). A firm having this market structure will always attempt using counter strategies in order to counter actions or strategies used by other firms having oligopolistic market structure. The demand curve of oligopoly is kinked (shown in figure 1).

Ease of Entry

There are high barriers for new firms to enter in the market. Organizations in the oligopolistic industry retain market control by barriers to entry. The most common barriers to entry include copyrights and patents, high start-up costs, government restrictions as well as exclusive resource ownership. Because of these barriers to entry, it is not easy for new firms to enter in the oligopolistic market. For instance, a new firm wishing to enter the market may face entry difficulties due to lack of copyright or patent that can give it authority to enter the market. This characteristic separates oligopoly from monopolistic market structure.

Product Differentiation

Oligopolies may either produce identical products or differentiated products. This makes oligopolies to exist as either differentiate product oligopoly or identical product oligopoly (Dwivedi, 2010). Identical product oligopoly tends to produce intermediate goods or process raw materials, which are used as inputs by other firms. On the other hand, differentiate product oligopoly tends to focus on commodities that are sold for personal consumption.

Figure1

Anexample of a firm that has oligopoly market structure is a firm inthe auto industry such as Ford. This firm fits as an oligopoly sinceit operates in a market that has high barriers to entry and there arefew large firms operating in the industry.

Monopolistic Competition

Number of firms

This market structure is characterized by many firms, but the firms’ size are relatively small relative to the entire market. Every firm is unique in its location, atmosphere, and quality of products it offers.

Pricing Decisions

In monopolistic competition, there is concern with the issue of prices and there are rules, organizations, procedures, or mechanisms through which prices become set. In this market structure, there are problems in setting the price level. In this market structure, price is usually greater than the marginal cost since firms have some market power. Every firm in this market structure has some freedom of fixing price that is, due to differentiation, a firm having this market structure will not lose all its clients when it increases the price for its products. Therefore, firms that have this kind of market structure have the capacity of making independent price decisions based on its market, its products, and costs of production.

Output Decisions

The amount of output, which is produced by a monopolistically competitive organization is usually smaller compared to the amount that minimizes average total cost. This is an indication that firms operating in monopolistic competition have excess capacity (Dwivedi, 2010). This is because a firm having this market structure may increase its output and decrease its average total cost of production. Every firm having monopolistic competition structure has its share of the market which is devoted to a given brand name. A firm has to produce for this share it has in the market. A new firm entering the market has to create its own devotees in the market, which will determine the output that it will produce based on the market share.

Profits

In this market structure, profits are made in the short run. The profits are realized by convincing customers that the products being offered are different in kind. How well a firm becomes devoted in convincing clients of its products, the higher the short run profits. It is possible for firms having this market structure to earn supernormal profits in the short run. However, in the long run, new firms become attracted to the market which reduces the opportunity of making supernormal profits. Firms having this market structure are perceived to be profit maximisers since firms tend to be small, but having entrepreneurs that actively manage the business.

Demand Curve

Firms that have monopolistic competition market structure have a downward sloping demand curve because these firms are considered to be price makers. Since every firm is involved in making a unique product, it is capable of charging a lower or a higher price compared to its competitors. A firm has the freedom of setting its own price and does not need to take price from the industry. Therefore, because a monopolistic competitive firm has the freedom of fixing its own price, its demand curve slopes downwards.

Ease of Entry

In this market structure, there are low barriers to entry. Firms in this market structure have the freedom of entering the market. Unlike in oligopolistic market structure, firms in monopolistic competition can freely enter into the market since there are no restrictions guiding how firms can enter the market.

Product Differentiation

A key characteristic of this market structure is that products are differentiated. There are four basic types of differentiation that firms having this market structure may use. One of such differentiation entails marketing differentiation. In this case, firms attempt to differentiate their products through distinctive packaging as well as other promotional techniques. Physical product differentiation is another type of differentiation, where firms use design, color, performance, shape, and other features in making their products unique. Other types of differentiation include differentiation through distribution and human capital differentiation. Differentiation through distribution is where a firm considers differentiating its products through distributing its products through internet shopping or mail order. On the other hand, human capital differentiation is where a firm develops differences by utilizing the skill of its employees, distinctive uniforms, and training level received amid other things.

Figure2 Downward Sloping Demand Curve for Monopolistic Competition

Anexample of a firm that has monopolistic competition structure is arestaurant. This is because restaurants are capable of offeringdifferentiated products or services and there is freedom of entryinto the market.

Monopoly

Number of Firms

In monopoly, there is only one firm producing a given commodity or providing supply for the commodity or service.

Pricing Decisions

Firms that have monopoly market structure have full control of determining the price at which they will sell their products. In setting the price, the price is usually set above the marginal cost. Therefore, firms operating under monopoly have the power of altering the price charged on a commodity.

Output Decisions

When it comes to output decisions, firms operating under monopoly market structure have the power in determining the quantity of output that they would produce. When monopoly firms want to increase the price of commodities or services, they decrease the output. Besides, since monopoly firms have the sole power of supplying a certain commodity or service, they have the authority of determining the amount of output that they will produce within a given period. In addition, in determining the output level, monopoly firms set output level where marginal cost is equal to marginal revenue.

Profit

Just like in perfect competition market structure, monopoly firms usually maximize their profits by equating marginal revenue with marginal cost. The intersection of these two curves establishes the equilibrium level of output. Although a monopoly is thought to make positive economic profits in the short run, this may not always be the case as may also incur losses. A monopoly would experience short run losses, when the average total cost exceeds the price at which a monopoly can charge for the profit maximizing output level. For a monopoly, increasing production increases more cost compared to revenue, which implies that there is a decline in profits when the level of production is increased. Alternatively, decreasing the production level subtracts more from revenues compared to costs, which means that profit decreases.

Demand Curve

A monopoly has a negatively sloping demand curve. This is because a monopoly is a price maker, which implies that in order to sell more of its output it has to lower the price it offers for its commodity. Being in a position to determine its own price for the commodity and services it provides, a monopoly can either increase or decrease the price level for its commodities and services. Therefore, the demand curve for a monopoly is negatively sloping. Besides, being a single seller, a monopoly is a firm and an industry. This means that the market demand curve is the demand curve of the firm hence, it is down sloping. This is shown in figure 3.

Ease of Entry

In a monopoly, there is a single supplier of a certain commodity that does not have a direct substitute. As such, it is not easy to enter the market. There are different barriers to entry that may exist in the monopoly market structure. Such barriers to entry may include institutional barriers, licensing restrictions from government, economic barriers, tariffs and quotas, and exclusive franchise rights among others. Since these barriers to entry make it difficult for a new firm to enter the market, then the ease of entering the market is very low in the case of a monopoly.

Product Differentiation

Unlike in monopolistic market structure where there is product differentiation since every firm desire to create uniqueness in the products or services it offers, product differentiation is not a characteristic of the monopoly. Since in a monopoly there is a single supplier of commodities/products, there is no need of creating differentiation. Creating uniqueness in the products is not required because there are no close substitutes for the commodities that a monopoly provides/supplies in the market.

Anexample of a firm operating under a monopoly is a public utilityfirm. This falls under a monopoly because such a firm is the solesupplier of a certain public utility in a nation. Besides, there arebarriers in entering the market.

Figure3 The Demand Curve for a Monopoly

PerfectCompetition

Number of Firms

In a perfect competition, there are many firms in the market since firms have the freedom of entering the market.

Price Decision

When it comes to perfect competition, firms do not have control over prices. This is because firms operating under this market structure offer products that have a close substitute. Besides, there are no restrictions for firms entering or leaving the market. In this market structure, prices for goods and services offered by firms are usually determined by the forces of demand and supply prevailing in the market. Therefore, since different sellers in a perfect competition take the price prevailing in the market, then firms operating under perfect competition are considered to be price takers.

Output Decisions

Despite firms operating under the perfect competition having no power over prices, these firms have control over what they produce. Firms operating under the perfect competition can control their output level and they set the level of output at profit maximizing level where Marginal cost equals marginal revenue.

Profit

In order to maximize their profits, firms operating under perfect competition market structure needs to determine the level of output where marginal revenue equals marginal cost. Perfect competition firms can be in a position to increase their profits through increasing production. Increasing production helps these firms in obtaining additional revenues, which have an effect of increasing the profits made by firms. However, profit cannot be increased in case marginal revenue is equal to marginal cost. This is because the profit is already maximized at this level of output. In the short run, firms operating under perfect competition can make abnormal profits, but they make normal profits during the long run. This is because, during the short run, there are incentives for joining the market, but with time, more firms join the market since there is freedom for entry into the market.

Demand Curve

Firms operating under perfect competition market structure have perfectly elastic demand curve. This is because firms operating under this market structure can sell any number of units at a predetermined price. Buyers are more than willing to purchase any number of units for a given commodity from the market at a given market price. Figure 4 below shows a demand curve for a perfect competition firm.

Ease of Entry

Unlike in monopoly, where are high barriers to entering the market, entry into market for a new firm operating under perfect competition is easy. Firms can enter the market as they may require since there are no restrictions.

Product Differentiation

There is no product differentiation in perfect competition. Firms operating under the perfect completion offer identical products (Jayachandran, 2004). The products offered by different firms operating in perfect competition are perfect substitutes. Therefore, since products offered under perfection are supposed to be perfect substitutes, then there is no product differentiation in perfect competition.

Figure4 Demand Curve for Perfect Competition

Anexample of a firm operating under perfect competition is a firmoperating in a foreign exchange market. The firm operates under aperfect competition market because it exchanges a product (currency)that other firms in the market can offer.

Conclusion

Fromthe analysis of the different market structures, the following pointscan be noted

  • It is only firms that operate under monopolistic market structure that offer differentiated products

  • From the different market structures, it is only in perfect competition, where the forces of demand and supply are used in determining the market price for commodities

  • It is evident that from the different market structures, marginal cost must be equal to the marginal revenue in order for firms to maximize their profits

  • Price rigidities are experienced by firms that operate under oligopoly. In case an oligopolistic firm increases the price of its commodities, other firms in the industry do not follow the pricing decisions of such a firm.

  • It is only in oligopoly market structure that the demand curve has a kink

References

Dwivedi,D. N. (2010). Managerialeconomics.New Delhi: Vikas Publishing House Pvt. Ltd.

Jayachandran,S. (2004). Marketingmanagement text and cases.New-Delhi: Excel Books.

Mankiw,N. G., &amp Taylor, M. P. (2006). Economics.London: Thomson.

Sexton,R. L. (2008). Exploringeconomics.Mason, OH: Thomson/South-Western.