Types of Market Structures (Essay Sample)
This paper aims to extend the knowledge of market structure by describing each type of market structure, namely perfect competition, monopolistic competition, oligopoly, and monopoly using real-life examples. The paper also describes how high entry barriers into each market influences (1) the long-run profitability of the firms, (2) the cost efficiency of the firms in the industry, (3) the likelihood that some inefficient firms will survive, and (4) the incentive of entrepreneurs to develop substitutes for the product supplied by the firms. The paper concludes by describing the preferred market for selling and buying products respectively.source..
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A market structure can be defined as the way in which a market is organized, structured, and characterized. For many years, the study of market structure has taken centre stage in the business as well as the academic field. The study of market structure focuses on identifying various characteristics as well as the nature of pricing and competition in the market. Traditionally, the study of market structure has been focused on identifying and classifying various feature of the market such as the number of firms, the market share, the nature of costs, the extent of product differentiation, as well as the structure of buyers and turnover of customers among others.
This paper aims to extend the knowledge of market structure by describing each type of market structure, namely perfect competition, monopolistic competition, oligopoly, and monopoly using real-life examples. The paper also describes how high entry barriers into each market influences (1) the long-run profitability of the firms, (2) the cost efficiency of the firms in the industry, (3) the likelihood that some inefficient firms will survive, and (4) the incentive of entrepreneurs to develop substitutes for the product supplied by the firms. The paper concludes by describing the preferred market for selling and buying products respectively.
Types of market structures
There are four types of market structures namely perfect competition, monopolistic competition, oligopoly, monopoly as described in the following sections.
(a) Perfect competition
The main characteristic of this type of market structure is the availability of numerous small firms that are constantly competing against each other. Because of this, a single firm in a perfect competition market does not have any market power. Since none of the firms can significantly influence the market prices, the industry as a whole produces at socially optimal level. In this market, there is no any form of artificial restrictions imposed on buyers or sellers. Furthermore, as explained by Etro (2009), perfect competition market is characterized by complete absence of rivalry and all firms are price-takers.
In a perfect competition, it is assumed that all firms maximize profits, all firms sell homogenous goods, there are free entry and exit in the market, and lastly, there is no consumer preference. Because of these assumptions, it is not likely to find a perfect competition market in reality. The best real life example that is almost close to perfect competition is the stock market. Another close example is the forex market. In the forex market, there is no firm rivalry, as well as numerous firms, are participating buying, and selling of homogenous products, which make it the best real-life example of a perfect competition market.
In a perfect competition market, there is absolute freedom of entry into and exit from the industry. This implies that many new firms will enter the market whenever the industry is earning excess profits. However, in case the industry is earning losses, many firms will be willing to exit the market. In perfect competition, there are no barrier entries to influence the long-run profitability of firms, cost efficiency of firms, incentive of entrepreneurship to develop a substitute for products, as well as the likelihood of inefficient firms surviving in the market. As a result, the perfect competition is characterized by a lack of incentive to develop substitute products. In addition, the long-run profitability of each firm depends only on its internal factors without the influence of other firms in the industry. Lastly, competitive pressures are not present in this market because it has no barrier to entry.
Change in prices is a common phenomenon in a perfect competition. Because firms in this market are price takers, they respond to changes in prices by taking them without any alteration. This is because the number of buyers and sellers are so large to the extent that no individual firm can influence the market prices of products and services. Because firms in perfect completion market are unable to influence prices, they only have one option of adjusting their prices to the market prices.
In perfect competition market, firms are selling inelastic products. This is because there are few substitutes in the market and furthermore the quantity demanded is not affected by changes in prices. In addition, all the firms are selling homogenous products. Because the market will be selling inelastic products, the market price charged will remain relatively unchanged.
In perfect competition market, it is assumed that there is no government intervention. In essence, any form of government intervention would lead to imbalances in the perfect competition market. However, the government plays a significant role in establishing price controls that would ensure that consumers are not exploited. Under perfect competition market structure, the international trade increases competition, which further ensures that prices are fair. It also ensures that consumers have access to a wide variety of products to choose from.
(b) Monopolistic competition
A large number of small firms that are actively competing against each other is the typical characteristic of this type of market structure. However, even though firms in monopolistic competition sell similar products, they are slightly differentiated. The differentiation of products thus gives firms in this market structure a certain degree of market power allowing them to charge slightly higher prices (Stackelberg et al., 2011).
A monopolistic competition market is based on four major assumptions namely free entry into and exit from the market, differentiation of products, all firms maximize profits, and lastly, consumer preference of certain products. Unlike perfect competition, monopolistic competition market does not result in socially optimal outputs. In addition, firms have more market power hence can easily influence prices in the market in order to take advantage of it. Real life example of monopolistic competition includes the market for cereal products. The cereal market is characterized by a huge number of similar but differentiated brands such as Apple Jack, Lucky Charms, as well as Froot Loops among others. Even though these products as all meant for breakfast cereals, they taste slightly different.
Even though there is keen competition in this market, it is not a perfect one because many firms make similar products. As a result, no firm in a monopolistic competition can have a perceptible influence on the market prices and other output policies. Another important feature of a monopolistic competition is that all firms enjoy freedom for entry into and exit out of the market. Firms can leave or enter the market at any time because they are small in size and are capable of producing similar substitute products.
Changes in prices occur in this market due to the internal competition caused by high level of product differentiation. Firms, therefore, respond to price changes by being price takes even though some have small levels of market powers. Furthermore, firms in this market structure do not respond to price changes by a cut in prices but rather through an increase in sales. Because no single firm controls the market, a reduction in prices in one product will increase its sales but have little effect on the market prices and outs.
In monopolistic competition, all firms are selling elastic products; however, they are not perfectly elastic products. This is because all firms are selling similar but differentiated products, which can act as substitutes to one another. This affects the market price charged in the sense that firms will not respond to increase in the price of other products by raising theirs. Just like in perfect competition, the government plays a significant role in establishing price controls that would ensure that consumers are not exploited.
International trade also affects the monopolistic competition. Under this market structure, the international trade ensures the production of high quality differentiated products. This also plays significant roles in establishing of fair prices of the differentiated products.
This type of market structure is characterized by the presence of only a small number of firms. Because of a small number of firms, there is limited competition in the oligopoly market. However, the few firms can either collaborate or compete against each other. Furthermore, they have collective market power, which they can use to drive up prices in order to earn more profits. Because there are only a few firms, the action of one is likely to affect the other.
There is interdependence amongst firms in the oligopoly market. Hence, the action of one firm may make the others to take countermeasures. For example, if one firm reduces their prices the others might follow suit and do the same. Another characteristic of oligopoly is that there is a high level of competition (Kamien & Schwartz, 2014).
The oligopoly market is based on the assumption that oligopolies can set prices, all firms maximize profits, products are homogenous or differentiated, no barrier to entry or exit, and lastly, only a few firms dominate the market. Based on these assumptions and other market characteristics presented above, the perfect real-life example of oligopoly is the gaming consoles market. In this market, only three firms dominate the market namely Sony, Microsoft, and Nintendo; each of them has significant market power to set prices...
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