Different Market Structures
By James Pattee
A type of competition within an industry where:
- All firms produce similar yet not perfectly substitutable products.
- All firms are able to enter the industry if the profits are attractive.
- All firms are profit maximizers.
- All firms have some market power, which means none are price takers.
Monopolistic competition differs from perfect competition in that production does not take place at the lowest possible cost. Because of this, firms are left with excess production capacity.
- Each firm makes independent decisions about price and output, based on its product, its market, and its costs of production.
- Knowledge is widely spread between participants but it is unlikely to be perfect. For example, diners can review all the menus available from restaurants in a town, before they make their choice. Once inside the restaurant, they can view the menu again, before ordering. However, they cannot fully appreciate the restaurant or the meal until after they have dined.
- The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making.
- There is freedom to enter or leave the market, as there are no major barriers to entry or exit.
- A central feature of monopolistic competition is that products are differentiated. There are four main types of differentiation:
- Firms are price makers and are faced with a downward sloping demand curve. Because each firm makes a unique product, it can charge a higher or lower price than its rivals. The firm can set its own price than its rivals. The firm can set its own price and does not have to “take” it from the industry as a whole through the industry as a whole, through the industry price may be a guideline, or becomes a constraint. This also means that the demand curve will slope downwards.
- Firms operating under monopolistic competition usually have to engage in advertising. Firms are often in fierce competition with other (local) firms offering a similar product or service, and may need to advertise on a local basis, to let customers know their differences. Common methods of advertising for these firms are through local press and radio, local cinema, posters, leaflets and special promotions.
- Monopolistically competitive firms are assumed to be profit maximizers because firms tend to be small with entrepreneurs actively involved in managing the business.
- There are usually large numbers of independent firms competing in the market.
- In the long run new firms are attracted into the industry
- As new firms enter the market, demand for the existing firm’s products becomes more elastic and the demand curve shifts to the left, driving down price.
- Clearly, the firm benefits most when it is in short run and will try to stay in the short run by innovating, and further product differentiation.
- There are no significant barriers to entry; therefore markets are relatively contestable.
- Differentiation creates diversity, choice and utility. For example, a typical high street in any town will have a number of different restaurants from which to choose.
- The market is more efficient than monopoly but less efficient than perfect competition – less allocatively and less productively efficient. However, they may be dynamically efficient, innovative in terms of new production processes or new products. For example, retailers often constantly have to develop new ways to attract and retain local custom.
- Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive.
- As the diagram illustrates, assuming profit maximization, there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases. In the long run the firm is less allocatively inefficient, but it is still inefficient, but it is still inefficient. The firm is allocatively and productively inefficient in both the long and short run.
- There is a tendency for excess capacity because firms can never fully exploit their fixed factors because mass production is difficult. This means they are productively inefficient in both the long and short run. However, this may be outweighed by the advantages of diversity and choice. As an economic model of competition, monopolistic competition is more realistic than perfect competition- many familiar and commonplace market have many of the characteristics of this model.
Examples of monopolistic competition can be found in every high street. Monopolistically competitive firms are most common in industries where differentiation is possible, such as:
- The restaurant business
- Hotels and pubs
- General specialist retailing
- Consumer services, such as hairdressing
A situation in which a particular market is controlled by a small group of firms. An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.
- Oligopolists may use predatory pricing to force rivals out of the market. This means keeping price artificially low, and often below the full cost of production.
- They may also operate a limit-pricing strategy to deter entrants, which is also called entry forestalling price.
- Oligopolists may collude with rivals and raise price together, but this may attract new entrants.
- Cost-plus pricing is a straightforward pricing method, where a firm sets a price by calculating average production costs and then adding a fixed mark-up to achieve a desired profit level. Cost-plus pricing is also called the rule of thumb pricing. There are different versions of cost-plus pricing, including full cost pricing, where all costs – that is, fixed and variable costs- are calculated, plus a markup for profits, and contribution pricing, where only variable costs are calculated with precision and the mark-up is a contribution to both fixed costs and profits.
- Oligopolies may adopt a highly competitive strategy, in which case they can generate similar benefits to more competitive market structures, such as lower prices. Even though there are a few firms, making the market uncompetitive, their behavior may be highly competitive.
- Oligopolists may be dynamically efficient in terms of innovation and new product and process development. The super-normal profits they generate may be used to innovate, in which case the consumer may gain.
- Price stability may bring advantages to consumers and the macro-economy because it helps consumers plan ahead and stabilizes their expenditure, which may help stabilize the trade cycle.
- High concentration reduces consumer choice.
- Cartel-like behavior reduces competition and can lead to higher prices and reduced output.
- Firms can be prevented from entering a market because of deliberate barriers to entry.
- There is a potential loss of economic welfare.
- Oligopolists may be allocatively and productively inefficient.
- The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market. An oligopoly is a market structure in which a few firms dominate.
- Major airlines like British Airways (BA) and Air France operate their routes with only a few close competitors, but there are also many small airlines catering for the holidaymaker or offering specialist services. Oligopolies may be identified using concentration ratios, which measure the proportion of total market share controlled by a given number of firms. When there is a high concentration ratio in an industry, economists tend to identify the industry as an oligopoly.
A pure monopoly is a single supplier in a market. For the purposes of regulation, monopoly power exists when a single firm controls 25% or more of a particular market. A Monopoly controls the selling of the market. If anyone seeks to acquire the production sold by the monopoly, then they must buy from the monopoly. This means that the demand curve facing the monopoly is the market demand curve. They are one and the same. The characteristics of monopoly are in direct contrast to those of perfect competition
- A single firm selling all output in a market.
- Selling a unique product.
- Have restrictions on entry into and exit out of the industry, and more often than not.
- Specialized information about production techniques unavailable to other potential producers.
These four characteristics mean that a monopoly has extensive (boarding on complete) market control.
- They can benefit from economies of scale, and may be “natural” monopolies, so it may be argued that it is best form them to remain monopolies to avoid the wasteful duplication of infrastructure that would happen if new firms were encouraged to build their own infrastructure.
- Domestic monopolies can become dominant in their own territory and then penetrate overseas markets, earning a country valuable export revenues. This is certainly the case with Microsoft.
- According to Austrian economist Joseph Schumpeter, inefficient firms, including monopolies, would eventually be replaced by more efficient and effective firms through a process called creative destruction.
- It has been consistently argued by some economists that monopoly power is required to generate dynamic efficiency, that is, technological progressiveness. This is because:
- High profit levels boost investment in R&D.
- Innovation is more likely with large enterprises and this innovation can lead to lower costs than in competitive markets.
- A firm needs a dominant position to bear the risks associated with innovation.
- Firms needs to be able to protect their intellectual property by establishing barriers to entry; otherwise, there will be a free rider problem.
- Why spend large sums on R&D if ideas or designs are instantly copied by rivals who have not allocated funds to R&D?
- However, monopolies are protected from competition by barriers to entry and this will generate high levels of supernormal profits.
- If some of these profits are invested in new technology, costs are reduced via process innovation. This makes the monopolist’s supply curve to the right of the industry supply curve. The result is lower price and higher output in the long run.
- Restricting output onto the market.
- Charging a higher price than in a more competitive market.
- Reducing consumer surplus and economic welfare.
- Restricting choice for consumers.
- Reducing consumer sovereignty.
- A less competitive economy in the global market-place.
- A less efficient economy: Less productively efficient, Less allocatively efficient.
- The economy is also likely to suffer for ‘X’ inefficiency, which is the loss of management efficiency associated with markets where competition is limited or absent.
- Less employment in the economy, as higher prices lead to lower output and less need to employ labor.
Examples Of Different Types Of Monopolies:
- Natural Monopoly- A natural monopoly occurs when the type of industry makes it financially impractical, if not impossible, for multiple companies to engage in the business. For example, if you had multiple companies attempting to offer sewage services, that would require multiple sewer lines running to homes which is financially—and likely spatially—impossible. This makes the sewage industry a natural monopoly.
- Geographic Monopolies- Geographic monopolies occur when there is only one company that offers a particular good or service in an area. For example, in a small town there may be only one general store, which has a monopoly on the goods it sells. Because of the small size of the town, it may not be financially feasible for another company to come in—if the profits were split neither business would make money.
- Technological Monopolies- Technological Monopolies occur when the good or service the company provides has legal protection in the form of a patent or copyright. For example, if a company develops and patents a drug to cure brain cancer, that company has a legal monopoly over that drug.
- Government Monopolies- Sometimes a government will pass laws reserving a specific trade, product, or service for government agencies. For example, many times a government agency will be in charge of running water. The legal barriers that are put up to prevent companies from competing with the government.