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Economics Sample Paper on Market Structures

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Economics Sample Paper on Market Structures

Perfect Competition Market Structure.

As the name suggests, this market structure is synonymous with a perfect degree of competition and a prevalent single price. This market structure is very scarce in the real world; however, its characteristics are replicated in several industries. This market structure is composed of many sellers and buyers. This is significant since any individual firm’s decisions do not by any means affect those of another firm. Essentially, these decisions also do not have any impact on the market conditions and prices. Firms present in this kind of market deal in homogeneous goods and products that are perfect substitutes (Melitz & Ottaviano, 2008). All sellers, therefore, deal in identical products implying no seller has an advantage over the other because of the products. The sellers are all price takers. As mentioned above, these sellers’ decisions do not impact the market prices. Therefore, the prices are solely determined by the forces of supply and demand ceteris paribus. This market is lastly characterized by the absence of entry and exit barriers. Sellers can enter anytime into the market and consequently leave at their discretion.  A close real-life example of such a market structure is the agricultural market for instance tomatoes produced from a certain region. Firms in this market make normal profits and have perfectly elastic demand curves owing to them being price takers.

Effects of High Entry Barriers.

High entry barriers will correspond to few competitors entering the market. This phenomenon will negatively affect the market and cause it to resemble the monopoly market. The effects of this scenario will take on two varying trends depending on the revenues the sellersrealize in the short term. If firms make positive economic profits in the short run, this could trigger several other sellers to enter the market and consequently drive prices downwards (Melitz & Ottaviano, 2008). However, with the preexistent high entry barriers, the entrance of these firms will be restricted, and only a few will enter. This will ensure that the sellers in the market continue enjoying economical profits with very few competitors entering the market. The presence of many competitors entering the market would increase supply and hence cause prices to decrease. The lower prices would lower profits for the firms. This is also supposed to ensure productive efficiency; firms produce at the minimum average costs. However, the high barriers will allow firms to produce at higher prices than the minimum average costs. The firms will, therefore, remain cost inefficient since there no many substitute firms present.

The likelihood that some inefficient firms will survive is very high. The prices will remain relatively higher than the average costs, and they will unlikely reduce to the point where they will equal the average costs. These firm will still experience profits even though they produce inefficiently. There will be little to no incentive for producers to develop substitute goods. If there are high entry barriers, then why develop a product that you will not be allowed to sell. Firms in the perfect competition have very elastic demand curves. Any changes in prices will affect quantity supplied. An increase in prices will result in a reduction of quantity supplied the opposite is true. These firms, therefore, respond to changes in price by varying the quantity supplied since they can’t do much about their costs. These markets deal in elastic products whose prices are set by the association of demand and supply (Amacher & Pate, 2013). Government involvement in this market should be restricted to correcting market inefficiencies. Otherwise, government involvement may not affect the firms’ ability to price their products because these firms are price takers. International trade distorts this market because there is no free mobility of factors of production and transport costs are high to alter the prices.    

 Monopoly Market Structure.

A pure monopoly market structure is existent when there is only one single, dominant firm producing a good or service with no identifiable close substitutes. This market structure is characterized by only one firm that is synonymous with the industry. This firm produces a product for which there is no close substitute. This firm is, therefore,by default the price maker in this market. The firm’s decisions affect the market prices directly because it is the only present supplier. This market is lastly typified by the existence of strict barriers to entry into the market(Dunne et al., 2013). The sources of entry barriers range from large economies of scale, control of vital production resources and protection by Gazette law. The monopoly firm will possibly experience supernormal profits both in the short and long runs because of lack of close substitutes to provide competitive pressure. The railway networks of most countries are an example of a monopoly market structure.

Effects of High Entry Barriers.

High entry barriers are a normality in this market structure. These ensure that the monopoly firm is guarded against competition from other sellers and close substitute products. The firm will experience the same results regarding profits both in the long run and in the short run. The absence of competitors allows this firm to produce at a level where price is equal to marginal cost but not equal to the minimum average cost. This producer will likely charge a higher price than a firm in a perfectly competitive market for the same quantity of goods. This firm is most times not cost efficient since no matter its cost structure there are no competitors to pressure it to produce at the minimum average cost level(Dunne et al., 2013). There is no incentive fordeveloping a substitute product in this market structure. This is either outlawed or just a waste of time because the market can only accommodate one seller.

Price changes in this market are a preserve of the producer. Changes in quantity suppled will drive prices in the direction the producer wants. Monopoly firms in most cases deal in highly inelastic products such as electricity generation and distribution. A proportionate change in the price of these products will cause a less than proportionate change in the quantity supplied. This is partial because there are no close substitutes to these products. Government involvement in this market will either reinforce it or break it. If the government decides to allow entry into the market by for instance privatizing such a firm, then the market structure changes with the entrance of other sellers. If the government protects this firm, then the monopoly status of the firm is reinforced. The firm will price its product at a level higher than its minimum average costs (Amacher & Pate, 2013). International trade can provide competition to this market structure but only to the point it is allowed by the government. If there is the presence of a substitute good in the international arena, then the firm may not be a monopoly in as much as it wishes to engage in international trade. The monopoly status of the firm will depend on its ability to maintain its barriers to entry and absence of close substitutes in the international market.

Monopolistic Market Structure.  

Monopolistic Market Structure comprises of many sellers and buyers with the sellers offering similar but highly differentiated products. Each seller has a certain small portion of the total market share. The differentiated products make this market different from the perfect competition market. Products are differentiated in the form of packaging, branding, advertising and pricing strategy(Bar-Isaac, Caruana & Cuñat, 2012). Like the perfect competition market, this market has easy entry and exit out of the market with no costs attached to this in the long run. The firms make independent decisions and possess information asymmetry. Examples of such markets include the toothpaste market and fast food restaurants.

Effects of High Entry Barriers.

High entry barriers will prevent more firms from entering the market. If the existing markets are making economic profits, then the high entry barriers will cushion them from additional competition from new firms and hence prevent them from breaking even and continue enjoying high profits. The firms are therefore likely to continue enjoying economical profits in the long run under such barriers. Cost efficiency is only enforced by the presence of many competitors as buyers will tend to prefer lower prices that lower a seller’s costs until the point where it equals the minimum average costs. At this point, the seller is producing cost efficiently. High entry barriers prevent this from happening. The firm is unlikely to produce at cost efficiency since they will be enjoying some form of market power over their market share. Inefficient firms are likely to survive in the long run since they will be producing at a level of average cost that is higher than that of firms in perfect competition markets. Such firms earn normal profits and will prefer these normal profits which are lower than their opportunity cost(Bar-Isaac, Caruana & Cuñat, 2012).

Entrepreneurs will not have any incentive for producing substitutes in this market structure. This is because firstly, the market deals with similar products and secondly due to the barrier to entry (Amacher & Pate, 2013). The exception is only given to entrepreneur already in the market, and their innovation should be in either the branding or differentiation. Prices in this market reflect the value of differentiation. Firms in this market will, therefore, respond to price change by undertaking further branding and product differentiation. Firms in this structure will most likely produce elastic goods and brand these goods, so that price changes will not affect their market shares adversely. Government involvement in this market will affect pricing either positively or negatively. An increase in taxation for instance for these products would raise prices, and the reverse holds true. International trade opens the market to more substitute goods whose prices are dependent on the production costs of the different countries. Lowerprices in the international market will influence the market to lower general prices or risk losing buyers to the lower prices since the goods are similar.

Oligopoly Market Structure.

Oligopoly market structure contains a few large firms dealing in homogeneous or differentiated goods. These firms are interlinked and compete both in prices and quantities. A single firm’s decision affects the other firm(s). These firms offer standardized products that involve widespread advertising. Entry into this market is not impossible but very hard considering the large initial capital outlay required and the high economies of scale that the preexistent firms are operating at(Ciliberto & Tamer, 2009). These firms offer products that are very good substitutes to others. Oligopoly firms have a choice of colluding and hence functioning as a monopoly, but they tend to cheat on each other and hence prefer competing with one another. These competing firms view their individual demand curves as highly inelastic for price reductions and elastic for price increases. The collusion of these firms forms a cartel a good example being the Organization of Petroleum Exporting Countries (OPEC). Though many countries have anti-trust laws that prevent cartels from emanating and taking advantage of buyers.

Effects of High Entry Barriers.

The nature of this market structure is inhibitory to entrants. These barriers effectively prevent new firms from providing competition to the already existing firms. High entry barriers will not have any significant effect on the long run profitability of these firms because they own sizeable shares of the market already. Their long run profitability will only be affected by their competitors’ actions regarding pricing and quantity produced. These firms’ competition regarding price and quantity ensures that their actions are cost efficient. Costs, in the long run, are raised because of advertising competition among these firms. It is unlikely to encounter an inefficient firm in this market structure though a collusion, in the long run, may ensure its survival. However, if it is unable to cope with the predatory pricing of its competitors, then it might not survive(Ciliberto & Tamer, 2009). The incentive present to entrepreneurs is only dependent on their ability to be able to penetrate the market past the entry barriers. Otherwise, there is no incentive. Firms will respond strategically to any price changes because of their competitors’ actions. These firms respond by either raising their prices likewise or retaining their prices. These firms deal in inelastic products though these products are less inelastic compared to those of the monopoly market. This nature of their products ensures that their price changes do not affect demand and hence quantity supplied more that proportionately. The role of government will have little influence on the firm’s ability to price their products since these firms enjoy large profits and operate under high economies of scale. Nevertheless, the government can enact policies against certain forms of predatory pricing. International trade widens these firms’ market shares. Firms can look for places where production costs are lower and hence maximize their profit shares.

Competitive pressures are only present in market structures where there is an easy entry into the industry. Markets where entry is restricted are shielded form competitive pressures by the barriers to entry(Vives, 2008). This is the case with the monopoly market. Barriers to entry in terms patents and control of vital resources will protect the monopolists form competitive pressures. The monopoly market is my best preference for selling products alluding the fact that there’s no competition present and super-normal profits are earned both in the short and long run periods. On the other hand, I would prefer buying products form the perfect competition market. This is the products’ prices are determined by the forces of supply and demand solely with no government involvement. Prices are guaranteed to be lower and customer friendly. Lack of transport costs and easy mobility of factors of production also ensure that the cost of production is low translating to low prices of goods.

 

 

 

 

 

 

 

 

 

References.

Amacher, R., & Pate, J. (2013). Microeconomics principles and policies [Electronic version]. Retrieved from https://content.ashford.edu/

Bar-Isaac, H., Caruana, G., & Cuñat, V. (2012). Search, design, and market structure. The American Economic Review102(2), 1140-1160.   

Ciliberto, F., & Tamer, E. (2009). Market structure and multiple equilibria in airline markets. Econometrica77(6), 1791-1828.

Dunne, T., Klimek, S. D., Roberts, M. J., & Xu, D. Y. (2013). Entry, exit, and the determinants of market structure. The RAND Journal of Economics44(3), 462-487.    (Dunne et al., 2013)

Melitz, M. J., & Ottaviano, G. I. (2008). Market size, trade, and productivity. The review of economic studies75(1), 295-316.

Vives, X. (2008). Innovation and competitive pressure. The Journal of Industrial Economics56(3), 419-469.

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