Introduction
A market structure is the number and size of buyers and sellers who are interested in a product or service. Apart from buyers and sellers involved in the market, market structures for a commodity also include the likely entrants. Because of the differing level of competition within market, different market structures emerge with varying effects in the market. Thus, Firms have to know not only about costs, but also about revenues when they make pricing and output decisions. To recognize, for instance, the relationship between output, revenues, and price, a firm has to know the structure of the market or industry in which it is selling its product (Maurice & Thomas, 2008).
There are various market structures, all dependent upon the extent to which buyers and sellers can assume that their buying and selling decisions do not affect their price. This paper discusses the following market structures: competitive markets, monopolies, and oligopolies. Based on their differences, the paper looks at the characteristics, economics in terms of profit maximization, and the role of each market form.
Types of Market Structures
Perfect Competition
At one stage, when buyers and sellers correctly assume that they cannot affect the market price, the market structure is one of perfect competition. A perfectly competitive market structure assumes the following characteristics:
- The product that is sold by the firms in the industry is homogeneous.
- Any firm can enter or exit the industry without any serious impediments.
- There must be a big number of participants in the market who do not influence the price individually, and
- There must be complete information; both buyers and sellers must know about market price, product quality, and cost conditions (Maurice & Thomas, 2008).
In essence, a perfectly competitive firm is such a small part of the total industry in which it operates, and that it cannot significantly affect the product in question.
Economics and Role of Perfect Competition
A perfectly competitive market structure results to various judgments regarding solutions to some economic problems, such as how much is produced, price charged, and methods of production. Since an individual firm has to accept the price set by the market, the supplier must determine the quantity to produce as per the available price. A supplier will produce the quantity that maximizes the profit of the firm; this is where the marginal cost of production equals the market price.
Thus, the total production of all companies in the market determines the market supply of the commodity under consideration. This market supply of the commodity, together with the collective demand of the product by all buyers, determines the price of the market. For a firm to maximize profits, it has to look at cost and revenue. If the marginal revenue exceeds the marginal cost, a firm will continue to produce. A firm stops to produce when marginal revenue is equivalent to marginal cost, hence profit maximization (Case & Fair, 1999).
Perfect competition is desirable in the society since the price charged to people equals the marginal cost of production of every supplier. It ensures that consumers are charged at a reasonable price. Another importance is that the collective output in this market structure is larger than other market forms. In essence, perfect competition ensures democracy since no single firm can dominate the market.
Monopolistic Competition
Monopolistic competition is described by the existence of many sellers, just like the perfect competition. However this market structure is also characterized by the existence of differentiated products. In essence, the products produced are not termed as identical due to different composition, change in packaging, and different brand image or advertising. Consequently, a monopolistic competitive market is characterized by ease of entry into the industry (Maunder et al., 2000).
Economics and Role of Monopolistic Competition
A firm in this market structure produces the amount that maximizes its profit. More so, the firm stops supplying when marginal revenue coincides with marginal cost of production. However, individual firms can determine the price of their products because of the existence of different product range in the market. This price marking power is considerably small, as there are many firms in the market. Because price is a determinant of demand, price charged for a commodity is different from the marginal revenue of the product. The net result of maximizing profit in this market structure is that prices are relatively high.
Monopolistic competition gives firms the power to set prices for their products, and in doing so the price associated with a product is considerably higher than the marginal cost. In addition, this market structure ensures that there is fairness in the industry.
Oligopoly
Oligopoly is characterized by the interdependence of companies in the industry. This is because of few firms in the business. Unlike the case of monopolistic competition, when a company in an oligopoly market structure changes its price or output, it has diverse effects on its competitors in regard to their profits. In addition, an oligopoly structure experiences the concept of economies of scale. This implies that when the level of production rises, the cost per unit of product reduces for the use of any plant (Maunder et al., 2000). This is an advantage for a larger supplier. Consequently, there is huge barrier to entry in this market structure because of large financial needs, accessibility of raw materials, and convenience of the required technology.
Economics and Role of Oligopoly
Output and pricing in oligopolies vary because of many theoretical frameworks that describe the markets. For instance, if a firm reduces its price, competitors settle this by cutting their prices. Though, if it increases its price, competitors may not match the price. Thus, prices in an oligopolistic market structure may be constant for a long period of time. Therefore, oligopoly is desirable because it provides a fair competition in the market since most firms in the industry do not collude.
Monopoly
This is the converse of perfect competition, in which only one seller controls the output and pricing decisions of a product. A monopoly can be enacted by the government or if the company owns the whole supply of a required raw material. Thus, there is no competition in this market structure. In the case of new entrants, monopoly blocks entry of new firms; especially by law or large financial requirements.
Economics and Role of Monopoly
Like in the case of monopolistic competition, a monopolistic company also capitalizes on its profit by producing up to the state where the marginal revenue is similar to the marginal cost. A monopolistic firm can increase the amount of sales by reducing its price and inducing buyers. Monopoly plays a major role in regard to price regulations by the government. In case of natural monopoly, this market structure is considered desirable to the economy since a firm can survive in the market (Case & Fair, 1999).
Conclusion
Markets are the important aspects of a capitalist economy, and different degree of competition results to various market structures. Based on the different effects of these market structures, economics consider some markets desirable from others. This paper has discussed different market structures and their strategies in maximizing profits. The market structures analyzed include competitive markets, monopolies, and oligopolies.
Competitive market structures are featured by large number of firms; these firms have less or no control of the market price. Firms can easily enter a competitive market. Competitive firms produce up to the level where there is profit maximization, and thus the price is determined by the demand of buyers. In an oligopoly, only few companies produce a product, therefore firms can have less price control. In the case of monopoly, there is only one seller who also determines the price. In this case, oligopolistic and monopolistic markets experience high barriers to entry of new firms. These barriers include huge investment, accessibility of raw materials, desirable technologies, and government regulations.
References
Case, K.E. & Fair, R.C. (1999). Principles of Economics. 5th Ed. New Jersey: Prentice Hall.
Maunder, P., Myers, D., Wall, N., & Miller, R. (2000). Economics Explained. London: HarperCollins Publishers.
Maurice, S. & Thomas, C. (2008). Managerial Economics. 9th Ed. New York: McGraw-Hill.