Characteristics of the Market Structures - Coursework Example

Research essay Student Course Professor Date Introduction All firms aim to maximize profits from their output by ensuring marginal Revenue is equal to marginal cost. However practically they operate in different economic and business environments. These environments may be based on the prevailing market conditions, which influence how the firm will make decisions affecting its behaviour. Various characteristics are common to some firms or markets, for example the average strength of sellers or/and buyers, their, number, the level of collaboration among them, the competition between them, product differentiation, the level of difficulty to enter or exit the market, among many more. The four categories of market structures have different characteristics. This paper seeks to discuss the key characteristics of the four market structures. Additionally, the paper will evaluate the concept of negative externalities. Monopolistic competition A monopolistic competition is a market structure with many sellers of a certain commodity; however, the product of each differs from one seller to another. Consequently, one of the key attributes of a monopolistic market is product differentiation. Product differentiation can be described as a salient characteristic of monopolistic competition. It basically implies that at any particular time, the consumer should be provided with a wide range of brands, styles, types and quality graduations of a given product. Product differentiation aims at enabling the buyers to distinguish between one product and from another. Advertising is high as the firms strive to inform the consumers of the advantages of their special products. Firms aim at having their brand name easily recognized and develop consumer confident in their products (Jain and Ohri, 2010). Firms within the monopolistic competition also have limited control on the price of the product. The AR and the MR curves of the firms operating under the monopolistic market slope down as that of a monopoly, as indicated by figure 1.0. This implies that when a firm wants to sell more of its products it has to reduce its price per unit. The existence of product differentiation also enables a firm under monopolistic competition to have minimal control on the price of the product. Also, limited control over price is influenced by a large market and close substitutes that make firms to have less power when it comes to controlling the price of their products (Jain and Ohri, 2010). Figure 1.0 Another attribute of the monopolistic market is that entry it is unrestricted. New firms can easily venture into the market and begin their production of substitute products that exist in the market. This occurs in businesses such as restaurants, barbershops and other types of retail activities. Due to the relatively free enter; economic profits are eliminated eventually (Baumol and Blinder, 2011). Monopolistic firms also use the non-price competition. Different firms can compete without changing the price of a certain products. For example, a company can offer free gifts to the customers without changing the price of the products. By using such an approach, the company is able to attract more customers through the use of non-price competition (Jain and Ohri, 2010). The existence of imperfect knowledge is another key attribute of monopolistic competition. Buyers and sellers do not have perfect knowledge concerning the price of a product due to product differentiation. For instance when buyers develop a liking for a certain brand of a wide range of differentiated products, they have to purchase it although the price may be a little higher that the products offered by other firms (Jain and Ohri, 2010). A case of monopolistic competition can be seen in the restaurant business where firms can be selling a similar product which is food, however the seller has to differentiate their products from that provided by other sellers. In order to survive in the restaurant business the sellers have to make their products different from that of other existing competitors. Oligopoly The oligopoly market structure covers scenarios that are not in line with monopolistic competition, perfect competition and monopoly models. Moreover, economists have not been able to analyse one single model that sufficiently explains the behaviour of all businesses in an oligopoly (Mukherjee, 2002). Nonetheless, this market structure does explain more real world situations than the theories explained in other market structures. A key characteristic of oligopoly is the existence of few firms in which most or all firms are relatively large. Supply in the industry is therefore concentrated in the hands of the few firms. As each firm has a big market share, the activities and decisions of each firm affect the actions of its competitors. If a company does not respond appropriately to its competitors activities, it risks losing a portion of its market share and profits (Anderton, 2006). An additional characteristic is that firms in oligopoly are interdependent. The action of a large firm is also bound to affect another firm. For instance, if a certain firm decides to adapt policies that aim at increasing sales, such action can is an expense to other firms in the industry. One firm is likely to make more sales only through taking the sales of other firms (Anderton, 2006). Firms in the oligopoly market structure have a kinked –demand curve, as illustrated by Figure 2. The kindled demand curve demonstrates the high level of interdependence found among firms. Each oligopoly faces a market demand curve that is determined by the price and output decision of other firms in the oligopoly, this is basically the main contribution of the kinked- demand theory. The demand curves interconnect at point b making the oligopolist to face a kindled – demand curve marked abc (Mifflin, 2014). Kinked demand curve An oligopolistic market is also characterized by the existence of strong barriers to entry. Some of the main barriers to entry include economies of scale, threats of price cutting absolute cost advantage, licencing and patent rights and absolute cost advantage. The existence of barriers to entry assists companies to earn profits in the long-run (Ghai and Gupta, 2002). One case example of oligopoly is the Australian airline industry. The industry has only a few firms providing an identical product. Based on the fact that the industry has a few sellers , the actions taken by a particular firm in the market can have an effect on the profits of other firms. Perfect competition A perfect competition is a market structure that is characterised by the existence of a large number of sellers and buyers essentially of the same product. The existence of homogeneity in the products rules out the issue of rivalry that arises in advertising and quality differences. Due to existence of homogeneity, consumers may not prefer a particular firm’s product and mostly choose the product with the least price (Tucker, 2008) Another attribute of a perfect competition is that the market is easy to penetrate and exit. This indicates there are no economies of scale. Firms already in the market can easily halt production and exit the market (Tucker, 2008) Every participant in the market is usually too small to influence the price in the market. Individual buyers and sellers are therefore price takers. Firms and customers take the price in the market as prescribed and develop their buying and selling strategies accordingly. The price of a product is therefore determined by the demand conditions and market supply over which the firm does not have power to influence (Tucker, 2008). Figure 3.0 illustrates the demand and supply curve of the perfect competition market. Figure 3.0- Supply and Demand Curve in a Perfect Competition A key factor to take note of is that the demand curve for market slopes downwards while that for the individual firm is perfectly elastic or flat. This signifies the fact that the firms have to take the price that exists in the market. A case of the perfect competition can be associated to the agricultural product markets, the retail market and the unskilled labour markets. In the agricultural egg market for example, the egg farmer produces eggs that are identical to those provided by other farmers. Likewise, each buyer purchasing a small portion of the aggregate production and there is no possibility of the buyer to obtain a volume discount or a cut rate. This is because the buyers and sellers are able to transact on many eggs as they want at the existing price, thus both the egg market and the price takers are perfectly competitive (Tucker, 2008). Monopoly Monopoly market structure has one firm supplying or dominating the market. The firm’s product has no close substitutes and the size of the market can be small or large. The dominating firm in this market structure is called a monopolist. The firms demand curve is not different from the markets demand curve. The firm is synonymous to the industry. Moreover, the monopolist is the price setter and has a significant market power. Entry into the market is hard and expensive as the large firm being most efficient as it enjoys economies of scale (Wyant, 2013). Contrary to perfect competition market structure, the price set is not equal to the marginal revenue in a monopoly. The monopolist can set its price at the intersection between the profit maximizing quantity and the demand curve. As the demand curve lies above the Marginal Revenue curve, the price is higher than in a perfect competition market structure. The average revenue curve is also depicted in the demand curve since price is determined by the demand curve and price is equal to average revenue (Wyant, 2013). All other factors held constant, then a monopolist will prefer to sell a lower quantity at a high price unlike what is the norm in perfect competition. The firm shows no or little responsiveness to the consumers’ needs. Governments therefore try to control such firms by; setting price controls where they can set a minimum or maximum price for certain goods or services, nationalizing the monopoly and splitting the firm into two or more firms that will compete against each other. A case example of monopoly is the natural gas company. The company dominates the firm in addition the product does not have any other close substitute. Negative externalities A negative externality is a cost incurred by a third party after an economic transaction. Here, the third party does not refer to the producer or the consumer who are the first and second party respectively. It may include an organization, individual or resource that is affected indirectly. A negative externality can be defined as a spill over that affects a party not directly involved in the economic transaction (Hubbard, et al , 2014). It may be either a production externality such as emissions from factories or a consumption externality that is detrimental to others who are not compensated by the individual. Why there may be a case for government intervention to address them Where there is no or minimal regulation in a market, producers or consumers will not take responsibility for the negative externality and they end up being transferred to society. Producers thus incur lower marginal costs than they should and pass the high costs on society. For instance, as shown in the diagram below, a negative externality such as pollution from industrial pollution raises the (MSC) Marginal Social Cost above the (MPC) private marginal cost (Hubbard, et al, 2014). The supply curve is increased and resulting in more units of the product being produced and sold than is efficient. The marginal benefit and the marginal cost are not equal causing a deadweight welfare loss. Government intervention is needed to assist in “pricing” or regulating the externality to ensure efficiency and that firms do not neglect their responsibility (Hargroves and Smith, 2006) Ways of correcting the negative externalities. Taxing The government can impose a pigouvian tax that will reduce the production and consumption of a particular good. This will inevitably increase the production cost and other costs related to the goods production and sale (Hubbard, et al, 2014). For instance, the government can implement a tax on cigarettes to discourage production and consumers from purchasing it. One of the benefits of this remedy is that it will help the government to earn more revenue from the commodity or service, which can be used for alternative purposes. Also, producers will reduce production due to the higher costs imposed and avoid the externality. Consumers might try to avoid the additional cost of consuming the good and reduce their purchases (Hubbard, et al 2014). The limitation linked to the use of tax as a remedy is that it might only adjust the spending of the consumers or firms who will find the tax inconsequential compared to the benefits they earn (Hubbard, et al 2014). Another disadvantaged is that the consumers may decide to appropriate more of their earnings or savings on the good instead of reducing their consumption. Also, it may be challenging to determine who is causing the externality. Government regulation This is where the government can declare the action causing the negative externality illegal. Any firm or company found guilty of the action can be heavily penalized or necessary action taken. For instance, various governments have regulated oil spills and company’s ships found guilty of the act are heavily penalized. This will assist to reduce instances causing the negative externality and recover money to help fix harm caused by the externality. Alternatively, the government can issue permits that legally allow pollution up to a certain limit (Hall and Lieberman, 2008).  One of the benefits of government regulations is that the actions leading to the negative externality will be avoided by companies due to the heavy fine. Furthermore, the Fines charged can help raise funds that can be used to fix the damage caused and make companies more careful in avoiding the externalities (Hall and Lieberman, 2008).  The disadvantage linked to government regulation is that the penalties imposed may not exceed the financial return thus make companies just pay the penalties and continue causing the damage. In addition, monitoring the firms to ensure they are not polluting especially late in the night, or causing negative externalities may be too expensive to be efficient. Sometimes it may be difficult to measure or price the level of the negative externality. For example, what is the cost of air pollution from the smoke of a car (Hall and Lieberman, 2008).  The Coase Theorem Alternatively, the polluters and the affected third party can come to a bargaining solution where the third party may be compensated for the damages. According to Robert Coase, if property rights are assigned and people negotiate with each other at low cost, they may come up with efficient solutions to the negative externalities (Hubbard, et al, 2014). For example, property rights can be given to the community who will set the regulations and price on the negative externality controlling the firm’s actions and make them pay fully for their actions. One of the benefits of the approach is that it requires explicit government intervention to regulate or tax the externality. Additionally, compensation would contribute to the social benefit of the society. In addition, it increases responsibility and accountability to the property rights and negative externality (Hubbard, et al, 2014) The existing disadvantage is that it may result in long tiresome court proceedings that may not be beneficial to the affected party. Also, firms may still cause externalities ready to pay the little amount charged for the pollution or damage (Hubbard, et al, 2014) Case study of externalities in the current market Carbon emission is one of the impending environmental challenges within the Australian today. This is because emission of carbon dioxide contributes to environmental as well as social issues such as global warming. It is a negative externality as everyone else who inhales the carbon dioxide feels the cost. Moreover, carbon intensive factories cause externalities where the private cost of production is less than the social cost. When looking at the Aluminium industry for instant. It can be stated that the sector has been instigating negative externalities due to the emission of carbon dioxide . Hetherington, (2008) therefore proposes that there is need for the industry to cut down on its level of carbon emission while it still continues to provide employment to the people. The Australian government has evaluated various alternatives to deal with these externality. Various parties support a carbon tax as a means of dealing with Australian emissions. One of the approaches is the used of carbon tax as a form of tax levied on energy sources that release carbon dioxide. It is a type of pollution tax. This can be done by imposing a tax on burning fossil fuels, petroleum products, coal, among others. In a free market, the externality is not considered in the price that results in the inefficiency and excess consumption (Hall and Lieberman, 2008).  Then, the cost of carbon is neglected. Placing a cost on the externality aims at reducing emissions of car bon dioxide and thus lessening global warming. Where SMC represents Social Marginal Cost which is the cost, passed on to society. PMC is the Private Marginal Cost or the cost to the carbon emitting individual or firm and PMB is the benefit to the individual or Private Marginal Benefit. At point Q1 the equilibrium quantity is sold and there is no externality. At Q2 there is social inefficiency and the negative externality results in this quantity of production.      The optimal production amount is Q 1 but the negative externality leads to a production of Q1. In a free market carbon is over consumed resulting in a welfare loss to society. The deadweight welfare loss is highlighted in the area shaded red. Another approach used by the government is the use of incentives whereby individuals who conserve the environment are provided with incentives (Hall and Lieberman, 2008).  Conclusion The above discussion has evaluated the key characteristics of the four market structures, which include the monopolistic competition, the perfect competition, monopoly and oligopoly. From the discussion, what is evident is that each market structure has different attributes, which make it distinct from the other market structure. Thus, firms should venture in a particular market after effectively examining the key attributes. The paper also examined the concept of negative externalities and identified some of the approaches that can be used in dealing with negative externalities. Some of the approaches include; taxation, The Coase Theorem and government regulation. The paper also examined the case of carbon emission in Australia as a negative externality. In conclusion, it can be stated that it is essential for the government adopt more proactive approaches that can deal with the issue of negative externalities. References Anderton, A, 2006, Economics, FK publication Baumol, W and Blinder, A, 2011,Microeconomics: Principles and Policy, Cengage Learning, . Jain, T and Ohri, K 2010, Principles of Economics , FK publications . Ghai and Gupta, 2002, Microeconomics Theory And Applications Sarup & Sons. Hetherington, D, 2008, The Full-Cost Economics of Climate Change Aluminium: A Case Study, percapita. Hall, R and Lieberman, M, 2008,  Microeconomics: Principles And Applications. Mason, OH, Thomson/South-Western. Hubbard, G. R., Garnett A. M., & O’brien A. P, 2014, Microeconomics, Australia, Pearson. Hargroves, K and Smith, M. H, 2006, The Natural Advantage Of Nations Business Opportunities, Innovations And Governance In The 21st Century, London, Earthscan. Mifflin , H, 2014 , Firms in the oligopoly market structure have a negatively sloping demand curve, Cliffs Notes. Mukherjee, S, 2002, Modern Economic Theory. New Age International. Tucker, I 2008, Microeconomics for Today, Cengage Learning. Wyant, J, 2013,  Basic Economics For Students And Non-Students Alike, Sage. Read More