Chapter Twenty: Ownership and Market Structures
By now, you understand that a market requires business owners, consumers, and a basic economic structure or model to follow. The most common types of markets include those that are pure competition, monopolistic, oligopolies, and monopolies.
A purely competitive market is as a market in which no individual business can influence the market price on its own. In this type of market, it is industry in general that creates the influence. The interaction between the industry and buyers determines the price. An individual firm takes prices as given and then decides how much to sell at this price. This is why an individual firm is called price taker.
Pure Competition markets all have the following distinguishing characteristics:
- Large number of buyers and sellers: The number of sellers is so large that output by an individual seller is an insignificant proportion of the total output of the industry.
- All firms produce homogeneous products: Goods produced by different firms are homogeneous so that all the buyers are willing to pay the same price for the products of all producers of a good. So, no producer is in a position to charge a different price of the product it produces. A uniform price prevails in the market.
- There is perfect knowledge about market and technology: This means that all producers and consumers are fully informed about the market. So, no consumer is prepared to pay a price higher than what is being charged in other parts of the market. Also, no producer sells its product at a price lower than the price charged by other producers simply because he is fully informed about the market. Each business has perfect knowledge about the technology. Each producer is aware of all the available techniques for producing a good. All of these details ensure the same per unit cost by all the firms in the industry.
- Freedom of entry and exit to firms: There are no obstacles in the way of new businesses joining the industry or existing ones leaving it. This ensures that there are neither above average profits, nor exorbitant losses by any firm over the proverbial long run. In the “short run”, however, profits and losses are possible because during this period firms are not in a position to enter or leave the industry. If firms are making profits, new firms enter and raise the total supply of the industry. This reduces market price and can reduce profits. Over the long term firms are incurring losses; the existing firms start leaving the industry; and this reduces the total supply. This raises prices till any losses are eliminated.
A monopoly is a market situation in which there is only one firm producing a good, or in which a single business seems to dominate the entire market.
Monopoly markets all have the following distinguishing characteristics:
- A single seller: There is only one producer of a product. It may be due to some natural conditions prevailing in the market, or may be due to some legal restrictions in the form of patent, copyright, sole dealership, state monopoly etc. Since there is only one seller, any change in the supply plan of that seller can have substantial influence above the market price.
- No close substitute: A producer faces competition from its substitutes. A good may have many substitutes, but not all substitutes offer competition. The substitutes which are too costly and inconvenient do not offer any competition. Such substitutes can be called “distant substitutes”. The substitutes that can be conveniently used in place of the given product, and which are available at a similar price, offer competition. These may be called “close substitutes”. A monopoly market has no such close substitutes, and does not face any competition.
- No freedom of entry: There is no freedom for the new firms to enter the industry. This may be due to some government order. For example, production of many defense goods can be seen as monopoly of the government due to national security considerations. Similarly, production of some public utility goods is also monopoly of states in the US. For example, electricity, water supplies, etc. are often called state monopolies.
Monopolistic competition is a situation in which the market is basically a competitive market but with some elements of a monopoly as well.
- Large number of buyers and sellers: The number of sellers is so large that output by an individual seller is an insignificant proportion of the total output of the industry. As such any change in the output plan of a single producer, assuming that there is no change in output by other producers, has a negligible effect on total output and hence no influence on the market price. Similarly, the number of buyers is so large that an individual buyer purchases an insignificant proportion of the total output sold in the market. As such any change in quantity demand of other buyers has negligible impact on total market demand and hence no influence on market price. To sum up, no individual seller or an individual buyer is able to influence the market price on its own.
- Firms produce differentiated goods: It implies that buyers differentiate among the products of different firms. It may be on account of different brand names, packing, color, shape, and the friendly behavior of the seller or any other consideration. These differentiated products are close substitutes of each other. Since a group of buyers prefers the product of a particular producer, that producer enjoys some monopoly in the product and is in a position to influence in the market for it. This makes monopolistic competition different from pure competition.
- Firms have perfect knowledge about market and technology: All producers have the perfect knowledge about the market price and the technology. All consumers also have the knowledge about the market so that they can conveniently shift from one substitute to another in the event of bigger price difference in the products of different firms.
- Freedom of entry and exit to the firms: There are no obstacles in the way of new firms joining the industry or existing firms leaving the industry. This ensures that there are neither above average profits, nor tremendous losses by any firm in the long run. In the short run, profits and losses are possible because during this period firms are not in a position to enter or leave the industry. If firms are making profits, new firms enter and raise the total supply of the industry. This reduces market price and wipes out profits. However, in the long run firms are incurring losses. The existing firms start leaving the industry and reduce the total supply. This raises the price until all the losses are wiped out.
Oligopoly is an important form of imperfect competition where there are few (two to ten in most cases) sellers in the market selling homogeneous or differentiated product.
Oligopoly markets all have the following distinguishing characteristics:
- Interdependence: The most important feature of oligopoly is interdependence in decision making between the few firms which comprise the entire industry. This is because when the number of competitors is few, any change in price, output, or advertising technique by a firm will have a direct effect on the fortune of rivals who will then retaliate by changing their own prices, outputs or advertising techniques as the case may be.
- Importance of advertising and selling costs: A direct effect of interdependence of oligopolists is that the various firms have to employ various aggressive and defensive marketing weapons to gain a greater share in the market or to maintain their share. For this, various firms have to incur a good deal of costs on advertising and other measures of sales promotion.
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