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Investigation of Market Structures

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Investigate a range of market structures

( 1.1 + 1.2 )

Type of Monopolies :

  • Pure Monopoly : One firm dominates the market and can maintain this because of high barriers to entry
  • Natural Monopoly : One firm is able to supply the entire market at a lower cost than two or more firms

Natural Monopoly Definition: A monopoly describes a situation where all (or most) sales in a market are undertaken by a single firm. A natural monopoly by contrast is a condition on the cost-technology of an industry whereby it is most efficient (involving the lowest long-run average cost) for production to be concentrated in a single firm. In some cases, this gives the largest supplier in an industry, often the first supplier in a market, an overwhelming cost advantage over other actual and potential competitors. This tends to be the case in industries where capital costs predomination , creating economies of scale that are large in relation to the size of the market, and hence high barriers to entry , examples include public utilities such as water services and electricity.

For instance in New Zealand is electricity , electricity generation split from line-transmission and retail activities. I chose New Zealand electricity to be my example because the electricity in New Zealand is a huge industry, like utilities, require enormous initial investment and New Zealand electronic is a natural monopoly elements. However , It can be represented by the downward – sloping average cost curve.

Graph 1 : Cost/Price/Revenue

MR = MC

P’ Supernormal profit

P EMC

AC

AR =P= D

Q MRQuantity

The monopolist increase. The price by reducing electricity output. The given rise huge profit. This profit is earned exclusively for monopoly advantage. This abnormal, profit is the profit that arises over and above the normal profit. Abnormal profits are earned without entrepreneurial effort.

Likewise, all of the companies always want to achieve the maximum profit or minimizes a loss so the best way to do that is to produce the quantity and charge the price at MR = MC (Marginal Revenue = Marginal cost) point. If the electricity becomes higher price, people have no choice but still need to use it and pay for it . As a result, it might produce at the same Quantity but charging price and it would charge a higher price at P become Subnormal .Government imposes a maximum price of P ‘’resulting in an output of Q’ where P=MC .This will result in subnormal profits .

Graph 2 :

Cost/Price/Revenue

MR = MC

P’ Supernormal profit

Subnormal profit E MC

P’’AC

AR =P= D

Q Q’ Quantity

MR

SUB-NORMAL PROFIT - is any profit less than normal profit. In the long run a firm will leave an industry if it continues to make only sub-normal profits. Also called an economic loss.

  • A subsidy : A subsidy is a grant or other financial assistance given by one party for the support or development of another. Subsidy has been used by economists with different meanings and connotations in different contexts. According to one OECD definition, “A subsidy is a measure that keeps prices for consumers below market levels, or keeps prices for producers above market levels or that reduces costs for both producers and consumers by giving direct or indirect support." The most common definition of a subsidy refers to a payment made by the government to a producer. Subsidies can be direct – cash grants, interest-free loans – or indirect – tax breaks, insurance, low-interest loans, depreciation write-offs, rent rebates .This form of support can be legal, illegal, ethical or unethical. Subsidies are used for a variety of purposes, including employment, production and exports.

A production subsidy encourages suppliers to increase the output of a particular product by partially offsetting the production costs or losses.

Subsidies are often regarded as a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports. Subsidies may distort markets, and can impose large economic costs. Financial assistance in the form of a subsidy may come from one's government, but the term subsidy may also refer to assistance granted by others, such as individuals or non-governmental institutions.

Graph 3 :

It is difficult to determine where AC is. It involves finding the value of normal profits. Setting P=AC. Consumers will be able to pay a lower price. This type of regulation does not require any remedial action by the govt in the form of a subsidy.

Cost/Price/Revenue

DWL

MC

AC

AR =P= D

Q MRQuantity

DWL = deadweight loss

A deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, either people who would have more marginal benefit than marginal cost are not buying the product, or people who have more marginal cost than marginal benefit are buying the product.

Minimum wage and living wage laws can create a deadweight loss by causing employers to overpay for employees and preventing low-skilled workers from securing jobs. Price ceilings and rent controls can also create deadweight losses by discouraging production and decreasing the supply of goods, services or housing below what consumers truly demand. Consumers experience shortages and producers earn less than they would otherwise. Taxes are also said to create a deadweight loss because they prevent people from engaging in purchases they would otherwise make because the final price of the product will be above the equilibrium market price.

(1.3)

  • Perfect competition : Describes a market structure whose assumptions are strong and therefore unlikely to exist in most real-world markets. Economists have become more interested in pure competition partly because of the growth of e-commerce as a means of buying and selling goods and services. And also because of the popularity of auctions as a device for allocating scarce resources among competing ends. Perfect competition exists when there is a very large number of small companies trading in the same or very similar commodities or services, and none of whom can affect the price by increasing output or restricting it.

Also, the entrepreneurs have perfect knowledge about costs and prices across the market. Everyone knows the state of everyone else's costing and has perfect information on the likes and dislikes of buyers. Also, there are no barriers to entry into the market. Anyone can join if they believe there is money to be made.But as soon as one trader begins to advertise or use a brand name to attract trade, the market perfection will be lost. When each trader tries to create a niche in the market, by claiming higher quality or a long-established family tradition for service, the competition will become less than perfect .You can see that perfect competition is never likely to exist in reality. Some simple agricultural markets in the developing world will fit the model. It is often said that the petroleum market is perfectly competitive but that can't be true. The barriers to entry are enormous in terms of capital expenditure, geological exploration, branding and so on.

Assumptions for a perfectly competitive market :

- Many sellers each of whom produce a low percentage of market output and cannot influence the prevailing market price. For example in this market, there are many sellers who form total of market supply. Individually, seller is a firm and collectively, it is an industry. In perfect competition, price of commodity is decided by market forces of demand and supply. i.e. by buyers and sellers collectively. Here, no individual seller is in a position to change the price by controlling supply. Because individual seller's individual supply is a very small part of total supply. So, if that seller alone raises the price, his product will become costlier than other and automatically, he will be out of market. Hence, that seller has to accept the price which is decided by market forces of demand and supply. This ensures single price in the market and in this way, seller becomes price taker and not price .

- Many individual buyers, none has any control over the market price. Because individual buyer's individual demand is a very small part of total demand or market demand. Every buyer has to accept the price decided by market forces of demand and supply. In this way, all buyers are price takers and not price makers. This also ensures existence of single price in market.

  • Perfect freedom of entry and exit from the industry. Firms face no sunk costs and entry and exit from the market is feasible in the long run. This assumption means that all firms in a perfectly competitive market make normal profits in the long run.
  • Homogeneous products are supplied to the markets that are perfect substitutes. This leads to each firms being “price takers” with a perfectly elastic demand curve for their product.
  • Perfect knowledge – consumers have all readily available information about prices and products from competing suppliers and can access this at zero cost – in other words, there are few transactions costs involved in searching for the required information about prices. Likewise sellers have perfect knowledge about their competitors.
  • Perfectly mobile factors of production – land, labour and capital can be switched in response to changing market conditions, prices and incentives.
  • No externalities arising from production and consumption.

Graph 4 a :

In the short run, it is possible for an individual firm to make an economic profit. This situation is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C .

Price

MC

AC

P Economic (abnormal ) profitD = AR = MR

C

Cost of production

O Qe Quantity

Graph 4 b :

In the long period, economic profit cannot be sustained. The arrival of new firms or expansion of existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point.

price

MC

ATC

P D = AR=MR

Q Quantity

  • Monopolistic competition : Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries.

Has the following characteristics :

- Product differentiation .MC firms sell products that have real or perceived non-price differences.

- Many firms : There are many firms in each MC product group and many firms on the side lines prepared to enter the market. A product group is a "collection of similar products"

- Free entry and exit in the long run .

- Independent decision making .

- Market Power .

- Buyers and Sellers do not have perfect information (Imperfect Information).

Examples : Shops and other service providers. : Dairies ,Takeaway shops ,Hairdressers and Garages

https://en.wikipedia.org/wiki/Subsidy#Economic_Effects

http://en.wikipedia.org/wiki/Natural_monopoly

http://www.tutor2u.net/economics/revision-notes/a2-micro-perfect-competition.html

http://en.wikipedia.org/wiki/Perfect_competition


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