Market Structures and Profit levels
A market refers to a set-up that brings together willing buyers and willing sellers who come to buy and sell goods and services at a particular price. Buyers determine the demand while the sellers determine the supply of the product or service. Markets are highly competitive for each buyer knows several sellers to choose while each seller knows that their product is similar to that of other sellers. A market structure refers to the characteristics of a market that determine the behaviors and results of the various firms working in the market. It is characterized by; the level of competition, the number of agents, the number of sellers and buyers, the negotiation strength to set the prices, the degree of concentration, the differentiation and the uniqueness of the products and services (Mankiw 2011; 161).
Competition among firms depends on the nature of the products, number of firms in the industry and the freedom for firms to enter and leave the industry. The type of market structure has great influence on how a firm operates in terms of pricing, supply chains, efficiency, barriers to entry and the level of competition (Conway 2012; 195). A host of factors that include the freedom of entry and exit, control over supply of products, the nature of the products (homogeneity or differentiation), control over price and entry freedom determines market structures. According to economists, there are four main models of market structure, which vary from one extreme to another. They include perfect competition, monopoly, monopolistic competition and oligopoly. This paper will focus on the perfect competition market structure and the monopolistic market structure to explain why the levels of profits differ among these market structures.
Perfect competition
This is a theoretical market structure, which has no barriers to enter and it has unlimited number of procedures and consumers. It yields a perfectly elastic demand curve with many buyers and sellers buying and selling homogeneous products at a uniform price. The buyers and sellers accept the price determined by the market and they are therefore the price takers (Mankiw 2011; 197). Various factors affect the demand of these products including the level of income, prices of other goods (substitutes or compliments), tastes, expectations, and the number of buyers. A higher income shows that one has much to spend hence a higher purchasing power leading to a higher demand as opposed to lower income levels. A normal good is one where its demand falls with the fall of income. A good is a substitute if the price of one good reduces the demand for another. If a fall in price of one good leads to higher demand for another good, both goods are complements. If the buyers’ expectations about the products are met then the demand rises. At the point where the supply meets the demand, then the equilibrium price is formed thus the perfectly elastic demand curve.
The market An individual firm
Price ($) Price ($)
D S
D
S D
Quantity per week Quantity per week
Fig 1: Showing the demand and supply curve for the market and an individual firm in perfect competition
Source: http://www.personal.psu.edu/~dxl31/econ2/Spring_2006/lecture22.html
From the figure above, the price at which the individual firms are selling is the market price. The line found in the second graph represents the demand curve for the firms’ products. Individual firms are at the mercy of the market for they do not have control over the market price.
Assumptions in the perfect competition market structure are that there is infinitely large number of buyers and sellers. The buyers cannot determine the market price as well as the sellers. The forces of demand and supply determine the price (price maker). An individual firm cannot change the price given by the market since if it did so, buyers would shift to another firm thus losing revenue (Bannock 2011; 157). There are homogeneous products. Products are identical in that the packaging and quality colors are the same. These products substitute each other since the output of one firm is the same as the output of all the others in the market. Firms have freedom to enter and leave the industry. Normal profits refer to the minimum level of profit to keep the factors of production operating in the long run. It is the opportunity cost to invest financial capital in a business. Abnormal profits are achieved when there is an excess of the normal the profits earned. Abnormal profits in a perfect competitive market structure entice other firms to enter the market. Normal profits are achieved when the level of output reflects an equality between total revenue and total cost (TR=TC). The average revenue and the average cost are equal at this point. Abnormal profits are achieved when the total revenue is greater than the total cost.
Monopoly
| Price |
| Po |
| Quantity |
| Qo |
| AR |
| MR |
| MC |
This market structure involves a single seller of a product, which does not have close substitutes. Assumptions here are that this structure involves a single seller, products do not have close substitutes, and there are barriers to entry of other firms, price discrimination and limited consumer choice. The seller is the sole producer of the products, which may be due to some natural conditions prevailing in the market. Barriers to entry are because of economies of scale, product differentiation mergers, control of key factors, and legal protection among others. Firms that are already established have lower costs of production thus; they take advantage of internal economies (Mankiw 2011; 197). By doing so, they keep off competitors. The monopolist realizes that it cannot compete and leaves the industry. Brand loyalty happens when customers believe that only the monopolist’s products are genuine. This is impacted into people’s brains through advertising.
Fig 2:Showing the Marginal Revenue curve under monopolistic competition.
Source: http://catalog.flatworldknowledge.com/bookhub/reader/21?e=rittenberg-ch14_s04
The consumer has limited choice because the products do not have close substitutes.
| P Monopolist |
| ATC=MC |
| Cost
Revenue |
| Monopolistic price maximizes here |
| Equilibrium price and quantity is set here |
| P competition |
| AR market |
| MR market |
| Monopoly Output |
| Output |
| Competitive Output |
Fig 3: Showing a comparison between perfect competition and monopolistic market
Source: http://www.intertic.org/Media%20Briefings/riley.html
Profits can be defined as reward for any entrepreneurial function. They can be classified as gross profits or net profits. Normal profit is defines as the least amount of profit that a businessman will have to earn and still remain in his or her current business. Normal profits are made when an entrepreneur exhibits effort for a relatively long period. The entrepreneur utilizes his own capital, land and managerial service thus opportunity costs help them make the normal profits (Begg 2009; 155). On the other hand, abnormal profits are realized when the total income exceeds the sum of total production cost and opportunity cost. This arises to reward the entrepreneurs risk taking and his courage to venture in an uncertain market. Introduction of innovation can also lead to abnormal profits for it ensures that products are highly differentiated. Monopolies have exclusive power over production and entries by other firms are highly prohibited hence abnormal profits. These profits do not necessarily require entrepreneur’s effort.
Monopolists use barriers of entry to maintain abnormal profits since they are the price makers. Encouraging other firms means that, the supply is increased thus decreasing the average revenue. Price discrimination occurs when different firms charge different prices to different groups of buyers (Begg 2009; 155). The seller should divide buyers into two or more groups then charge different prices to each group. The monopolist should have a certain degree of monopoly power to categorize different classes of customers and charge these groups different prices, the price elasticity of demand must be different among the groups and there should be no resale of the product among the groups. This is possible due to factors like geographical distance (high transportation costs), extreme use of the product, and absence of distribution channels among others. Charging the customers differently ensures that they are exploited t the maximum at the seller’s interest of profit.
Comparing the assumptions of the two market structures, it is evident that both firms have the assumptions geared towards making a certain level of profit. Both market structures have buyers who buy products hence help the firms to make profits. The difference is that in the perfectly competitive market there are many buyers and sellers while the monopolistic market structure involves a single seller and buyers. The market structures involve products and services that are differentiated to meet the customer needs. If the consumer needs are satisfied then they buy more hence high profits are realized. All the products and services are sold at a certain price. In a perfectly competitive market, the price is determined by the forces of demand and supply while in a monopolistic market, the monopoly firm is the price maker (Anderton 2008; 179). The set level of prices determine the profits to be made hence the price should be ideal to the amount of profit anticipated.
Conclusion
The economy of a country also determines the success of the firm. If it is highly stable it means that there is a higher purchasing power hence firms make high profits. Economic instability may be brought by high inflation rates, political instability, natural disasters like floods, earthquakes and so much more. Therefore, the place where a firm is located is important to determine the level of profits. Advertising a product generates a higher demand hence more profits. If the costs are high, the profits are highly affected. These costs involved are like labor costs, costs of raw materials and rental costs. With the knowledge of these market structures, both buyers and sellers are able to make wise decisions concerning the way firms operate. For example, understanding that monopolies are discriminative in terms of pricing saves the buyers from exploitation. Sellers also are in a position to create more customers since they understand the behavior of their buyer.
Bibliography
Anderton, alain. (2008). Economics as level. Gardners books.
Bannock, g. (2011) penguin dictionary of economics 8th edition
Begg, d., & dornbusch, r. (2009). Foundations of economics. London [u.a.], mcgraw-hill ed.
Conway, e. (2012). 50 ideas you really need to know: economics. London, quercus.
Gillespie, a. (2011). Foundations of economics. Oxford, oxford university press.
Mankiw, n. G. (2011). Principles of economics. Mason, Ohio, Thomson south-western.
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