Market Structures and Maximizing Profits, Essay Example

Generally, there are three different types of market structures in economics: perfect competition, monopolistic, and oligopolistic.  This essay will explore the basic characteristics of all three market structures.

First, the competitive market structure is typically introduced at the beginning as it serves as a pure “model” of how a competitive market should operate in theory.  In a competitive market, there are an infinite number of buyers and sellers: That is, unlike a monopoly and an oligopolistic where there are a fixed number of firms, the competitive market structure allows an indefinite number of buyers and sellers to enter and exit the market (Krugman, 2004).  As a result, the barriers to entry and exit are zero: Firms enter and leave the market based on their ability to compete and produce goods.

Another important feature of the market competition model is the profit maximizing equation: marginal cost= marginal revenue (Mankiw, 2004).  This equation means that a firm will produce goods as long as the cost to produce an additional good is equal to the additional revenue received for producing that good. The implication of this entity is that firms are “price-takers” in market; firms have no power to dictate what price is received for a good because they are all “homogeneous” or similar (Baumol, 2004). In a perfect competition model, there is no way to distinguish one product from another or to spend on advertising to build market power.  Finally, in the perfect competition model there are no externalities: That is to say, the social and market price of the good is reflected in the good’s market price.  While the perfect competition model is interesting from a theoretical point of view, it is rarely (if ever) seen in the real world. There are a number of reasons for this, but a few of the model’s assumptions do not hold: 1) In the real world, goods are not all homogenous- even if the features of certain goods may be similar, firms spend significant resources to differentiate their products from advertisers; 2) Although there are a few markets where externalities do not play a major role in pricing, in the real world such externalities play a role in how buyers and sellers are matched in the market (Krugman, 2004).

The monopolistic market structure is an extreme form of market organization that is often times observed in the real world.  In a monopolistic market, there is only one seller of goods, while there are an infinite number of consumers for those goods.  There are different types of monopolies observed in the real world.  For example, a natural monopoly is typically found in natural resource industries where there are excessively high fixed investment or start-up costs.  There are also other types of monopoly such as technology or government monopolies. Unlike a perfectly competitive market, there are high barriers of entry in a monopolistic market. The barriers of entry may be different in different industries: For example, access to different natural resources or to different technologies (via patent) may prevent other firms from entering the industry.

The profit maximizing entity is also different in a monopolistic structure: The profit maximizing structure is where marginal revenue is equal to average total cost, or a firm will continue to expand production as long as marginal revenue is greater than marginal cost (Baumol, 2004). A monopolistic firm’s profit entity is different because of two key factors: 1) A monopolistic firm does not produce homogeneous goods- a monopolistic firms produces unique goods due to limited access that allows the firm to charge a price above the competitive market equilibrium. 2) Monopolistic firms are not price takers but price makers- they set the price for their goods. Because the monopolistic structure is often observed in different economic situations, it is more practical than the market competition standard.

The third and last market structure is the oligopoly. The oligopoly shares more in common with a monopoly than it does the perfect competition model. Indeed, while the monopoly boasts only one firm, the oligopoly firm structure typically boasts two or three firms that have substantial market power.  Because there are two to three different firms, the dynamics underpinning competition in the market also changes.  The profit maximizing entity for oligopolies is MR=MC.  There are a number of other characteristics of an oligopolistic structure including low entry barriers as firms charge a price that is above equilibrium: an industry where the price is above the equilibrium will attract more firms and lead to greater competition.  Instead of necessarily competing on price, however, oligopolistic firms will use different mediums such as advertising to differentiate their products and build sufficient market power to remain a price maker rather than a price taker.  Of all the market structures examined in this essay, the oligopoly is probably the most commonly observed in different types of an economy.  Indeed, if one looks at most industries in an industrialized economy, they would likely be oligopolistic in nature.

References

Mankiw, G. (2006).  Microeconomics.  New York: Southwestern Press.

Krugman, P. (2004).  Microeconomics.  New York: Worth Publishers.

Baumol, W. (2004).  Microeconomics.  New York: Southwestern Publishers