Market structures
There are four idealized (ideal as opposed to reality) types of market structures:
Perfect competition: Many sellers in the market selling identical goods
Pure monopoly: a market with only one seller and many buyers
Monopolistic competition: many sellers in the market with slightly differentiated goods
Oligopoly: very few sellers where each needs to watch what the others are doing (This used to be the case of petroleum products retailing in East Africa in late 1990s – where there were few retailers (dominated by Shell, Caltex, Total).
PRICE MECHANISM
- The price mechanism can be traced to Adam Smith and the invisible hand theory.
- In a free market economy (as opposed to the command economy) each individual (as a consumer, producer, or resource owner) is engaged in an economic activity with a large measure of freedom.
- Resources are privately owned.
- Prices are determined by the forces of demand and supply.
Advantages of the price mechanism
In developed economies the price mechanism offer advantages to the system.
- Prices determine what to produce. It means that consumers determine what product is produced and sold to them. There is consumer sovereignty (“the customer is king”).
- Resource allocation Factors of production will be allocated to the production of commodities which will attract high prices.
- Income distribution Those who can offer goods and services that are in demand have their incomes rise.
- Price provides incentive to investment.
- A price mechanism encourages competition. Competition results in quality products, efficient production. In a competitive environment, inefficient firms are eliminated.
PERFECT COMPETITION
Conditions of Perfect Competition:
- There is free entry and exit for producers of the good or services within an industry. There are no barriers to entry or exit of firms from the industry.
- All buyers and sellers have perfect information on where the good or service is available, the price at which it is offered, and whether profits are being made.
- There are several small sellers and buyers – too small that no individual seller or buyer can affect the market price
- Within the market, only one kind of good or service (which is identical) is traded. Since the good or service traded is identical, buyers won’t care which firm they buy from.
- Free from government intervention – to fix prices, offer subsidies, or nationalize some of the firms. The government of-course comes in tax the industry
OLIGOPOLY
This is the prevalent form of market structure in most societies.
In this market structure, the products may or may not be differentiated. What matters is that only a few firms account for most or all of total product. In such a market, some or all firms earn substantial profits over the long run because barriers to entry make it more difficult (not impossible) for new firms to enter. Examples of oligopoly include automobiles, steel, aluminum, petrochemicals,
electrical equipment, computers, and petroleum retailer companies (common in the EAC are Total, Shell).
Managing an oligopolistic firm is complicated because pricing, output, advertising, and investment decisions involve important strategic considerations. When making decisions (pricing, location of offices, advertising, and administrative costs) each firm under oligopoly must carefully consider how its actions affect its rivals, and how its rivals are likely to react. Any decision each firm here undertakes will also be considered by others before they also make a decision.
Oligopoly market conditions:
- There are only a few sellers in the market, and at least some of which control enough of the market to be able to influence the market price.
- Entry is difficult – not restricted.
- Completion not based on price but other marketing factors – output, advertising, and location.
MONOPOLY
Pure monopoly: A market that has only one seller and many buyers. Pure monopoly is rare, but in most markets only a few firms compete with each other. So we better say pure monopoly as a market that has one seller and many buyers as idealized in most cases. This is not saying that it completely does not exit.
Examples of monopoly: let us try to find some examples of near-monopolies if not pure monopolies.
- Microsoft Corporation’s dominance in the PC operating system can be a good example here.
- A local monopoly – where a firm is the only supplier in a given geographical area (however small the area is)
In monopoly, the firm does not necessarily have to be so big to have monopoly power – it has to be just large in relation to the relevant market.
- The only pay or cable TV, or dance club, or dance and drama theatre, or even a movie theatre in a small town is also a local monopoly.
Natural monopolies
Economies of scale may make it too costly for more than a few firms to supply the entire market. In some cases, economies of scale may be too large that it is most efficient for single firm (natural monopoly) to supply the entire market. The minimum efficient scale of a producing firm or unit is large relative to the total market demand. We can say that a natural monopoly is a firm that can produce the entire output of the market at a cost that is lower than what it would be if there were many firms.
Conditions of monopoly
- There is only one sellers – and many buyers
- The good being sold has no close substitutes (This means that buyers must buy from the monopolist or not at all)
- There are barriers (economic, legal, and deliberate) to entry that prevent others firms from entering the market and start to produce the good
Barriers to entry of firms
- Economic barriers: such barriers arise primarily from the nature of technology used in production.
- Production technology can be characterized by high fixed costs, size of the market and economies of scale, or network externalities and all this can discourage entry of new firms to compete with the monopolies. First, high fixed costs on entry prevent potential competitors from entering the sector on a small scale and expanding. It means therefore that competitors must invest large scale operation at the outset, which may be too risky – and therefore most firms do not enter this sector/ industry.
- Second, is the size of the market relative to the minimum efficient scale if the firm. A market may too small for several firms to invest and operate in it efficiently. Therefore if several firms try to operate in this market, they will higher average costs. It is then left to only one firm – the monopolist – to serve and be able to efficient.
Legal barriers (also called natural barriers to entry)
These barriers include copyrights (which protect creative works), patents (preventing other firms from using technological innovations – until the patent expires), trade marks (which protect brand names), and franchises and concessions (which directly prohibit entry).
- A firm may have a patent on the technology needed to produce a particular product. Until the patent expires, it is difficult, if not impossible, for other firms to enter the market. In US, patent protection allows a firm exclusive use of an invention for period usually covering 17 to 20 years – that is when the patent expires.
- Copyright. This, like the patent, is another legally created right that works in the same way as the, patent. A copy right can limit the sale to a single company of the copyrighted material – a book, music, or a computer software program.
- Government can give a license to a firm which can prevent new firms from entering the market – for some time – and it has mostly been done for telephone service, television broadcasting, etc.
