Lecture 6 Market Structures.pdf

Lecture 6 – Market Structures Market A market is created when prospective buyers came into contact with prospective sellers and where means of exchange are accessible. A simple example of a market is when you buy groceries, you enter a place where a seller offers his goods or services, or when you purchase services (haircut) in a barbershop and to culminate the transaction, you pay them in cash, or with your credit or debit cards. Although, there are some types of markets having a more complex and sophisticated mechanisms compared to those simple markets explained earlier which do not require a physical place to conduct exchange. In the Philippine Stock Exchange (PSE), ownerships of various corporations are traded in the form of common stocks. There are no boundaries for buyers of stocks, even investors from the US and Europe can buy and sell local common stocks, as well as Filipino investors can buy common stocks in the New York Stock Exchange or in European and Asian Stock Markets. The internet also provides means to trade goods regardless of your location. Facebook, Instagram, olx.ph, cashcashpinoy.com, and other shopping websites create cyber –market. Never to be outdone is Television – that is, it also provides venue for buyers and sellers to interact and conduct exchanges, examples are those home TV shopping programs such as O-Shopping and HSN. There are two types of market, the first type is what we call Perfect Market where price and quantity supplied are determined solely by the free interactions between buyers and sellers, and no other factors can influence them. The other type is the Imperfect Market where price and quantity supply are induced not by the free interactions of buyers and sellers but through the control of a dominant buyer or seller, and/or because of government interventions (price controls). One of the important elements in evaluating the kind of market a particular good or service is being traded is the structure of the competition – regardless of the number of sellers in the industry. The organization of the sellers (level of interactions among themselves) defines a market instead of the sheer number itself. For example, a market for a good has many sellers, but, there is no one considerable enough to lead the market in terms of volume and influence for other sellers to benchmark with. This will render the seller insignificant in terms of the market and will render the seller practically an unobserved entity in the radar of other sellers. On the other hand, a market with few sellers of a good denotes noticeable actions and rivalled by other sellers. This only shows that a firm is relatively large to the size of the market. Another important element to take note in market analysis is the homogeneity or heterogeneity of the good in the market. A good may be considered as homogenous if it follows a particular standard and consumers are indifferent to the good of one seller to another. For example, a person is indifferent in buying ground meat from any meat stalls in a market. In this case, it doesn’t matter to the buyer where she buys the good. Conversely, if buyers prefer the good of one seller over the good of another seller, this implies that goods are unique or distinctive. The differences among the goods are perceived by the buyers, and good marketing strategies come into play. Some of the differences may be in the form of brand names, advertising, promotions, and trademarks. Free flowing of information is another element that plays a crucial role in evaluating market. Inadequate information available to both buyers and sellers regarding the price and other aspects of the good would create under-allocation of resources in the economy. To simplify this idea, if Local Government Units (LGU’s) will not inspect weighing scales of meat or fruit vendors in different public markets, buyers would be paying more for less goods. Or a person who purchased life insurance from a company but concealed health problems, the company would be in a bad financial position.

The Market Structure Market structure is defined as the organization of sellers and market characteristics that impact the characteristics of competition and product pricing. There are six main market structures and organization and these are perfect competition, monopoly, oligopoly, monopolistic competition, monopsony, oligopsony.

1. Perfect Competition It is the most competitive of the four different types of market structures. The following give the conditions for a perfectly competitive market: 

Large number of buyers and sellers. There are many buyers and sellers in the market in which the quantity of output bought by each buyer and the quantity of output sold by each seller represent an insignificant portion of the total output of the market. Therefore, no buyer or seller can influence the market price or quantity. Also each buyer and seller makes decisions independently of one another;

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Firms operating in a perfectly competitive market are considered as price takers (no market power), meaning, they take the market price as it is. Furthermore, there is no reason for a firm to lower the price since it can sell any level of quantity of output at that given price. It can also be explained by the idea that the total revenue of a single firm will have no effect on the market price mainly because of two reasons: first, a single firm just represents a small fraction of the total sellers in a perfectly competitive market and hence will have no significant effect on the market price; and second, market price is determined based on the interactions of all the buyers and sellers and not just determined based on the action of a single firm. Therefore, all firms in the market sell the product at the market price, making them as price takers;

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Homogeneous product. It means that firms are selling identical products (products are not differentiated; that is, the product that seller 1 sells is a perfect substitute for the product sold by seller 2, 3, 4, and so on. Since all sellers are selling the same product, it implies that a market cannot be divided into small portions which will violate the first condition above;

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Free entry and exit. Any firm is free to enter the market because there are no barriers present: may be legal, technical, or financial barriers. In addition, existing firms cannot bar the entry of the new firms. Also, a firm is free to cease production and leave the market;

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Perfect mobility of resources. Factors of production or resources (land, labor, capital, entrepreneurial ability) flow easily from one sector to another in the market; and

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Perfect information among buyers and sellers. All buyers and sellers are perfectly informed regarding present and future production costs and prices. Buyers know if a seller is offering a particular good at a lower or higher price than other sellers.

Perfect competition cannot be found in the real world. For such to exist, the above conditions must be met. But if the last two assumptions will be relaxed, then we will call that as a Purely Competitive Market Structure.

2. Monopoly Monopoly is at the other end of the scale from perfect competition; Pure monopoly is a market condition where there is only a single seller dominating a particular market. Because of this sole supplier, the monopolist faces the market demand curve for its product and thus, he is considered as the price maker because he can actually influence the market price of the product. A market in which there is only one seller (producer) of products within an area is public utilities. In a specific market, usually there is only one firm that provides electricity or water services. Furthermore, the government itself supply many services for which other (private) firms do not usually provide such as fire, police, and military protections. Most of these situations are similar to a pure monopoly. But for most of these products, substitutes are available; people using LPG can switch to electric oven (or vice versa). In some areas, residents can even substitute deep well water for what the local water company provides. The following are sources of monopoly:     

There is only one producer or seller of goods and only one provider of services in the market; New firms find extreme difficulty in entering the market. The existing monopolist is considered giant in its field or industry since it invested heavily in capital; There are no available substitute goods or services so that it is considered unique; It controls the total supply of raw materials in the industry and has control over price; It owns a patent or copyright; and

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A single firm can operate more efficiently in a market instead of having competitor(s) due to cost advantage (lower average total cost) is referred to as economies of scale.

Classifications of Monopoly Monopolies are classified according to circumstances they arise from, that is, cost structure of the industry, possibly the result of law, or by other means. 1.

Natural Monopoly. It is a market situation where a single firm can supply the entire market due to the fundamental cost structure of the industry. It arises whenever capital cost is large enough as compared to variable cost, and they have cost advantage over competitors. This classification is common to the distribution of electricity (MERALCO), water services (Maynilad and Manila Water), and other public utilities.

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Legal Monopoly. This is sometimes called as de jure monopoly, a form of monopoly which the government grants to a private individual or firm over the product or services. Most of the utilities granted with an exclusive franchise by the government such as water and electricity services enjoy legal monopolies.

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Coercive Monopoly. It is a form of monopoly whose existence as the sole producer and distributor of goods and services is by means of coercion (legal or illegal), so that most of the time it violates the principle of free market just to avoid competition. Examples of this are Philippine Postal Corporation (PHILPOST) and Philippine Amusement and Gaming Corporation (PAGCOR).

3. Oligopoly The word comes from a Greek words “oligo” means few sellers and “poly” from monopoly. It is a market situation in which there is a small number of sellers each aware of the action of the others. All decisions depend on how the firms behave in relation to each other. Changing output or price has an immediate effect on the output and price of others. Each firm knows and expects a reaction to its own actions. A firm would not normally change the price and quality of its product without considering how the other firms would respond. In oligopoly, conjectural interdependence is present, that is, the decision of one firm influences and are influenced by the decision of other firms in the market. Automobile and steel industries are some examples of oligopoly. The characteristics of an oligopoly include:  Few sellers in the market selling homogenous or heterogeneous products;  A firm can manipulate the price due to the fact that there is a small number of competitors supplying  market of a certain product; and  It is very tough for new sellers to enter the market. Types of Oligopoly Oligopolies are often distinguished based on the products they sell in the market. The first category is those few sellers that produce identical products known as pure oligopoly. This type of oligopoly is common in a market situation where the products sold are fairly homogeneous. Examples, of the products they sell include cement, sugar and other raw materials. The second type refers to a few sellers of differentiated products commonly known as differentiated oligopoly, that is, value characteristics or a quality of goods varies. Classic examples of these types are airline and shipping industries because of the numerous characteristics of their services. Some instances give rise to cause a situation where only two producers exist in a given market. This is commonly known as duopoly. This type of oligopoly market is seen in the telecommunications industry where Globe and Smart dominate the market. Maynilad and Manila water are providers of water services in Metro Manila, where Maynilad operates in the north while Manila Water in the south.

Types of Organization of Oligopoly Cartel is a formal agreement among oligopolists to set-up a monopoly price, allocate output and share profit among members. A good example of this type of oligopoly is the Organization of Petroleum Exporting Countries (OPEC). OPEC is an international cartel made up of twelve countries having the richest reservoir of crude oil in the world. Central to this organization is the establishment of unified price policies for their petroleum products in order to assure fair and stable prices for each member. As well as efficient, economic and stable supply of petroleum to other nations and a fair return on capital to those investing in the industry. Collusion is a formal or an informal agreement among oligopolists to adopt policies that will restrict or reduce the level of competition in the market. This usually happens in the bidding process for road-development work in several regions of the country. Bidders (Contractors) will collude by simply agreeing whose going to “win” the project by backing out at the last minute of the bidding process. The winning contractor will then pay other bidders afterwards.

4. Monopolistic Competition This type of market structure is the closest thing to reality. This is a market situation in which there are many sellers producing highly differentiated products. Under this condition, there is competition because many sellers offer products that are close, but not perfect, substitute for each other. Monopolistic competition is a mixture of perfect competition and monopoly. It has similar characteristics with perfect competition but in addition to product differentiation. Sellers are price makers since product differentiation creates some degree of market power to monopolistic competitors since each competitor can somewhat raise price without losing all its customers. Industries producing personal care products, cars, apparel, gadgets, furniture, medicines, fast-food, private schools, and the likes are good example of monopolistic competition. Essential characteristics of monopolistic competition are:  A large number of buyers and sellers in a given market act independently;  There is a limited control of price because of product differentiation;  Sellers offer differentiated products or similar but not identical products;  New firms can enter the market easily. However, there is a greater competition in the sense that new firms have to offer better features of their products;  Competition in the market focuses not only on price but also on product variation and promotion; and  Perfect information among buyers and sellers. All buyers and sellers are perfectly informed regarding present and future production costs and prices. Buyers know if a seller is offering a particular good at a lower or higher price than other sellers.

5. Monopsony A monopsony is a market situation where there is only one buyer of goods and services in the market. It is sometimes considered analogous to monopoly in which there is only one seller of goods and services in the market. Since only one buyer, this market has the control of supply and it can reduce the number of input demanded in order to decrease the price of that particular input. Monopsony power gives them the ability to control their unit cost for an input which is similar to the way the monopoly controls their price.

6. Oligopsony This is a market situation where there are a small number of buyers. This is usually with a small number of firms competing to obtain the factors of production. Under this market situation, firms are buyers and not sellers. This is sometimes analogous to oligopoly, where there are few sellers.