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In economics, the term competition refers to buyers and sellers striving for a bigger share in the market. Individuals and firms have some interest in the products and services within a market structure. Because of the differing levels of competition in the market, different market structures emerge with varying effects in the market.
Thus, Firms have to know not only about costs, but also about revenues when they make pricing and output decisions (Maurice & Thomas 34). There are various market structures, all dependent upon the extent of competition. This paper discusses the competitive markets, monopolies, and oligopolies with regards to levels of competition.
Economic competition can be categorized in three levels: direct competition, substitute competition, and budget competition. Direct competition involves products of the same features competing in the market. Substitute competition is where products with different features can act as substitute of one another. Lastly, budget competition is where consumers take charge in spending their money.
At one stage, when buyers and sellers correctly assume that they cannot influence the market price, the market structure is one of perfect competition. Perfect competition has the following features: 1. The products in the market have same features. 2. Any firm can enter or exit the industry at will. 3.
There must be a big number of participants in the market who do not influence the price individually, and 4. There must be complete information; both buyers and sellers must clearly know about market price, product quality, and cost conditions (Png & Lehman 118). In essence, a perfectly competitive firm is one that is such a small part of the total industry in which it operates, and that it cannot significantly affect the product in question.
Perfect competition results to various judgments regarding solutions to some economic problems, such as how much is produced, price charged, and methods of production.
Since an individual firm has to accept the price set by the market, it is important for the supplier to determine the quantity to produce as per the available price. A supplier will generate the quantity that capitalizes on the profit of the company; this is where the marginal cost of production is the same as the market price. Thus, the entire production of all firms in the market establishes the supply of the commodity.
This market supply of the commodity, together with the collective demand of the product by all buyers, determines the price of the market. For a firm to capitalize on profits, it has to consider the cost and revenue. If the marginal revenue is more than the marginal cost, a firm will continue to produce. A firm stops to produce when marginal revenue is equivalent to marginal cost, hence profit maximization (Case & Fair 45).
Perfect competition is desirable in the society since the price charged to people is the same as the marginal cost of production of every supplier. It ensures that consumers are charged at a reasonable price. Another importance is that the collective output in this market structure is larger than other market forms. In essence, perfect competition ensures democracy since no single firm can dominate the market.
Monopolistic competition is described by the availability of many suppliers, just like the perfect competition. However this market structure is also characterized by the existence of differentiated products. In essence, the products produced are not termed as identical due to different composition, change in packaging, and different brand image or advertising (Mankiw 312).
A firm in this market structure produces the amount that capitalizes on its profit. More so, the firm stops supplying when marginal revenue coincides with marginal cost of production. However, individual firms can determine the price of their products because of the existence of different product range in the market.
The power to determine the price is considerably small, as there are many sellers in the market. Because price is a determinant of demand, price charged for a commodity is different from the marginal revenue of the product. The net result of maximizing profit in this market structure is that prices are relatively high. Monopolistic competition gives firms the power to set prices for their products, and in doing so the price associated with a product is considerably higher than the marginal cost.
Oligopoly is characterized by the interdependence of companies in the industry. This is because of few firms in the business. As contrasted with monopolistic competition, when a company in an oligopoly market structure alters its price or output, it has different results on its competitors in regard to their profits.
In addition, an oligopolistic firm can achieve economies of scale. This implies that when the level of production increases, the cost per unit of a commodity reduces for the use of any plant; this is an advantage for a larger supplier (Mankiw 365). Consequently, there is huge barrier to entry in this market structure because of large financial needs, accessibility of raw materials, and convenience of the required technology.
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In some cases, there exist only two sellers in the market. This is referred to as a duopoly. Antoine-Augustin Cournot (1838) and Joseph Bertrand (1883) came up with the major models of oligopolistic competition (Corhon 3). Cournot observed that in a duopoly, the major concern is profit maximization and therefore output decision by any firm does not affect its rival.
Bertrand believed that companies compete on price and not the amount of output, thus a duopoly can change to perfect competition. However, these models vary in different industries, depending on the need of each model.
Output and pricing in oligopolies vary because of many theoretical frameworks that describe the markets. For instance, if a firm reduces its price, competitors settle this by cutting their prices. Though, if it increases its price, competitors may not match the price. Thus, prices in an oligopolistic market structure may be constant for a long period of time.
This is the converse of perfect competition, in which only one seller controls the output and pricing decisions of a product. A monopoly can be enacted by the government or if the company owns the whole supply of a required raw material. Thus, there is no competition in this market structure.
In the case of new entrants, monopoly blocks entry of new firms; especially by law or greater capital required to survive. Cournot, a French philosopher, constructed a “one monopoly profit” theorem, in which he argued that a monopolist can increase its profit by improving its market condition; monopolizing a different market would generate equal returns (Corchon 68).
Same as the monopolistic competition, a monopolistic company capitalizes on its profit by supplying until the marginal revenue is similar to the marginal cost. A monopolistic firm can raise the amount of sales by reducing its price and attracting buyers. Monopoly plays a major role in regard to price regulations by the government. In case of natural monopoly, this market structure is considered desirable to the economy since a firm is able to survive in the market (Png & Lehman 198).
Markets are the important aspects of a capitalist economy, and different degree of competition result to various market structures. This paper has discussed different types of competition in markets and strategies in maximizing profits. The market structures analyzed include competitive markets, monopolies, and oligopolies.
Competitive market structures are featured by large number of firms; these firms have less or no control of the market price. Firms can easily enter a competitive market. Competitive firms produce up to the level where there is profit maximization, and thus the price is determined by the demand of buyers.
In an oligopoly, only few companies produce a product, therefore firms can have less price control. In the case of monopoly, there is a single seller who also determines the price. In this case, oligopolistic and monopolistic markets experience high barriers to entry of new firms. These barriers include huge investment, accessibility of raw materials, desirable technologies, and government regulations.
Case, Karl, and Ray Fair. Principles of Economics. 5th ed. New Jersey: Prentice Hall, 1999. Print.
Corchon, Luis. Theories of Imperfectly Competitive Markets. 2nd ed. New York: Springer-Verlag, 2001. Print.
Mankiw, Gregory. Principles of Economics. 5th ed. USA: Cengage Learning, 2008. Print.
Maurice, Charles, and Christopher Thomas. Managerial Economics. 9th ed. New York: McGraw-Hill, 2008. Print.
Png, Ivan, and Dale Lehman. Managerial Economics. 3rd ed. UK: Blackwell Publishing Ltd, 2007. Print.