Competition & Market Structure

Competition among sellers lowers costs and prices, and encourages producers to produce more of what consumers are willing and able to buy. Competition among buyers increases prices and allocates goods and services to those people who are willing and able to pay the most for them. When it comes to setting prices, we've previously discussed that one positive is that little interference needs to be done by a bureaucratic state. Adam Smith had this same thought back in the late 1700's when he coined the french term of Laissez-faire, meaning, "allow them to do." This philosophy limited the government's role to protecting property, enforcing contracts, settling disputes, and protecting firms against foreign competition, which therefore then stated that government should not interfere with business activities.

However, many conditions have changed since Smith's time, and these conditions help determine market structure, or the nature and degree of competition among firms doing business in the same industry. Economists group firms into four different market structures that reflect the competition conditions of those markets.

This market structure is characterized by a large number of well-informed independent buyers and sellers who exchange identical products. With perfect competition, market supply and demand set the equilibrium price for the product. Theoretically, perfect competition would be an ideal situation, but would need to meet the five necessary conditions below:

1. There must be a large number of buyers and sellers.
2. Buyers and sellers deal with identical products. Since the products are identical, there's no need to advertise, or have brand names, which helps to keep prices low. One seller's merchandise is just as good as another's.
3. Each buyer and seller acts independently.
4. Buyers and sellers are reasonably well-informed about products and services. Well-informed buyers shop at the stores that have the lowest prices and the sellers match the lowest prices of their competitors to keep customers.
5. Buyers and sellers are free to enter into, conduct, or get out of business.

Very few markets meet the conditions of a perfectly competitive market structure. However, the grain market for number two yellow corn fulfills four out of five of the conditions. Due to the large investment needed to start a farm focusing on this grain, the market for this corn fails to meet the last condition because of the difficulty to enter into the market.

The final three market structures falls under imperfect competition, because they do not meet all of the conditions of perfect competition. Most firms and industries in the US fall into one of these market structures. Within imperfect competition, there tends to be less competition, higher prices for consumers and fewer products offered.

This structure is one that meets all of the conditions for a perfect competition, except the condition of having identical products. The products under this market structure are generally similar and includes designer clothing, cosmetics, and shoes. The monopolistic aspect is the seller's ability to raise the price within a narrow range. The competitive part is that if sellers raise or lower the price enough, customers will ignore minor differences and change brands. Monopolistic competition is characterized by product differentiation, which is a real or imagined difference between competing products in the same industry. This applies to most items produced today.

To make their products stand out, monopolistic competitors try to make consumers aware of product differences. They do this with nonprice competition, which is the use of advertising, giveaways, or other promotions designed to convince buyers that the product is somehow unique or fundamentally better than a competitor's. All of these tactics would increase the cost of input, which would raise the price that consumers pay. However, if they are able to convince customers that their product is better than others through advertising, then they could most likely get away with raising their prices anyways.

An oligopoly is a market structure in which very few large sellers dominate the industry. The products in this market have distinct features, such as in the car industry; or they could be standardized, like in the steel industry. Therefore an oligopoly is even further from perfect competition than monopolistic. There are many US industries that already follow this market structure, such as fast-food, domestic airlines and domestic automobile industries.

Due to the large size of oligopolies, the different firms in the industry act interdependently of one another. They tend to follow the actions of others to avoid losing customers. Back when Chrysler introduced their first minivan, other companies followed suit. Companies in this type of market usually act together in their pricing behavior: when one company reduces their prices, so does the next. If you ever notice the ads that come in from your local grocer, the types of sales they run usually fall in line with each other. Since oligopolists are more in line with each others prices, they choose to compete more on a nonprice basis by enhancing their products with new or different features.

Sometimes oligopolists will enter into a collusion, which is a formal agreement to set specific prices or to otherwise behave in a cooperative manner. These agreements are often illegal because they restrain trade. One form is price-fixing where the firms agree to charge the same or similar prices for a product. These prices are then usually higher than those that would be determined under competition. They could agree to simply divide the market so that each is guaranteed to sell a certain amount.

At the opposite end from perfect competition, a monopoly has only one seller of a particular product. This is a very extreme case, and the US economy has very few, if any, pure monopoly. Any industry you can think of has some form of competition. Monopolies don't really exist because of the dislike by consumers, who therefore ban or outlaw them. Also, with the constant change and growth of technology, new products are always created that compete with current monopolies. For example, when Amazon came out with the Kindle, the first e-reader, it was not long before Apple opened the iBooks store on their devices.

Sometimes the nature of a good or service dictates that society would be served best by a monopoly. There are four different types of monopolies:

1. Natural Monopoly - costs of production are minimized by having a single firm produce the product. This applies to public utility companies, because it would be wasteful to duplicate the network of pipes and wires that distribute water, gas, and electricity throughout the city.
2. Geographic Monopoly - one firm has a monopoly in a specific area. This usually applies to small towns that could not support more than one grocery store or gas station.
3. Technological Monopoly - based on firm's ownership or control of a production method, process or other scientific advance. These situations are due to a government granted patent, or copyright.
4. Government Monopoly - monopoly owned and operated by the government. These are found at the federal, state and local level, and usually involve them providing products or services that private industry cannot adequately supply.

Because there are no competing firms in this market structure, there is no equilibrium price.

Sources

• https://www.khanacademy.org/economics-finance-domain/microeconomics/perfect-competition-topic/monopolistic-competition-oligop/v/oligopolies-and-monopolisitc-competition