Comparing Market Structures

Welcome to the final blog entry. In this entry we will be looking at four different types of competitive markets: perfect competition, monopolistic competition, monopoly and oligopoly. Below is a table that shows the differences between four markets. We will then explore each market individually by a brief description of how they work and then look at them further by looking at some graphs.

	Perfect Competition	Monopolistic Competition	Monopoly	Oligopoly
Number of Firms	Infinite	Many	One	Few
Freedom of Entry	Easy	Easy	Very Difficult	Difficult
Nature of Product	Identical	Similar	Unique	Identical or Similar
Implications for Demand Curve	Horizontal/Highly Elastic	Downward Sloping/Elastic	Downward Sloping/Inelastic	Downward Sloping/Inelastic/Kinked
Average Size of Firms	Infinite Small	Many Small/Medium	One Large	A Few Large
Possible Consumer Demand	High Elasticity	Elastic	Inelastic	Inelastic/Kinked
Profit Making Possibility	Normal Profit	Normal Profit	Economic Profit	Normal, Maybe Economic  Profit
Government Intervention	No  Regulation	Slight Regulation	Heavy Regulation	No Regulation
Efficiency	Yes	No	No	No
Example	Wheat	Restaurants	Cable Company	Oil and Gas

Perfect Competition

In a perfect competition, there are a large number of sellers and buyers. If a seller enters or exits the market, then there is no effect on equilibrium. The price of goods is stable. Prices are determined by the market as opposed to the producers. As we can see in the graph below the price is equal to the marginal cost. This means that not only is the price constant, but so is the efficiency. This produces constant normal profits.

Monopolistic Competition

Below are two graphs. These graphs show monopolistic competition in the short run and in the long run. The major difference between the two graphs is that in the short run, there is an economic profit where in the long run, there is only normal profit. The reason for this is in the short run, the price is higher than the average cost and in the long run, the price is equal to the average cost. Monopolistic competitors produce similar but not identical products. The differences are small such as brand name, features or simply packaging. This makes products for sale substitute products.  Productive efficiency is not achieved because the price is above the lowest point of the average cost curve. Monopolistic competition is does not meet allocative efficiency because the price is above the marginal cost curve.

 

Monopoly

A monopoly contains a single firm with a unique product. Freedom of entry into a monopoly is extremely difficult. Monopolies are heavily regulated by the government; in particular their prices. In the graph below we see that monopolies make economic profits because firms operate above cost. We also see at price level  (P2) that demand (average revenue) meets the average cost. This is known as the fair return price. P3 shows us the price where marginal cost meets demand. This is the socially optimum price which is the price that produces the best allocation of products from the point of view of society (Morris, 2009).

Oligopoly

An oligopoly contains a few firms selling identical or similar products. As we see in the graph there is a kink in the curve. D1 is elastic and D2 is inelastic. Again, this market is inefficient because the price is higher than the marginal cost. The point between B and C is the area where the demand does not change. In an oligopoly, firms can come together and control the market prices. This is known as a cartel. There is no government regulation here.

 

Morris, A. J. (2009). Principles of Microeconomics 6 Edition. Toronto: McGraw-Hill Ryerson.



Game Theory

“Game theory was first developed by economists John Neumann and Oskar Megenstern in the 1940s to analyze strategic behaviour.  This idea can be applied…to any situation where people seek to work out the best possible action, taking into consideration the possible reactions of rivals” (Sayre, 2009).

Various games related to game theory have been around as early as the 1700s. What we now know as Game Theory began in the 40s by Neumann and Megenstern publishing a book called Theory of Games and Economic Behaviour. 

There are examples of game theory that exist today. Let’s look at the electronics market. Flat screen TV’s are around the same price at electronics stores. If one company lowers their TV prices then that company’s sales will increase for a while but then the competition will soon lower their prices and things will balance out again.

Different possible outcomes are shown in the form of a matrix. A classic example of the payoff matrix would be in the prisoner’s dilemma game. In this game two people are arrested. There is not enough evidence to charge either of them, so both prisoners are separated. The police instead try to get the prisoners to rat each other out. If neither prisoner says anything, then both are sentenced to a month each. If prisoner one rats out prisoner two, then prisoner two receives a one year sentence. If prisoner two rats out prisoner one, the same result will occur. If they both rat each other out, they will both receive a three month sentence (Wikipedia, 2012) .  

A cartel is “an association of sellers acting in unison” (Sayre, 2009) . If companies working together can restrict the supply of their products, then they can control the market price. “Cartels work to the advantage of their members only if there is no cheating among the participants” (Sayre, 2009). Collusion works the same way as a cartel however collusion is illegal because it “can involve price or wage fixing, kickbacks, or misrepresenting the independence of the relationship between the colluding parties” (US Legal, 2012).

Sayre, J. E. (2009). Principles of Microeconomics 6 Edition. Toronto: McGraw-Hill Ryerson.

US Legal. (2012, 12 05). Collusion Law & Legal Definition. Retrieved from US Legal: http://definitions.uslegal.com/c/collusion/

Wikipedia. (2012, 12 04). Prisoner's Dilemma. Retrieved from Wikipedia: http://en.wikipedia.org/wiki/Prisoner's_dilemma

Monopolistic Competition

Monopolistic competition is a market where many firms sell similar products but not identical ones. The products sold may have the same functions but could physically look different or just simply have different packaging. This makes the products sold as substitute products. Firms in monopolistic competition have some control of the price of products they sell.  Almost all retail businesses are in monopolistic competition as well as services aimed at homeowners.  There are 4 characteristics of a monopolistically competitive industry:

·         There are many small firms

·         There is freedom of entry

·         Firms have some control over price

·         Differentiated products

Below is a table that shows some features and examples of monopolistic competition.

Monopolistic Competitive Companies

Size:	Small Company	Medium Company	Large Company
Features:	Local Coffee Shop: Insomnia Coffee	Canadian Chain: Timothy’s	International Chain: Starbucks
Differentiated products	Packaging, Food	Packaging, Food, Accessories	Packaging, Food, Accessories, CDs
Control over price	Some	Some	Some
Mass advertising	Local Publications, Online	Print, Online	Television, Online, Print
Brand name goods	Few	Few	Few
Freedom of Entry	Yes	Yes	Yes

Compteting as Starbucks

In order for a perfectly competitive market to exist there must be four conditions that are met:

·         Many small buyers and sellers all of whom are price takers

·         No preferences shown

·         Easy entry and exit by both buyers and sellers

·         The same market information available to all

Looking at Starbucks it looks like all of these conditions are met. The only thing missing on Starbucks’ part would be no preferences shown. There are a lot of different coffee stores to choose from whether they are chain stores like such as Starbucks or local independent businesses and preferences are shown by consumers.

In the US, Starbucks closed 600 of its stores over the summer of 2008 (Allison, 2008). According to the company’s Chief Financial Officer Pete Bocian, the stores closed because they were not profitable and were not expected to generate profits in the future (Press, 2008). The closed stores “were being cannibalized by nearby Starbucks locations” (Allison, 2008).  It looks like the company was improving its efficiency with these closures.

In a 2007 memo, Starbucks CEO Howard Schultz stated that as the company has become more efficient over the years, the company has paid a price by “watering down the Starbucks experience” (Rebel, 2007).

Starbucks are known to sell expensive drinks. I believe that their prices are high because they are a brand that is recognized worldwide and that there is an “experience” when visiting the stores. There is a laid back atmosphere when entering a Starbucks store. It is also a very fashionable brand. Many celebrities are pictured with the famous Starbucks cups. Motiv Strategies’ Joy Thomas points out that “Starbucks coffee is widely perceived to be a small luxury, and people understand they are paying a premium for it” (Thomas, 2012).

If Starbucks lowered their prices, then demand would increase. Starbucks’ main competitors such as McDonalds or Tim Horton’s have lower priced coffee so right now Starbucks profits for coffee is higher. If Starbucks lowered their prices they could potentially steal customers from the competition. Once the demand increases, then the supply will increase. If we look back at the Elasticity article from earlier on in this blog, the same effect would happen to Starbucks. The demand is elastic based on price.  If the price of a Starbucks drink is reduced below $5, then demand would be inelastic and profits will begin to drop.

Since Starbucks have closed their selected locations, this means there are sunk costs related to building and operating costs. Closed locations mean laid off employees so in the short term at least, there are reduced employee wage costs until the company decides to hire more people.

Allison, M. (2008, 07 02). Business & Technology - Starbucks closing 5 percent of U.S. stores. Retrieved from The Seattle Times: http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

Press, C. (2008, 07 02). Starbucks Boosts Planned Store Closure to 600. Retrieved from CBC: http://www.cbc.ca/news/business/story/2008/07/01/starbucks-closures.html

Rebel, B. S. (2007, 02 23). Starbucks Gossip: Starbucks chairman warns of "the commoditization of the Starbucks experience". Retrieved from Starbucks Gossip: http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

Thomas, J. (2012, 01 09). Starbucks is Raising its Prices, But People Probably Won’t Occupy Starbucks. Retrieved from Motiv Stragegies: http://motivstrategies.com/motiv_blog/2012/01/starbucks-is-raising-its-prices-but-people-probably-wont-occupy-starbucks/