Power and Profit of Competitive Market Structures
Market structures are classified by the existence or absence of competition, three of which comprise perfect competition, monopoly, and oligopoly (Samuelson & Marks, 2015). Competition arises from the perceptions and opinions of consumers in competitive markets of the economic system (Hayek, 2016). A decision to purchase a good or service is based on individuals’ sentiments of the best, cheapest, or most favorable to opportunities (Hayek, 2016). Competitive markets lead to innovation, lower prices, and increased output that result in growth and gains for individuals and organizations (Crane, 2016).
Perfectly Competitive Market
A perfectly competitive market is an economic theory where identical goods are available to all competitors with no barriers to entry (Samuelson ; Marks, 2015). Price is not influenced by an organization and all firms will sell the entirety of its products at the market price (Samuelson ; Marks, 2015). Organizations in a perfectly competitive market will set a market price at the point where market demand meets market supply (Samuelson ; Marks, 2015). Firms can opt for any quantity of output on the condition that it accepts the prevailing market price (Hayek, 2016). Levels of profit will increase with higher output or the total number of goods sold at a specified price such as $5 for one item or $9 for two (Hayek, 2016). If MR is lower than MC, the firm fails to gain revenue, while it lacks output when MR is higher than MC (Hayek, 2016). Profit maximization occurs at price (P) = marginal revenue (MR) = marginal cost (MC).
While rare, a pure monopoly exists when an organization controls 90% or more of the market, such as Microsoft’s Windows-based operating systems (Samuelson & Marks, 2015). In a natural monopoly, a single firm consumes considerable resources in which duplication would be inefficient (Samuelson & Marks, 2015). Natural monopolies of regional electricity, gas, water, and public transportation companies require costly infrastructures that are protected and regulated by the government (Samuelson & Marks, 2015). Monopolies are able to influence the price of goods or output. Profit maximization (max ?) = total revenues (TR) – total costs (TC) (Leigh & Triggs, 2016). As the demand curve slopes downward, the monopolist must reduce its prices to sell more of its goods that will increase demand (Leigh & Triggs, 2016).
In an oligopolistic market, few organizations dominate the market, such as the four major wireless providers – AT&T, Sprint, T-Mobile, and Verizon. Pricing may be competitive; yet, the dominant company will have greater control, i.e., Verizon’s wider coverage and higher plan costs. An oligopoly can also result from the merger of a domestic and foreign monopoly (Kraft, 2016). It would be difficult for new companies to enter the market due to the high costs associated with setup (Bloch, Eaton, ; Rothschild, 2014). Firms in the oligopolistic focus on profit maximization and must use aggressive strategies against competitors’ positioning challenges (Bloch et al., 2014). A common practice in the airline industry is the collusion of setting quotas to maintain the price at profit maximizing levels (Bloch et al., 2014).
Market Entry, Efficiency, and Power
According to the U.S. Census (as cited in Leigh & Triggs, 2016), two-thirds of American markets have increased in concentration in the past 20 years. Additionally, studies reveal that approximately half of the wealthiest 2.4% households in the U.S. were attributed to capitalized monopoly gains (Leigh & Triggs, 2016). Of the nearly 900 industries in the U.S. that were analyzed, the largest four firms controlled 33% of the market (Leigh & Triggs, 2016). Previous studies have indicated that employees receive a wage premium in a monopoly (Crane, 2016).
A perfectly competitive market is a theoretical model rather than a practical application (McDermott, 2015). There are many small firms that have the freedom of entry into and exit out of the market (Samuelson & Marks, 2015). Firms in the market structure are price takers with no dominant firm and have perfect knowledge of price and supply of homogenous units of output (Samuelson & Marks, 2015). Firms in a perfectly competitive market have no individual but collective market power
Market entry into a monopoly has restrictive barriers that include large start-up capital and a vast supply of goods (Samuelson & Marks, 2015). A monopolist offers differentiated products that consumers may prefer to other products like Apple iPhones over Samsung Galaxy Note wireless phones, both of which have significant market power with neither having perfect substitutes. Apple relies on its loyal customer base and annual events that highlight technological upgrades of its iPhones, as well as MacBook, iPad, and Apple Watch lines. Apple has substantial market power in its ability to raise product prices on upgraded devices which tens of millions of consumers worldwide are willing to spend on.
Oligopolies ally with each other in an agreement known as a cartel with the leading firms seizing larger concentrations of the market share (Samuelson & Marks, 2015). There is interdependence between firms in an oligopolistic market – T-Mobile’s dependence on AT;T for its customers that are beyond the company’s cell towers range and reciprocally in the reverse. The big four wireless service providers must rely on and have agreements to cover areas that are not serviced within its regions. Wireless service providers, like the industry leader Verizon, can charge higher prices due to its market power.
The economic theory of competitive market structures analyzes consumer behavior and interaction with sellers. The hypothetical structure of perfect competition has many buyers and sellers with no influence on prices or market share. A monopoly has a single seller with no real substitutes in which the firm has a great deal of control over supply and prices. Collaborative oligopolies are few sellers that have some degree of power over prices. Competitive markets in the U.S have achieved an expansion of their dominance to the global markets of supply, demand, and price points.
Power and Profit of Competitive Market Structures