Comparing Market Structures

Hello,

Today I would like to compare the four types of markets in the last post to my blog. Bellow I would like to present a brief comparison of four possible types of markets. Some of them are not presented very much in every day’s life while others we can see everywhere. Here are they:

Type of Markets	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
Number of Firms	Many / Very	Many / Several	Few	One
Freedom of Entry	Unrestricted	Unrestricted sometimes restricted by licencing	Restricted by economies of scale and licencing	Restricted technologically, legally or economically
Nature of Product	Undifferentia ted	Differentia ted	Undifferen tiated or Differen tiated	Unique
Implications for Demand Curve	Horizontal, firm is a price taker	Elastic, downward slopping, can little control price	More inelastic, downward slopping, can control price more	Most inelastic of all markets, downward slopping, has increased control over price
Average Size of Firms	Small	Small and medium sized	Big	Big
Possible Consumer Demand	No preferences given, many choices, demand in equilibrium with supply	Preferences to brands, many choices, demand in equilibrium with supply	Few choices, either preferences to brand or not, excessive demand and higher price paid when cartels or collusion exist	No choice of product, excessive demand not satisfied by supply, higher prices
Profit Making Possibility	Normal profit in long-run and possible economic profit for short time in short-run	Normal profit in long-run, possible economic profit in short-run	Possible economic profit in short-run and less possible in long-run	Possible economic profit in short-run, and long-run
Government Intervention	Minimum, dealing with external costs	Taxation, restricted entry	Collusion prohibition, taxation, restricted entry	Taxation, price setting, nationalization, restricted entry
Example	Wheat, milk, eggs	Coffee shops, clothing retailers	Oil production, sell phones, cars	Energy for cities (Enmax), public transportation system for small to medium-sized cities
Technological Innovations	Many as a possibility to have an economic profit	Many as a possibility to have an economic profit and develop brand	Many as a possibility to have an economic profit, more money involved because of economies of scale	More money involved because of economies of scale, sometimes no willing and restriction to innovations
Competition Among Participants	High	Very high	Nonprice competition	No competition

As we can see the markets are organised from perfect competition to monopoly what gives the idea of increasing power of the companies over costumers on the market and explains why the government sometimes has to interfere.

Below are graphs for the single firm operating in possible four types of market. The ideal free competitive market is represented in perfect competition graph:

 

This type of market is making normal profit in short-run and long-run (0Q1aP1). This is classical type of competitive market and though it is very rare to find in real life many economists treat it as ideal. The demand curve D faced by single firm on the competitive market is horizontal and it means that the firm cannot change the price and all output produced will be consumed as there is no difference in between the firms on the market. Also the firm’s marginal and average revenues are same as price and do not change with additional units added. It allows to achieve productive and alllocative efficiency in both short-run and long-run. With the implication of economies of scale the cost and price curves will shift down because of extensive competition.

Next is the monopolistic competition graph:

Here we can see downward slopping flat elastic demand curve D1 where there is the difference in between the companies on the market and the customers show preferences of one firm over another. That gives the company a little bit power over the prices charged and helps to operate with economical profit in the short-run that is 0P1cQ1-0P2bQ1 where P2b is the average costs and P1c are the price. But in the long-run it is impossible because many firms attracted by this possibility are entering the market and driving prices down to D2 curve and the firm is able to earn only normal profits 0P2bQ1. The company is neither productive nor allocative efficient because it is maximizing the profits and selling the output which has maximum difference between revenues and costs. It is located on intersect of MR and MC curves.Very similar to monopolistic competition is oligopoly:

It is type of market where there are a few large companies with either differentiated or undifferentiated products. The entry into the market is restricted by the size of dominating firms and sometimes licence is required. The companies have significant control over the prices but because of the existing mutual interdependence the prices tend to stay unchanged for long periods of time. This is illustrated on the kicked curve which is more elastic on the top than after the price point. The companies are more likely making economic profits in short-run and long-run though they often are making only normal profits as in the example with MC2 and AC2. Again, for the firm is better to make normal profit than change the price because it could drive many customers out and cause loss. And, what is important, the profit-maximising point is the same in both cases. This is one of the theories how oligopoly market is operating though. The other ones are game theory and price leader theory The companies are neither productive nor allocative efficient.

The last type of the market is monopoly:

This type of market is presented by only one firm. The entry is restricted or blocked. The monopolist has significant influence on the price and amount of output and as a result is producing at profit-maximization point and never on the inelastic portion of the demand curve. It is neither productive nor allocative efficient. This type of market is most interfered and regulated by government because of the threat that monopolist will make superprofits if is left unregulated. The government can impose lump-sum or sales taxes, set the socially optimum or fair-return prices on the product or nationalize the company. Without government intervention the monopolies usually are making economic profit in short-run and long-run.

Game Theory

 The game theory was first realized in 1928 when John von Neumann published his papers where he analysed the Brouwer’s fixed-point theorem of the possible outcome to the players of the zero-sum game when any of them cheats. Later Ockar Morgenstern joined him and together they published Theory of Games and Economic Behavior book. But first the main point in the theorem was that the player’s behaviour would be to cooperate, and based on it there were strategies developed. In the 1950^th the Prisoners' Dilemma came onto the scene introduced by notable mathematicians Merrill M. Flood and Melvin Dresher. Around 1950, John Nash developed a criterion for mutual consistency of players' strategies, known as Nash equilibrium, applicable to a wider variety of games than the criterion proposed by von Neumann and Morgenstern. This equilibrium is sufficiently general to allow for the analysis of non-cooperative games in addition to cooperative ones. ¹ The main ideas behind the game theory would be that this is always better to cooperate to produce mutually beneficial outcomes. However, each player is tempted to pursue his or her individual interests. Cooperation requires that both players compromise, and forego their individual maximum payoffs. Yet, in compromising, each player risks complete loss if the opponent decides to seek his or her own maximum payoff. Rather than risking total loss, players tend to prefer the less productive outcome. ²

The playoff matrix works like in the following video:



This is the shortest explanation why the matrix D would be preferred to the matrix A.



Though this is not always the best to cheat and really depends on possible outcome in each situation. If the possible earnings or loses are not significant fortunately many would prefer not to cheat. Now let’s look at where it is used.

Game theory has been used to study a wide variety of human and animal behaviors. It was initially developed in economics to understand a large collection of economic behaviors, including behaviors of firms, markets, and consumers. The use of game theory in the social sciences has expanded, and game theory has been applied to political, sociological, and psychological behaviors as well. In the politics the example is Cold War. During the Cold War the opposing alliances of NATO and the Warsaw Pact both had the choice to arm or disarm. From each side's point of view disarming while the opponent continues to arm would have led to military inferiority. If both sides chose to arm, neither could afford to attack each other, but at the high cost of maintaining and developing a nuclear arsenal. If both sides chose to disarm, war would be avoided and there would be no costs. If your opponent disarmed while you continue to arm, then you achieve superiority. Although the 'best' overall outcome is for both sides to disarm, the rational course for both sides is to arm. This is indeed what happened, and both sides poured enormous resources in to military research and armament for the next thirty years until the dissolution of the Soviet Union broke the deadlock.³

In environmental studies, the PD is evident in crises such as global climate change. It is argued all countries will benefit from a stable climate, but any single country is often hesitant to curb CO₂ emissions. The immediate benefit to an individual country to maintain current behavior is perceived to be greater than the purported eventual benefit to all countries if behavior was changed, therefore explaining the current impasse concerning climate change.³

Now let’s look at the collusions and cartels. They have lots in common cartel is distinguished as formal agreement between competitors⁶ and collusion is an agreement between two or more persons, sometimes illegal and therefore secretive⁷. Though the collusions are prohibited in most countries there is evidence about cartels in between countries. The most recognized one is OPEK. As long as the members of cartel are following the agreement all of them are better off. But if any of the members tried to cheat the well-being of all members is falling down dramatically. In the single country market there are also some other constrains for the Prisoners Dilemma.The knowledge that the game will be played again leads players to consider the consequences of their actions; one's opponent may retaliate or be unwilling to cooperate in the future, if one's strategy always seeks maximum payoffs at the expense of the other player.² This leads to collusive behaviour of the firms on the market in terms of keeping the promise. They do act in their best interests but do realise that it requires keeping in mind the interests of the other players and respecting them.  For the proof of this idea please watch the last two minutes of the following video:



Sources:

1. http://en.wikipedia.org/wiki/Game_theory
2. http://www.beyondintractability.org/bi-essay/prisoners-dilemma
3. http://en.wikipedia.org/wiki/Prisoner's_dilemma
4. http://connect.mcgraw-hill.com/connect/hmEBook.do?setTab=sectionTabs
5. http://www.youtube.com
6. http://en.wikipedia.org/wiki/Cartel
7. http://en.wikipedia.org/wiki/Collusion

Monopolistic Competition

Monopolistic competition is the closest to real life model of perfect competition market. It has a large number of firms with easy entry and exit, abundance of information available, but the products on the market are slightly different and the sellers can adjust the prices little bit. That is when on the market comes advertisement and high competition.

It is the prime importance for the seller to convince buyers that the product he is selling is better than similar product of the competitor. And as we can see from the table below it depends of the size of the company how that is accomplished. For the small company the service and freshness of the food and beverages are the most important things. Medium and fast-growing company is concentrated on exceptional signature beverages from the best coffee beans and comparably low-cost Internet advertisement in afford to keep the price higher and demand curve less elastic and shifted right. To achieve economies of scale the company is selling franchises. And finally the big famous company is using all possible advertisement to get profitable cafes in every town like all places in the USA where Tim Horton played. It actually creates a legend that is part of Canada’s recognition abroad. All possible advertisement methods are used, economies in scale is achieved. The freshness of goods and their taste is something that was given up. In fact, there are no more locations where the doughnuts are prepared left. They are just reheated from frozen state. Is it what the motto "Always Fresh" means? I don't know. But for the customers the brand is now more important.

Monopolistic Competitive Companies

Size:	Small Company	Medium Company	Large Company
Features:	Bumpy’s Cafe	Waves Coffee House	Tim Hortons
Differentiated products	Homemade fresh goods and drinks	Signature Beverages, Fresh appetizers	Beverages and Doughnuts, Breakfasts, Lunches
Control over price	Little	Little	More control as the costs are less because of economies of scale
Mass advertising	Flyers, old clients, Internet, Logo, Social Media	Internet, Banners, Logo, Flyers, Social Media	TV, Internet, Banners, Flyers, T-shirts, Tumblers, Cups, Sport Stars, Event Sponsorship
Brand name goods	Logo	Logo, Packaging, Franchise	Recognizable packaging, Logo, Franchise, Part of Canadian culture
Icon founder	N/A	N/A	Tim Horton
Atmosphere	Old happy times	Modern, Place to meet and relax	Yes as much as possible for fast food chain
Service	The best	Good	Average

 Sources:

http://www.bumpyscafe.com/index.html

http://wavescoffee.com/#1

http://www.timhortons.com/ca/en/about/index.html