MGE1108 Market Structure : Monopoly and Monopolistic Competition

The four market structures that exist in all world economies are monopoly, perfect competition, oligopoly and monopolistic. These for are classified according to different characteristics possessed by each. The classification are based on the number of both sellers and buyers (especially the suppliers), the availability of substitute, and the entry and exit barriers. This paper is aimed at determining the characteristic of monopoly and monopolistic structure and then use those characteristics to determine the various examples of each market structure that exist in Australia. The paper will also identify the advantage of each possessing different characteristics and how they misuse such advantages. The misuse of market power calls for intervention by competitive authorities mandated by the government (Kollmorgen, 2016). In market where there is a significant level of competition, the government fails to impose some regulations since it is believed that competition makes the firms only to offer fair prices. This paper shall confirm therefore the existence of regulation for monopolies, and the absence of regulation in monopolistic market structures.

Analysis

The monopoly market structure is characterized by only a single producer and very many buyers. This producer supplier to all consumers in an economy and thus have market power over output and price it offers (Carmody, 2015). What makes this producer to have no competition is because the product offered has no close substitutes and that there is high initial cost to be incurred for a new firm to start producing this good. This is given that the monopoly has economies of scale that enables it to produce and deliver products at the lowest cost. The monopoly sets its price too high and faces no competition (Murphy, 2017).

An example of monopoly firms in Australia include; the railways, the Australian Post, electricity production and supply, water service, a large employer operating in a small town (May, 2015). Most of the products provided by monopolies are necessities and thus they are on high demand (Mankiw, 2016). For instance, irrespective of the prices of electricity, households will continue consuming it because there is less option for electricity. Other sources such as generators may be found to be costly and inefficient. When you come to water, it has no other substitute, thus, the price does not affect consumption. Even if consumers cut their level of water spending owing to price increment, the cut will be insignificant. In order therefore to ensure that these products are sold at a fair price affordable to all, the government regulate such firms to avoid exploitation of consumers. If monopoly firms were not regulated, they would implement unfair market practices because, most private firms are aimed at improving their profits even at a cost to others (McTaggart, Findlay & Parkin, 2007). They would charge higher prices because the know that necessities have an inelastic demand, or rather, they would supply less in order for demand to exceed supply such that price will rise. The government intervenes to ensure that a fair quantity of such products is produced and sold at a price affordable to many.

Fig: Graph: Monopoly market structure

Without government’s regulation, monopolies normally produce Qm output; this is at the point where they maximize profits since the Marginal Revenue (MR) is equal to its Marginal Cost (MC) (Agarwal, 2017). This output is then sold at price Pm which is very high. At this price, the MC is lower and thus allocatively inefficient. Due to the absence of competition, monopolies are x-inefficient and have no incentives for price reduction. This raises the greater need for regulation by the government. The government regulates the monopoly by ensuring they produce Qr output and sell it at price Pr which is lower than Pm (Pettinger, 2017). This is where the MC = AR and the ATC is at its lowest level. This ensures that, monopolies breakeven but makes just economic profits. The society’s welfare is improved since households are buying at a lower price than what they were offered before the regulation.

Graph: Economies of Scale

Furthermore, it has been confirmed that these monopoly firm possess economies of scale and thus are able to supply the product at a very low price. The average cost of producing Qm is low AVm, that when there are many firms each producing Qc; the average cost of producing Qc is high at AVc. The government cannot promote competition in this sector since the economies of scale will be lost and thus the firms in the market would only be able to supply at a higher price than what was charged initially when only one firm was supplying.

Examples of monopolistic competition in Australia according to (Baum & McPherson, 2012) include; restaurant and Pizza places. Others include; salons, coffee shops, Nightclubs, pharmacies, dry cleaners, furniture stores, gas stations, hardware stores, car washes, automotive service companies, etc. (Lipovsky, 2018). In monopolistic competition, the firms producing the good, and the buyers are many. However, they are fewer compared to perfect competition. The products are differentiated and entry and exit is free. With free entry, firms cannot exploit the consumers because new firms are attracted to the market and they end up sharing the abnormal profit, eventually, in the long run, firms will be so many such that any given firm will only make normal profit. In some extreme cases, firms will be so many such that loses will be incurred. Again with free exit, some loss making firms will opt to exit the market and thus leaving the other firms with only normal profits. Differentiation of products means that the differentiating firm gets some market power of the product but competition still holds. There are two forms in which these firms can differentiate their products and thus sell at a higher price than the competitive price. The first one is real differentiation where the firm improves the quality of the product or makes it more user friendly than the others such that it becomes more useful than the initial product. The other form is that of imaginary differentiation where the firm tries to make its product look more attractive than those of others through advertisement.

Unlike in the perfect competition where there are no selling costs, in monopolistic competition selling costs exist because firms always try to make their product look better mostly through advertisement since their goal is to gain maximum profit from selling the product at the best price possible (McEachern, 2012). In this market, there exist the challenge of imperfect information since the sellers are not sure of what products the buyers would prefer to buy since there are many close substitutes. On the other hand, buyers are not very sure of the best products to buy based on quality and prices; thus they are forced to buy what is locally provided to them. Buyers are also aware of the existence of lower priced substitutes offered elsewhere but due to time and conveyance costs, they are forced to buy the local goods (Kumar, 2018). In this case, there is no party that is able to take advantage of the other. The demand curve in this case of monopolistic competition is elastic to prices such that a firm can only sell more by lowering prices which again will be beneficial to consumers.

Graph: Monopolistic competition

Monopolistic firms produce Q* output and sell at price P*. Since these firms do not produce at the point of minimum AC, they therefore have excess capacity of which is not produced because it would only raise costs. The absence of no economic profit in the long run is attributed to free entrance that allows for new firms to enter the market in the short run when firms are making supernormal profits.

Conclusion

The monopoly markets are regulated whereas the monopolistic markets are not regulated because monopoly firms have much market power which is frequently abused. There is no competition for monopoly markets while there is competition in monopolistic markets. The lack of competition is the source of this market power for monopolies. Since monopolies are considered x-inefficient in that they have no intention of price cutting, they call for regulation. Competition in monopolistic markets is such that a firm may decide to cut its price to enable it to sell more and this is good to the consumers. Due to the lack of competition, monopolies also lack innovation and if were left unregulated they would offer low quality products at a high price. Since monopolistic firms are in constant attempt to differentiate their goods, they are always innovative and thus quality products are produced. Regulation for monopolies raises the society’s’ welfare and thus important. The government can therefore be concluded to impose regulation because there would be market failure if the market operated freely.

References

Agarwal, P. (2017). Monopoly Market Structure. Retrieved from https://www.intelligenteconomist.com/monopoly-market-structure/.

Baum, S., & McPherson, M. (2012). Monopolistic Competition and the Very Small College. Retrieved from https://www.chronicle.com/blogs/innovations/monopolistic-competition-and-the-very-small-college/31279.

Carmody, B. (2015). Australia Post is hurting small businesses with PO Box monopoly, says delivery company. Retrieved from https://www.smartcompany.com.au/growth/49035-australia-post-hurting-small-businesses-with-po-box-monopoly-says-delivery-company-sendle/.

Kollmorgen, A. (2016). Market monopolies in Australia. Retrieved from https://www.choice.com.au/shopping/everyday-shopping/supermarkets/articles/market-concentration.

Kumar, M. (2018). 7 Main Features of Monopolistic Competition. Retrieved from https://www.economicsdiscussion.net/monopolistic-competition/7-main-features-of-monopolistic-competition/7297.

Lipovsky, W. (2018). 12 Monopolistic Competition Examples, 33 Oligopolistic Competition. Retrieved from https://firstquarterfinance.com/34-monopolistic-competition-examples-around-world/.

Mankiw, N. (2016). Principles of microeconomics. Australia: Thomson Nelson.

Murphy, J. (2017). The companies that make big profits even when customers shop around. Retrieved from https://www.news.com.au/finance/business/other-industries/the-companies-that-make-big-profits-even-when-customers-shop-around/news-story/ce907b48adcf31d5939539c0568d516d.

May, D. (2015). Export instability when international agricultural markets operate under oligopoly. International Journal of Trade and Global Markets, 8(2), 142. https://dx.doi.org/10.1504/ijtgm.2015.069424.

McEachern, W. (2012). Microeconomic principles. Australia: South-Western Cengage Learning.

McTaggart, D., Findlay, C. & Parkin, M. (2007). Microeconomics. Australia: Pearson Education.

Pettinger, T. (2017). Monopoly diagram short run and long run. Retrieved from https://www.economicshelp.org/blog/371/monopoly/monopoly-diagram/.