Overview of Market Structures
Question:
Explain, providing appropriate examples, why car manufacturers are constantly introducing new models.
In an economy, there are various market structures under which different types of production firms produce their commodities. These different market structures are perfect competition, monopoly, monopolistic competition, oligopoly and duopoly. Each market structure has different criteria. In perfect competition, there is large number of buyers as well as sellers and firm cannot change market price of their commodity as perfect competition exist in the market. Moreover, firms can easily enter or exit under this market. In monopoly market, though the number of buyers remains large, but the number of seller becomes one. Hence, this seller can change his or her product prices and can also charge different prices for same commodity in different markets. However, it should be mentioned that there exists a negative relationship between price and quantity of that product. In monopoly, the seller can earn economic profit. There is large number of buyers and sellers in a monopolistic competitive market. However, producers in this market do not sell same commodity, rather they sell different commodities which are closely substitute with each other. On the other hand, in an oligopoly market, interdependence among producers can be seen. Here, number of sellers is not more than 4. In duopoly, the number of sellers is 2. However, in this essay, the chosen market is car industry. This industry especially operates under the monopolistic competitive market structure. Hence, to discuss the reason that why car manufacturers introduce new models continuously, understanding of this market structure is important. Therefore, in this essay, market conditions and equilibrium under short-run and long-run of monopolistic competitive market will be analysed.
Car manufacturing companies operate under the automotive industry. The automotive industry or car manufacturing industry is very large and dynamic (Pisano, 2017). It helps to grow a country’s economy, especially for developing countries. There are various stages for producing cars. These are craft, mass and lean production. Both small companies and large companies make their standard level of production and business strategies through these stages.
Car manufacturing industry or automobile industry is expanding rapidly as there is a huge demand for cars all over the world. There are various car manufacturing companies worldwide and they are producing various models with different characteristic. However, the chief criteria are utility, safety, quality and reliability related to their customers. It can also be analysed from the economic point of view. Hence, to analyse this reason, some basic theories of economics are needed to discuss. These are cost-benefit approach to produce new model of car and market structure of car manufacturing industries.
In a car manufacturing industry, producers take a cost-benefit analysis to take a business decision. In this context, producer aggregates all benefits that will be received by them by taking an action, that is, by producing new model of a car. The same process is done for costs. Hence, before launching a new model of car, every car manufacturer conducts an analysis related cost and benefit to evaluate all possible costs and revenues that may generate after taking this action (Coates IV, 2014). Costs include both direct and indirect costs, opportunity costs, cost of risk and intangible costs. On the other hand, benefits consist of both direct and indirect revenues of the manufacturer. After calculating those costs and benefits, the final step is to see that whether benefit exceeds costs or not. If benefit exceeds cost then the car manufacturer can launch new models of car, otherwise not. In a car manufacturing industry, producer can earn benefit in various ways by introducing new models of car. It may happen that the demand for this new model increase. This generates huge amount of revenue for this producer. There may be other intangible benefits related to consumer surplus and environment. On the other hand, costs for launching new models of car may be the opportunity cost which the producer, tax imposed by government, new technology and negative externalities. Under monopolistic competition, advertisement is an important cost that every firms bear to sell their products. However, the manufacturer will always want to launch a model where benefit will be higher than costs.
Car Manufacturing Industry
In each country, where car manufacturing companies operate their production system, the automotive industry can be divided into two market conditions. These are production sectors and selling sectors. The overall car manufacturing industry operates under the monopolistic competitive market. This is because; there are different car manufacturing companies in an economy. Hence, they have perfect competition among each other. However, different companies are not producing exactly same cars. These cars are closely substitute with each other but not completely substitute (Bertoletti & Etro, 2017). Hence, all characteristics of a monopolistic competitive market can be seen in this industry. One of the important characteristic of this industry is that product differentiation and advertisement. It is very important to make new cars with different new features so that consumer will demand that particular car more than other cars. Therefore, launching new models of cars with new technology and new features are very important tools for the manufacturers. Consumer’s demand for car is changing day by day (Brand, Cluzel & Anable, 2017). With time, new technologies and facilities of cars are demanded by consumers. Producers are also using those criteria to make new models of cars as consumer demand is the principle priority for them.
In this context, it is important to analyse monopolistic competitive market under which this industry is operating. The chief characteristics of a monopolistic competitive market are important to understand the market nature. There are a large number of sellers or producers. Each producer is producing different products but those products are closely substituted with each other. Hence, the chief competition is based on the product quality, marketing strategy and price among those products. All other companies or firms can easily enter or exit from this market. As there are large numbers of companies in the market, it will indicate that the market share of each firm is very small. Hence, each firm has limited power to control market price for their products as there are other close substitutes of those products. Product differentiation of this monopolistic competitive market helps every firm to compete with each other from three different categories. These are quality, marketing, price and branding. Product quality means design, service and reliability. The demand curve of each firm’s product is downward slopping as firms produce different products which are not exactly equal. However, trade-off between quality and price can be seen in this market. As each firm produces differentiated products, they take two chief selling strategies to sell their products. These chief selling strategies are packaging and advertising. By applying those selling strategies, they try to attract new customers and at the same time try to maintain their old customers. Advertising helps customers to know more about the new features of a product.
The whole market operation of a monopolistic competitive market can be seen by a suitable diagram. As each firm operates like a monopolist, the demand curve of each firm will be downward slopping. The equilibrium amount of output will be achieved at the point where marginal revenue (MR) and marginal cost (MC) are equal (Parenti, Ushchev & Thisse, 2017). The corresponding price level will be the equilibrium price of that firm. However, it should be kept in mind that, in a monopolistic competitive market, producers can earn economic profit or normal profit and also can face economic loss during short-run. However, in long-run, they can earn only normal profit.
Cost-Benefit Approach to Produce New Model of Car
Figure 1: Equilibrium of Monopolistic competitive market with Economic Profit
Source: (created by author)
In this above figure, the producer is earning economic profit by A B C P0 amount. This is because; here price is greater than average total cost (ATC). Here, the equilibrium level of price is P0 and corresponding equilibrium level of quantity of output is Q0.
It is also possible that the producer is facing economic loss as cost is higher than revenue. This situation can also be drawn by the help of a diagram. In this situation, price is lower than the average total cost curve.
Figure 2: Equilibrium of Monopolistic competitive market with Economic Loss
Source: (created by author)
It can be seen from the above diagram that the producer is facing economic loss by A B C P0 amount. Here, equilibrium price level is P0 and equilibrium mount of output is Q0.
However in the long-run a firm only face normal profits. This is because; as firms enjoy economic profits in the short-run, other firms enter in the market to earn this excess profit. However, Due to increasing number of firms, market share of each firm will be decreased and as a result, each firm will earn only normal profit in the long-run. In this situation, price will be equal to average total cost. This situation is also shown by the following figure.
Figure 3: Long-run Equilibrium of Monopolistic competitive market
Source: (created by author)
It can be seen from the above figure that the firm is earning zero economic profit at point A. Here, equilibrium price is P0 and equilibrium quantity is Q0.
Hence, all economic conditions of a monopolistic competitive market are discussed under short-run and long-run. It can be said that to maintain an economic profit, a firm should continuously introduce new products. This method will allow a firm to earn a competitive success if it produces before its competitors. This situation is also true for a car manufacturing industry. Hence, they also make new models to earn economic profits.
Though innovation is costly, it can help those car manufacturing companies to increase total revenue. It will be convenient for those firms if the marginal social benefit and marginal social cost equate with each other. Marginal social benefit means the amount that a customer is willing to pay for new and innovated products. On the other side, marginal social cost means those costs that a firm bear to innovate something.
It is important for a car manufacturing company to maintain their customers so that they can earn profit. Therefore, they always try to attract their customers by making new models of cars. Hence, in this market, product variation and advertising are two important concepts. There are different geographical and economical differences all over the world. Income inequality is a serious problem from some developing countries. Based on this criterion, a car manufacturing company can make new models with lower price but with new and technologically updated features. Every car company applies different market strategy to sale their products in other countries. Innovation of new products is also a part of this. There are some basic features which each customer wants. These are comfort, designing bode and safety. Manufacturers are also producing their car to control pollution in the environment. It is an important issue at present. Hence, by launching new models with new technologies, they try to reduce this pollution level (Damert & Baumgartner, 2017).
Hence, it can be said in conclusion that producing new models of cars is a very important matter for each car manufacturing companies. As they operate under monopolistic competitive market, they have huge numbers of competitors. Hence, to remain in the market and to earn economic profit at the same time, it is necessary for them to produce new models of cars with new technologies. The main priority of those car manufacturing companies is the meet the increasing demand of customers. Safety, comfort, stylish body are some basic features that each customer demands. The car manufacturing industry or automotive industry is one of the biggest industries of an economy. Hence, it is important to make huge amount of profit as this contributes a large part in a country’s national income. Hence, producers should be more innovative
References:
Bertoletti, P., & Etro, F. (2017). Monopolistic competition when income matters. The Economic Journal, 127(603), 1217-1243.
Brand, C., Cluzel, C., & Anable, J. (2017). Modeling the uptake of plug-in vehicles in a heterogeneous car market using a consumer segmentation approach. Transportation Research Part A: Policy and Practice, 97, 121-136.
Coates IV, J. C. (2014). Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications. Yale LJ, 124, 882.
Damert, M., & Baumgartner, R. J. (2017). Intra?Sectoral Differences in Climate Change Strategies: Evidence from the Global Automotive Industry. Business Strategy and the Environment.
Parenti, M., Ushchev, P., & Thisse, J. F. (2017). Toward a theory of monopolistic competition. Journal of Economic Theory, 167, 86-115.
Pisano, G. P. (2017). Toward a prescriptive theory of dynamic capabilities: connecting strategic choice, learning, and competition. Industrial and Corporate Change, 26(5), 747-762
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