Effects Of Market Structure Changes And Housing Affordability Crisis In Australia

Perfect Competition and Monopoly

1. Effects of a perfectly competitive industry changing to a monopoly on price, quantity, consumer surplus, producer surplus and deadweight loss
2. Perfectly competitive industry

A perfectly competitive industry consists of numerous buyers and sellers in the market buying and selling products which are homogeneous at the prevailing market price (McNulty, 2012). In a perfectly competitive market structure competition is stiff and is at its highest level possible. No single buyer or seller can attempt to deviate from the market price. Perfectly competitive market structure has the following features:

A large number of buyers and sellers: a perfectly competitive market structure has a vast number of buyers and sellers. One single buyer cannot influence the general market price and also one single seller cannot influence the market total output.

Homogeneous products: products sold by sellers in the market are identical and hence consumers are indifferent in their purchase (Robinson, 2014). They are unable to prefer certain sellers over others as products are just the same.

Free entry and exit: buyers and sellers are free to enter and exit the market (Geroski & Jacquemin, 2013). A seller who suffers losses can exit freely as sellers’ mobility is not restricted.

Perfect prices and technology knowledge: buyers and sellers in a perfectly competitive market stricture have perfect knowledge about the price of commodities in the market and the production technology being used. Hence sellers can use perfect methods of production and buyers can buy products of their choice.

No government or artificial intervention: in a perfect competition market structure, the price of commodities are determined by the market conditions of demand and supply. This implies that no any big producer or the government can intervene and control the entire market.

Under perfect competition industry, firms can either make supernormal profits or losses in the short-run period. During the short-run period, only a few firms are in the market. This makes sellers sell their commodities at higher prices making supernormal profits. Firms in the industry maximize their profit where the marginal cost equals the marginal revenue. The average revenue is high above the average costs as shown in the diagram below:

In the short-run period, there is still the possibility of firms making losses. Firms still maximize their profits where the marginal cost equals the marginal revenue. This happens if the firms’ average costs are above the average revenues as shown in the diagram below:

In the long-run, firms in a perfectly competitive industry make normal profits. The loss-making firms exit the industry in the long run as there are no barriers to exit making the remaining firms to adjust and go back to making normal profits. An industry with firms making supernormal profits attracts more firms to enter the industry in the long run as there are no barriers to entry. This increases the overall market supply shifting the industry supply curve to the right and hence lowering the overall market price for commodities. As a result, firms lower their prices and start earning only the normal profits. Firms still produce at the profit-maximizing point whereby the marginal revenue equals the marginal cost. This is shown in the diagram below:

1. A monopoly industry

Short-Run and Long-Run Profits or Losses in Perfect Competition

A monopoly industry consists of only one single seller who sells unique goods and services which have no close substitutes (Panzar & Rosse, 2016). A monopoly firm is an industry by itself. A monopoly industry bars the entry of new firms into the industry. It has the following features:

Single seller and a vast number of buyers: in a monopoly industry, there is only one seller for a given product selling to a vast number of buyers in the industry. The firm is the same as the industry as it is the only firm selling a particular product.

No close substitutes: in a monopoly industry, the seller offers goods and services which have no close substitutes. In fact, the price elasticity of demand for a particular product in a monopoly industry is zero.

Barriers to new entrants: a monopoly industry puts in place barriers for new firms not to enter the market (Bresnahan & Reiss, 2013). These barriers can be natural or artificial. Some of the barriers to entry in a monopoly industry include huge start-up capital, copyrights, control of important raw material in the market, legal monopolies established by law and patents and trademarks among others.

Price makers: in a monopoly industry, monopolists are the price makers as they have full control of the entire market. Since buyers are vast in number, a single seller demand is infinite as compared to that of the entire industry and hence no single seller can influence the prevailing markets prices. As a result, buyers have to pay the prices set by the monopolists whether they like or not.

Downward sloping demand curve: the demand curve in a monopoly industry is downward sloping. This means that for the monopolists to increase their profits, they must make more sales. For sales to be increased, monopolists must lower their products’ prices.

In a monopoly industry, monopolists make supernormal profits both in the short-run and long-run period. This is due to the fact that there are barriers to new entries and the monopolists are the price makers. Monopolists, therefore, set higher prices to make more profits. Due to high prices, the quantity demanded decreases. Using the profit maximizing point where the marginal revenue equals the marginal cost, the quantity demanded and price can be found. This is shown in the diagram below:

Comparison of price, quantity, consumer surplus, producer surplus and deadweight loss

Consumer surplus actually refers to the difference between the maximum price that a consumer is willing to purchase a given good or service and the actual price that the consumer actually pays for the good or service (Yao & Wu, 2014).

Producer surplus refers to the difference between the minimum price that the seller is willing to sell goods and services at and the actual price that the seller actually sells the product (Hausman, 2011).

Deadweight loss occurs when both the productive and allocative efficiencies are not achieved in production (Cicchetti & Freeman, 2011). It is actually termed as an economic inefficiency which results in a reduction of both the consumer and producer utilities. Some of the reasons behind the occurrence of deadweight loss include taxes, price ceilings or floors, subsidies, monopoly pricing and externalities. The following diagram has been used in comparing the effects of a perfectly competitive industry changing to a monopoly industry on price, quantity, consumer and producer surplus and deadweight loss.

Features of Monopoly Market Structure

When a perfectly competitive industry changes to a monopoly, it raises the price for goods and services in order to make supernormal profits. As a result, less of its commodities are purchased by consumers leading to a reduction in quantity demanded. As a result, the quantity demanded falls from the original one Q_o to Q₁  as the price rises from the original P_o to P₁ as shown in the diagram above. This means that when a perfectly competitive industry changes to a monopoly, the price increases and quantity demanded decreases.

When a perfectly competitive industry changes to a monopoly, the consumer surplus is reduced. This is due to the fact that, consumers are forced to pay for higher price P₁ in a monopoly industry as compared to the initial price P_o they used to pay in a perfectly competitive industry.

The change of a perfectly competitive industry to a monopoly increases the producer surplus. This is due to the fact that monopolists set high prices P₁ as compared to the original price P_o in order to make high profits. Monopolists enjoy higher profits at the high set price P₁ and quantity Q₁.

Firms in a perfectly competitive industry produce goods and services at the profit-maximizing point where the marginal revenue equals the marginal cost. This enables them to attain both the allocative and productive efficiencies as firms maximally utilize the available scarce resources to offer the best quality and price in order to remain competitive. Therefore it is difficult for deadweight loss to occur in a perfectly competitive industry unless “externalities” occur. When a perfectly competitive industry changes to a monopoly, the price is raised from P_o to P₁ and as a result, the quantity produced decreases from Q_o to Q₁. This leads to productive and allocative inefficiencies in a monopoly as monopolists could produce at point (P_o, Q_o) where the marginal revenue equals the marginal cost in order to maximize profits. As a result deadweight loss occurs as shown in the diagram above. Deadweight loss can also be obtained from the sum of the “loss in consumer surplus” and the “loss in producer surplus”.

1. Oligopolistic industries

An oligopoly industry consists of few interdependent firms in the industry whereby all the firms are always alert on the decisions made by any firm in order to counter them (Brander & Lewis, 2016). An industry which is dominated by a few firms is generally highly concentrated. Although the industry is dominated by only a few firms, it is also possible for other small firms to operate in the industry. An oligopolistic industry generally has consideration of the dominant firms exceeding 50 percent. An oligopoly industry has the following features:

Interdependence: an oligopolistic industry consists of firms which depend on each other in as much as decision making is concerned. A firm must consider the possible reaction of the other rivals in the industry before implementing a decision. Generally, oligopolistic firms tend to adjust accordingly to the decisions made by their rivals to maintain their profitability.

Barriers to entry: oligopolies are associated with various barriers to entry which hinder new entries into the market (Demsetz, 2012). These barriers enable oligopolistic firms to gain a significant share of the market. These barriers can be either natural or artificial. Some of the natural barriers to entry into an oligopolistic industry include economies of large-scale production by the dominant firms, high initial capital investment, control of key raw material in the industry and high costs of research and development. Some of the artificial barriers include the high costs of advertising, predatory pricing, superior knowledge about the industry, strong brands and patents and licenses.

Effects of Monopoly on Price, Quantity, Consumer Surplus, Producer Surplus, and Deadweight Loss

Competition: the oligopolistic industry is dominated by only a few firms. This means that any action taken by one firm significantly affects the other firms. This, therefore, means that every firm keeps alert to monitor any move made by the rivals in order to counter-move. There are a few cases whereby oligopolistic firms collude in order to hike prices and eliminate competition. This is illegal and is highly condemned by law. True competition should exist for an oligopolistic industry to remain efficient in its operations.

Product differentiation: an oligopolistic industry most of the times involves non-price competition since other firms retaliate in case of change of price by rivalry firms. This, therefore, means that oligopolistic firms highly differentiate their products through advertising and branding among others (Smith, 2016). They try as much as possible to make their products unique and to capture the attention of many customers.

Role of advertising in an oligopoly industry

Advertising a commodity increases its awareness in the market. Advertisements in oligopolies differ depending on the product differentiation level that exists in the market (Maleug & Tsutsui, 2016). Consumers may have various preferences for certain goods and services but may not be aware of the characteristics of various brands in the market if informative advertisement about the brands is not made. Oligopolistic firms advertise their products in order to increase their market share by increasing the demand for their commodities. Oligopolistic firms must play it safe by ensuring that their advertisements are better of those of their rivals and they must be prepared to counter any retaliatory actions of the rivals as they may adversely affect their profitability. Advertisement helps consumers to make informed choices on what products to purchase. As oligopoly industries have few products, consumers have the time to do research on each product before they purchase. Advertisement provides the customers with details about the products and hence saves them time which they could have spent trying to research the various available products in the market.

Example of Australian oligopoly industry

The Australian financial industry has been identified to be oligopolistic in nature. It is dominated by four major banks and their subsidiaries. The four major banks include ANZ, Commonwealth Bank of Australia, Westpac and the National Bank of Australia. The banks control more than 80 percent of the Australian financial industry services. The banks have recently been setting higher prices for their products especially the home loan interest rates without even fearing that their market shares might reduce. This is due to protection from the four pillars policy which is supposed to maintain competition between the four banks which is now preventing competition (Bikker & Haaf, 2014). As a result, the four major banks have highly increased their profitability with current estimates showing that they recorded an overall net profit of A$31.5 billion ($24.5 billion) during the year 2017 which was 6.4 percent higher than that of the year 2016. The four Australian big banks account for more than 78 percent in terms of lending various types of loans according to the Australian Prudential Authority. They also account for more than 53 percent of the total premiums in the Australian insurance industry. The following table shows the gross loans and advances for the four banks for the month of October 2018:

Oligopoly in Australia

 The four banks also control 57.3 percent administrating investment products. These are commonly known to as wraps, platforms or master trusts. These example cases and several others such the number of top professionals employed by the top four banks show that the financial industry of Australia is oligopolistic in nature.

Advertising has been very crucial to Australian financial industry as they inform their consumers of various products available and their prices as well (Chan, Schumacher & Tripe, 2015). Such products include home loans and interest rates among others. They also inform the general public of various benefits to their shareholders in order to attract more shareholding. Of late the banks have increased their advertisements to improve their reputation and maintain their customers as the as the Productivity Commission has revealed their oligopolistic behavior of charging much to customers due to protection from the government’s top four policy. Some Australian oligopolistic industries do not advertise so much as consumers are aware of their products. The following data obtained from the Australian Standard Media Index shows results for the increase in Australian media agency ads advertisements as a result of increased advertisements by the big four Australian banks:

From the advertising ad spend results, the market total advertisement increased by actually 1.9 percent to $632.7 million due to an increased advertisement from the Australian big four banks especially Westpac as it was trying to improve its reputation (Sathye, 2013).

1. Australian housing affordability

Housing affordability is usually indicated by the relationship between the consumer level of income and housing expenditure which usually includes the prices, rents and mortgage payments. Housing affordability in Australia has been one of the major crises for the past decades (Beer, Kearins & Pieters, 2009). The OECD index of price to household income ratio indicates an increase of 78 percent from the 1980s to 2015. In fact, the Australian parliamentary calculations indicated that the household income ratio to house prices has increased from 3.3 to over 7 from the year 1981 to 2015. There are various factors which have led to the house affordability crisis in Australia. These factors have been discussed under two categories namely the demand and supply side factors as follows.

The price for houses in Australia has increased for the past decades in Australia by a greater margin. The consumer level of income has been increasing at a low rate compared to house prices (Milligan, 2013). In fact, the Reserve Bank of Australia report submitted to the Senate Economics Reference Committee Inquiry into Affordable Housing showed that the house prices in Australia increased by two thirds as compared to the household level of income since the year 2003. This increase in house price has led to the overall increase in average weekly household expenditure from 12.8 percent to 18.0 percent since the year 2000. This has led to the decline in demand for housing in Australia as most of Australian s cannot afford to own their own houses with their low levels of income. The following data from the Australian Bureau of Statistics shows the data for housing costs and housing costs proportional to gross household income respectively. From the data, it is evident that mean weekly housing costs and housing costs proportional to gross household income have been increasing over the past decades causing housing affordability crisis in Australia hence decreasing the demand for houses. Many Australian have opted for renting houses rather than owning theirs. This has led to an increased number of renters over the past decades.

Role of Advertising in Oligopoly

Supply-side factors have also led to a housing affordability crisis in Australia for the past decades as discussed below.

The complexity of the planning process: participants in the housing industry have been facing problems which lead to delays in the provision of housing in Australia. The housing planning process has been complex in Australia due to lack of coordination of various government agencies including local councils, state planning and environmental departments among others. This has been increasing the participants holding costs involved in paying land tax and acquisition finances. This leads to delays in the provision of housing and increases the house prices resulting in housing affordability crisis.

Problems associated with provision and funding of infrastructure: housing provision goes hand in hand with adequate infrastructure supply. Housing infrastructure includes electricity, water, energy and transport. The Australian government used to finance the provision of housing infrastructure from the collected tax due to the establishment of housing property. The government policies shifted and housing industry participants started catering for the infrastructure costs. This increases the overall cost of establishing housing as well as delays (Rowley & Ong, 2012). As a result, there has been a housing affordability crisis in Australia.

Various solutions have been proposed and attempted to solve the housing affordability problem in Australia. The Australian government has reduced infrastructural costs associated with the housing. For instance, infrastructure charges for Brisbane have an established cap of $20000 for one and two bedrooms and $28000 for three or more bedrooms. The government is doing its best to introduce more infrastructure caps in various Australian cities.

The Australian government has tried its best to streamline the process of approving housing projects which are code compliant. The time of approving the projects has been shortened. For instance, the R-code residential design has been expanded in Perth to reduce higher density restrictions on housing developments. In Sydney, the housing development compliance has been reduced and can now be assessed within a period of ten days.

The government of Australia should subsidize the housing industry participants’ projects. This will help the participants reduce their construction costs and build more houses. As a result of the overall market supply of houses increases and the supply curve shifts to the right from S₀ to S₁. This will lower the housing prices from P₀ to P₁ hence increasing housing demand from Q_o to Q₁ as shown below.

Effect of first home owners’ subsidy on price and quantity for perfectly inelastic supply

When the supply for a given product is perfectly inelastic, then it means that producers continue to produce the same quantity irrespective of price changes. Subsidy to first home owners will lower the price that they pay for the houses. The builders will still get the original price since the reduced price is met by the government subsidies. The demand will increase but the quantity will remain the same as shown in the diagram below:

Effect of first home owners’ subsidy on price and quantity for perfectly elastic supply

A perfectly elastic supply implies that the price to the supplier remains the same irrespective of the changes in the quantity that is actually supplied. First home owners’ subsidy decreases the price for houses as consumers pay the reduced price P₁. However, suppliers still receive the original price P_o as the reduced price is paid by the government in the form of subsidies. The quantity supplied actually increases from Q_o to Q₁ as shown below:

References

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