Market Structure, Resource Allocation And Negative Externalities

Key features of different market structure

The objective of this paper is to analyze on the different types of market structure and its key features. Market structure refers to the interconnected market characteristics including competition level, product differentiation, collusion degree between buyers and sellers and firms entry and exit. Market structure are of various types such as monopoly, oligopoly, perfect and monopolistic competition (Mankiw, 2014). The short run and long run profit or losses in these four market structures are also discussed in this report. The condition for profit maximization occurs when marginal revenue (MR) becomes equal to marginal cost (MC).  Further, comparison between different resource allocation in various market structures is also discussed in this study. The paper also highlights on the negative externalities and its impact on different market outcome. Negative externalities are defined as the external cost that the organization suffers owing to the outcome of economic transactions. In addition, the case study on how the government of the respective country addresses the existence of negative externalities is also reflected in this paper.

Perfect competition- This market structure is also termed as ‘pure competition’ where all the entities are price takers and have low market share. The organization in purely competitive market sells similar commodities and has no hurdle in entry and exit. Some key features of perfect competition are given below:

• Huge numbers of retailers and buyers- As there are infinite number of vendors and purchaser; no individual can influence the product price.
• Product homogeneity- Numerous entities sells similar commodities so that the purchaser’s do not have any product preference of any retailer over others.
• No barrier in entrance and exit of entities- Firms enter and exit the competitive market according to the business profitability.

Real life examples- The agriculture industry is one of the closest depiction of pure competitive market. In this marketplace, the vendors sell homogenous goods including vegetables and fruits.  The commodities prices are competitive and vendors cannot influence the pricing. In addition, the purchasers also have their preference in choosing any seller.

Monopoly- In this type of market form, the single vendor sells unique good and new entrant’s faces barrier in entering the market (Rios et al., 2014). The retailer does not face competition as the products have no substitute.

The features of this type of market framework are :

• One vendor and many buyers- This is imperfect form of market structure where the buyer’s reaction cannot affect the product price, as there is only single retailer.
• No substitute product- As the product has no substitute, the monopolist has the liberty in changing the product price.
• Huge entry barrier of the firms- The monopolist has full control over the commodities production and sale as the new entrant faces hurdle in entering the market.

Real life example-  Computer programming organizations such as Microsoft is an example of monopoly market form. There is only one seller and their product including Visa operating system has no substitute in the market.

Oligopoly- Small vendors selling similar or differentiated goods characterize this market. However, few retailers dominate this market and have full product price control.

The characteristics of Oligopoly market form are:

• Few retailers- Few entities control the market and thus enjoy full control over product price.
• Interdependence- The firms makes pricing strategy and business decision according to the action taken by other rivalries. Therefore, the sellers are interdependent in respect of policies of price and output.
• Competition- Intense competition exists among the vendors as there are few players playing in the market. Moreover, this competition benefits the buyers as firms tries to produce good quality products at lower price.
• Entrance and exit hurdle- Entities in this market have the ability to exit the market according to their wish but faces barriers in entering the industry (Okuguchi, and Szidarovszky, 2012). The barriers comes  in the form of government license, scale economies.

Real life examples- Mobile, television, music organizations are few examples of oligopoly market. These industries face huge competition from their rivalries and hence focus on the producing innovative goods according to the prevailing market conditions.

Monopolistic competition- In this type of market, the manufacturers sells differentiated product and are not close substitute( Rezai, 2016). The firms have no control over the goods price and set the price charged by competitors.

Some characteristics of monopolistic competition are:

• Huge number of purchasers and retailers- Each entity makes the pricing strategy independently and has control over goods price.
• No barrier in firms entrance and exit- The companies enters the market when other firms makes supernormal profit (Dunne et al., 2013). Therefore, increase in supply reduces the product price and hence the firms existing in the market attains normal profit.
• Goods differentiation-Companies differentiate goods in order to gain competitive advantage.

Real life examples- Restaurant and hotels business are some industries that faces monopolistic competition.

Short run and long run profits or losses in various market structure

Monopolistic competition- Monopolistic competitive entities in short run attains profit or faces losses by manufacturing that amount of quantity when MR=MC. When average total cost(ATC) becomes higher than market price, loss occurs (Matsumura and Tomaru, 2012).  On the other hand, if ATC lies below equilibrium price, profit is attained. In the long run, the competition in the industry causes each entities to attain normal profits. Moreover, the economic profits of the companies in long run are equal to zero.

Real-life examples of different market structures

Figure 1: Short run profit in monopolistic competition

Source: (As created by author)

Figure 2: Short run loss in monopolistic competition

Source: (As created by author)

Figure 3: Long run profit in monopolistic competition

Source: (as created by author)

Perfect competition- The firms in pure competitive market attains economic profit in the short run when MR> ATC and faces loss when MR<ATC.  In the long run, as firms do not face hurdle in entrance and exit, the market supply increases (Mankiw, 2014). However, all the entities gains normal profit, as the firms attain no incentive in entering or exiting the industry.

 

Figure 4: Short run profit in perfect competition

Source: (Author’s creation)

Figure 5: Short run loss in perfect competition

Source: (As created by author)

Figure 6: Long run profit in perfect competition

Source: (Author’s creation)

Figure 7: Long run loss in perfect competition

Source: (As created by author)

Monopoly- Monopolist do not always gains profit as the firm produces new product according to consumer’s preferences in the short run (AR> SATC). They also accepts loss in short run provided the firms variable cost are covered (AR<SATC). In long run, the companies gains supernormal profit when full utilization of plant does not occur.

Figure 8: Short run profit in monopoly

Source: (As created by author)

 

Figure 9: Short run loss in monopoly

Source: (As created by author)

Oligopoly- The firms in this market  attains profit when price is higher than MC and faces loss when P<MC. In the long run, the entities economic profit becomes equal to zero.

Efficient resource allocation refers to the economy’s state at which the total production of products depicts the preferences of consumers. Thus, optimal distribution of products is attained at the point where the consumer’s marginal benefit is equivalent to the marginal costs. In pure competitive market, resources are allocated efficiently at the point where the product price becomes equivalent to marginal production cost (Krugman, 2013). Therefore, the firms in pure competitive market maximize profits by manufacturing that amount where P=MC.  It also benefit the consumers as the amount purchased measured by price becomes equivalent to the economic cost of manufacturing marginal units measured in terms of marginal cost.

On the contrary, the entities do not always manufacture at minimum cost for some market structures including monopoly, oligopoly and monopolistic competition. However, the product price not always becomes equivalent to the marginal cost. As the goods in monopoly market has no substitutes that and the entity is price maker, the monopolist sets the product price to highest level in order to attain benefit (Claver-Cortés et al., 2012). Thus, this leads to resource misallocation. In case of monopolist market, the entities does not manufacture goods at optimum scale and produces lower than installed capacity. Therefore, the resource malalloaction occurs under this type of market. Similarly, the resources are misallocated in collusive or non-collusive oligopoly. Higher resources misallocation and resource waste in case of non-collusive oligopoly. Thus, the organizations coddle in non-price competition.

Short run and long run profits or losses in various market structure

Negative externality refers to the cost that third party including firms, persons or owner of a property suffers owing to economic transaction (Rezai, et al., 2016). It is also refers to external cost of the business. It mainly occurs in those circumstances where resource or funds rights are not allocated and thus uncertainty occurs (Naughton, 2013). Moreover, negative externality is the main reason behind market failure.

Figure 10: Negative externalities

Source: (As created by author)

The figure below highlights that external cost including pollution cost from industries creates marginal social cost (MSC) greater than marginal private cost (MPC). The output of the goods becomes socially efficient in that situation where MSC becomes equal to marginal social benefit (MSB) at lower output with respect to equilibrium output

Government intervention is required for aiding cost negative externality. The government of the respective country adopts regulation or provides solutions to the market (Chen et al., 2012). These implementation of regulations helps to recover assets for fixing damage caused due to negative externality. In addition, these policies facilitate in putting financial price on public cost. The data received helps the business to attain accurate number for the production cost.

The case study selected is on water scarcity of agricultural sector in India. Irrigation plays a crucial role in the production of agriculture. For the past few decades, the main resource of growth in irrigation is the ground water. In India, 70% of the total production of food grain mainly comes from the land that is irrigated and 60% of irrigation water is attained from irrigated area. At present, India is suffering from scarcity of ground water source due to over exploitation of irrigation water.

Negative externality- Scarcity of water causing bad environment is deemed as negative externalities in the production of agriculture in Indian market. Irrigation blocks that are deemed to be overexploited are increasing at a higher rate of 5.5% annually (Bresnahan, and Levin, 2012). Therefore, water scarcity owing to depletion of water resources creates adverse effect on agriculture production. As the people do not pay social cost for scarcity of water, the society incurs deadweight loss in social welfare. This

The demand curve (DD) reflects ground water demand and the supply curve (SS1) denotes private cost of ground water supply. The supply curve (SS) represents the social cost of ground water supply (Bar-Isaac et al., 2012). The total quantity of water that the farmers attain is depicted by Q1. As the farmers do not disburse payment on the social price of scarcity of water, the society incurs deadweight loss. The area is shown by EBO.

Government Initiative- Indian government adopted legal procedure that includes domination on the methods. As the water irrigation is affected by many variables including political, societal, the policies implemented by the government fails to forecast the state of mind of water users.  Hence, they fail to meet the expected target.

Apart from this, Indian government takes several measures in restoring water resource that includes harvesting rainwater, upgradation of water resource. Though the government has taken many initiatives, these policies are not implemented on huge scale (Baldwin and Scott, 2013). The ground water development is not attributed to the policy of the government. The decentralized farmers helps in ground water development by using natural resources in higher amount. Thus, the farmers faces huge financial crisis due to less funding from water users.

Comparison of allocation of resources in different market structures

Both the positive and negative externality influences the monopoly market in huge way. In addition, the monopoly market reduces the consumer welfare. This reduction in consumer welfare occurs due to lower output and this causes deadweight loss.  The deadweight loss in the monopoly market is shown below:

The monopolist manufactures that amount of quantity in which marginal revenue becomes equivalent to marginal cost. However, when total output becomes fewer than communally optimal, the dead-weight loss occurs (Adlakha et al., 2015). Dead-weight loss occurs in the situation when there are price restrictions or imposition of subsidies in the market. The deadweight loss attained from tax helps to measure the total consumer and producer lost surplus. In addition, the deadweight loss mainly depends on the product price elasticity of supply and demand. Therefore, if the good is less elastic , the amount traded with tax  becomes equal to amount traded without tax..

Externalities have no effect on the market result of perfect competition.  The cost or advantage of an action does not influence the third parties (Acharya and Bisin, 2014). Therefore, this criterion also keeps out from the government intervention. The existence of externalities leads to failure in the market. These externalities causes resource malallocation and hence both production or utilization becomes less  of Pareto optimality. However, perfect competition do not gain Pareto Optimality when both the social as well as private cost diverge. This is because under this type of market the private marginal cost (PMC) becomes equal to private marginal benefit (PMB).  There is always an occurrence of allocative efficiency under perfectly competitive market. This allocative efficiency situation occurs where price of commodities becomes equivalent to marginal cost. Thus, it is assumed that positive as well as negative externalities do not exist in the market (4Kirzner, 2015). Under perfectly competitive market framework, once the government assigns property rights clearly in resources and negligible transaction cost, the private parties that are influenced by externalities confer voluntary agreements. Thus, this leads to social optimal allocation of resource irrespective of how rights to property are assigned.

Conclusion

It can be concluded from the above report that, the four various type of market structure portray features of real market. The characteristics of different market structures vary from one another. Market framework is vital as it influences market outcomes through effect on motivations, chance and players decision participating in this competitive market.  The firms existing in these market structures face huge competition from the other rival companies in terms of product pricing and quality. However, they adopt certain business strategies in order to gain competitive advantage over the rivals. Existence of externality leads to market breakdown as equilibrium price does not highlight true cost and advantage of commodities. Presence of negative externality means that manufacturer does not consider all cost and hence leads to excess production. On the contrary, in existence of positive externality the consumer dies not gain advantage of product and this results to reduced production.

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