Comparing Market Structures

In the final posting of my blog, I would like to summarize the differences between the four market structures. Technically speaking, there are only three as perfect competition does not exist and is just the benchmark in which to compare the other types of market structures to. In an ideal world, everything would be in perfect competition. Perhaps one day it will exist, but I think that would require a lot of government intervention and would make a lot of very powerful people (oil tycoons etc.), extremely angry.

Below is a table which outlines the most important differences between the four:



	Perfect Competition	Monopolistic Competition	Oligopoly	Monopoly
Number of Firms	Infinite	Many	Few	One
Freedom of Entry	Easy	Relatively easy, few restrictions	Difficult	Nearly impossible
Nature of Product	Undifferentiated	Differentiated	Undifferentiated or Differentiated	Unique
Implications of Demand Curve	Horizontal Perfectly elastic	Downward sloping although relatively elastic	Downward sloping although relatively inelastic	Downward sloping, very inelastic
Average Size of Firms	Small	Small-medium	Large	Extremely Large
Possible Consumer Demand	No preferences Many choices	Some preference Many choices	Few choices with some preferences. Higher prices when producers in collusion	1 choice High demand Lower supply
Profit Making Possibility	Normal profits	Normal profits	Normal profits in short run, possible economic profits in long run	Economic profits
Government Intervention	None	Some restrictions Taxes	Taxes Price Caps Subsidies	Technical (resource ownership), Legal (patents, franchising)
Control Over Price	Some	Some	Significant Control	“Price Makers” Lots of control

If there's one thing I've learned in this economics class, you just can't have enough graphs! So, below we will take a look at the four different market structures along with a representation of the demand curve that would occur in each.

Perfect Competition:

In a perfectly competitive market, you will notice that the demand curve is horizontal or perfectly elastic. This means that consumers will purchase unlimited product at the price that is taken by the producers. Consumers will not purchase the same product at any other price, no matter how much the supply may change. The demand curve remains constant and will experience no fluctuations no matter what happens. The marginal revenue and average revenue also remain constant in this type of market because they are equal to the demand curve.





Monopolistic Competition:

 

Source: http://www.economicsonline.co.uk

The graph to the left represents a monopolistically competitive market in the short run. Maximum revenue is achieved at the point where MR and MC curves intersect (point A). In the short run, the graph shows that the firm is making economic profits which is represented by the box in between points A, B, C and P.



   

 

Source: http://www.economicsonline.co.uk 

In the long run, the demand and AR curves have shifted to do more competition entering into the market. The firm, according to this graph is no longer achieving economic profits because the AR curve has come down to be level with the point where MR and MC curves intersect.




Oligopoly 



 

The most noticeable feature in this graph is that the demand curve has a kink in it and that a portion of the marginal revenue line is completely vertical.

Point A on the demand curve illustrates the best price to sell at and the best quantity to produce because the price must drop quite drastically to in order to sell more, but revenues will also decline at that point, hence the completely vertical marginal revenue curve. The drop indicates that revenue will not increase at all with the sale of more product for a significant period.

Monopoly:

 

In monopolistic competition, one large dominates the entire market which makes gives the firm the ability to decide the cost at which they will sell and the optimal amount of output in order to generate the highest revenues with the lowest costs. Point A illustrates the price and quantity at which this goal would be achieved. Monopolies must take into consideration that consumers may not purchase their product at all if they attempt to charge an exorbitant price or they may start to develop alternative products to use instead.

Game Theory

For all of us non-economists, the Game Theory which was invented by John von Neumann and Oskar Morgenstern in 1944 might seem like a very unfamiliar and complicated theory. To quote the Stanford Encyclopedia for Philosophy, "Game theory is the study of the ways in which strategic interactions among economic agents produce outcomes with respect to the preferences (or utilities) of those agents, where the outcomes in question might have been intended by none of the agents." (Ross, Don) Confused yet? I would be. It doesn't need to be so complicated. To put it simply, game theory is based strictly on the strategic decisions that one person or business might make to try to out do it's competitor. More often than not though, this has a negative impact on both parties, and not just the one who is having consumers stolen from them.

They say pictures are worth a thousand words, so let's take a look at one to make this crystal clear. I may have a small addiction to Subway, so let's use it in an example along with Quizno's; two companies which could be considered interdependent due to their similar pricing.


Let's say that between the two sub companies, they have a combined total of 200 customers per day. Now, we can clearly see that if both companies charged $7 for a foot long sub, and we'll assume that customers are divided equally (100 & 100) that revenue's of $700/day are achieved. Now, let's say that Subway got a little greedy and lowered their price to $5/sub effectively stealing away 25% of the market share from Quizno's (top right box), their number of consumers may increase, but you can see that revenues have decreased for both competitors. Quizno's due to the loss of customers, and Subway due to the lower price. In the bottom left box, it shows the same scenario only with Quizno's lowering their price instead. Now, the bottom right box is very important. If Subway lowered their price down to $5/sub, Quizno's may choose to do the same in order to gain back the lost clientele. However, this clearly shows that now BOTH companies are making less revenue per day with the same amount of output as they originally had at $7/sub. In summary, lowering the price to steal customers from the competition may seem like a good idea but just ends up having a negative impact for each producer.

Sometimes companies may choose to work in cahoots with a competitor either directly (illegal) or indirectly (not illegal). Parties who work in unison legally or illegally are called cartels.

In order to maximize revenues while maintaining minimal output, some companies may choose to get together to discuss such things as price fixing, or quotas among one another. A good example of this would be OPEC as discussed in section 11.6 of the text. (Sayre, Morris) This illegal activity is known as collusion and comes with stiff penalties and fines if caught.

On the other hand, companies can often predict the actions of their competitors and can make decisions based on that alone. This is known as noncollusion as they are not directly discussing their future actions with one another.

To summarize; if each party in the cartel is honest, everyone wins.


References:

Morris, Alan; Sayre, John, Principles of Economics, p. 390-392

Ross, Don, "Game Theory", The Stanford Encyclopedia of Philosophy (Fall 2011 Edition), Edward N. Zalta (ed.), URL = http://plato.stanford.edu/archives/fall2011/entries/game-theory/.

Defining Monopolistic Competition

When a monopolistic competitive market exists, it means that there are many firms offering similar but differentiated products. Monopolistic markets include most retailers from clothing to gasoline and also includes most firms that provide a service that it specifically directed at home owners. For example, plumbing and electrical companies. On occasion this type of market may include large manufacturers as well such as furniture or textiles.

Four key factors must be present in order for this type of market to exist.

1. There must be many different firms that are all working independently of one another. Costs of production within each firm are also very similar.
2. There must be freedom to enter the industry. This does not mean that there are no costs involved however, but that no significant barriers will prevent a firm from entering into the market. This could include for example, a patent obtained by another firm that grants them exclusive rights for a period of time.
3. All firms have some control over the price but generally speaking there is minimal price competition between firms. Often there is an unwritten understanding as to what prices shall be and instead firms try to compete with their differentiated or "better" products.
4. Each firm sells a differentiated product.

The table below outlines the differences between small and large companies that are all part of the monopolistic market.

Size:	Small Company	Medium Company	Large Company
Features:	Bump to Baby Boutique (Municipal)	Toys r' Us (National)	Walmart (International)
Differentiated Products	More current and local fads and fashion trends. More personalized service.	Lower quality of customer service. More brand name products. More luxury.	Even more recognized brands offered at reduced prices.
Control Over Price	Some	Some	Some
Mass Advertising	Word of Mouth, Social Media, Mail-outs (fliers)	Word of Mouth, Social Media, Newspaper & Magazine Ads, Radio	Internet, Newspaper & Magazine Ads, Television, Billboards,
Brand Name Goods	Few	Some	Many
Service Quality	Excellent	Fair	Poor

Competing as Starbucks

Perfect competition is a theoretical or ideal market that is often used as the benchmark to describe other market structures. This market is best described as one where the four following criteria are met:

1. An infinite number of buyers and sellers exists giving no one the power to change the market single-handed. Also known as "price-takers".
2. There are no preferences shown as all products are homogeneous or undifferentiated.
3. There is easy entry and exit into the market for both consumers and producers. No association fee's etc.
4. All buyers and sellers have the same access to market information regarding availability, prices and quality of product being sold.

Starbucks does not meet all of the above conditions and therefore cannot be part of the ideal market known as perfect competition - not that any market has ever been or ever will be "perfect". I believe that Starbucks is in a league of it's own when it comes to the coffee market as their prestigious prices could only be compared to the smaller Ma & Pop stores that have much higher production costs due to lower sales. Starbucks however has nearly 17000 stores and more than likely buy their products at a reduced cost due to the high quantity they would be purchasing. I personally think that the price of a coffee at Starbucks is quite extreme (although I still treat myself a couple times a year) but they have managed to gain a great reputation even though customer service is not what it once was. Starbucks is a very trendy coffee shop, and the people who drink it and are willing to pay the outlandish prices will continue to do so religiously.

After reading the Starbucks Gossip memo that was allegedly sent in by Chairman Howard Schultz, I'd have to agree when he says that the extreme growth they have experienced since 2006 has lead to "the watering down of the Starbucks experience". They seem to have lost sight of their original ideas to spread their love of coffee in exchange for popularity and huge profits; but isn't this what all entrepreneurs strive for? A retirement plan? In the short term, the costs for breaking leases which was an estimated $120-$140 million according to Melissa Allison and a reported $8 million in severance packages would be a hard pill to swallow. However, in the long run, the reduction of overhead and non-profitable stores would lead to more efficient employees and greater profits.

I think that the closure of so many stores across the nation was a smart business decision for such a large franchise. In my opinion, there really isn't much point in keeping an unprofitable location open when there is another doing well just down the street. At one point on Robson Street in Vancouver, there was an intersection with a Starbucks on every corner, taking over all prime locations in order to prevent competitors from getting a piece of the pie. Overkill? I think so.

References:

Allison, Melissa, Starbucks closing 5 percent of U.S. stores, http://seattletimes.com/html/businesstechnology/2008028854_starbucks02.html

site accessed on November 30, 2012

Schultz, Howard, Starbucks chairman warns of "the commoditization of the Starbucks experience",
http://starbucksgossip.typepad.com/_/2007/02/starbucks_chair_2.html

site accessed on November 30, 2012



Better Book Keeping

If I had the means to start a business of my own, it would definitely be in book keeping as this is the field that I am studying. This type of business would be very low cost to start up as I could work directly out of my home, I already have a computer, and accounting software is fairly inexpensive if you only have a few accounts to look after. This business would be quite small to begin with (I'd probably have to keep my full time job.) until I developed efficient procedures and gained the trust of any current clients.

 In time, hopefully my name would spread by word of mouth and I could eventually open up a small accounting firm that would have a target market of small business owners. I would target this specific type of market because they are generally the ones who source outside help for this type of service. I find that many small business owners attempt to do the accounting on their own to begin with and often lose site of the important things such as marketing, quality of their products and customer service aspects. Another reason why they may source outside help in this area would be due to growth of their business. Keeping the books and doing payroll becomes far too much of a burden and they may not want to spend so much time focusing on the process when someone else could give them the numbers each month.

 

Long run costs for this type of business would be the amount of accountants employed, the cost of rent for an office space if I were to expand outside of my home and the number of software licenses that needed to be purchased.  

 

The short term costs as I mentioned earlier would be things such as up to date accounting software, a computer if necessary, office supplies and furniture.

 

Fixed costs for a home based book keeping business would be things such as an internet connection for keeping in contact with clients and a portion of the mortgage and utility bills could also be deemed a fixed business expense.

 

A business that I would eventually aspire to be like would be The Small Business Accountants who are locally owned and do exactly as their business name describes. http://www.smallbusinessaccountants.ca/. They provide several different types of services, including book keeping, tax planning, financial planning, business consulting and training services. I think that a lot of business owners are afraid of the monetary aspect of things in large part because a lot of it has a connection to the government and that's where a company such as The Small Business Accountants could step in to relieve some of the stress. Targeting specifically small businesses is a great strength because many larger companies have their own accounting departments and don't have the need to source outside help. According to the website startupcan.ca, between 2002 and 2007, an average of 104,000 small businesses were started each year. That being said, I think that getting into small business accounting could potentially be a very lucrative business as outputs could be quite large while maintaining low average costs.

Reference:
http://www.startupcan.ca/wp-content/uploads/2012/01/Statistics-on-Small-Business-in-Canada_StartupCanada.pdf

 Site assessed on November 27, 2012