4.1 The degree of competition

How much competition does a firm face?
 

Firms can face a lesser or greater degree of competition in the market place. In economics there are four main types of competition which are referred to as market structures.

In considering market structures we need to look at the no.of firms in the industry and their size, the nature of the product produced (i.e. branded or identical), the degree of control over price and the position regarding entry.

Perfect Competition.

This is the most competitive. There are a large no. of firms in industry producing similar products. Price is the same for all firms and entry is unrestricted. Examples here would exist often in unregulated agricultural markets e.g. strawberries.

Monopolistic Competition

Here again there are several firms in the industry. However each firm has a degree of monopoly over its own product. Entry is still fairly free.

Examples here would include services such as builders and plumbers.

Oligopoly

Here there are just a few firms in the industry who exercise a large degree of control.

Examples would be given by the banks and motor companies.

Monopoly

Here there is just one firm in the market which has control over price.

Entry to industry is either largely or completely restricted for a variety of reasons.
 
 

4.2  Perfect Competition

The most competitive market structure

There are a number of assumptions on which perfect competition depends.
 

  • Firms are price takers. There are many firms in the industry with none producing a significant amount of supply. Therefore each firm must accept the market price that is given.

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  • There is complete freedom of entry to and exit from the industry.

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  • All firms produce an identical product.

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  • Producers and consumers have perfect knowledge of the market.

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    The short-run equilibrium

    Price for each firm is decided in the overall market. Each firm then takes this price as given. It is possible for the firm to be making either supernormal profits or losses.

    See diagram 1
     

    The long-run equilibrium

    If firms are making supernormal profits in the short-run, new firms will enter which will bring down price. This will erode supernormal profits made

    Likewise if firms are making losses firms will leave the industry. This will restore supernormal profits for those remaining. So in the long run there is a tendency towards normal profits for all firms remaining.

    See diagram 2

    Perfect competition in general is good for consumers.

    As can be seen from the second diagram, Profits are maximised where MC = MR. Here no excess profits are made (AC = AR). Likewise the firm produces at the lowest possible cost (in equilibrium) where AC = MC.

    Thus the consumer benefits on both counts through low prices.

    This perhaps explains why competition so often (in any sector) is good for the consumer.
     
     

    4.3  Monopoly
     

    What is a monopoly?

    A monopoly is not always easy to classify.

    The extreme case requires that only one firm be in the industry and that there are no close substitutes. However this situation is rare - even in the public sector - so often monopoly is taken to refer to situation where an industry is dominated by one particular firm.
     

    Barriers to entry

    For a firm to maintain a monopoly position there must be significant barriers on entry.

    Economies of scale

    The best example of this is where a natural monopoly exists. For example in Ireland the ESB has a natural monopoly in electricity. Attempts to encourage new competitors into the industry have not been successful.

    Product differentiation and brand loyalty

    If a firm has a well-recognised brand it can give it a considerable degree of monopoly power. Waterford Glass in the past was dominant in the crystal market for this reason.

    Lower Costs

    A firm may gain a monopoly because of lower costs. The rising dominance in air travel of RyanAir is due to this fact.

    Ownership of key factors

    A mining company could have exclusive control over a raw material such as gold giving it a monopoly.

    Legal Protection

    Sometimes the government maintains legal monopolies e.g. Dublin Bus for social reasons (though this may now change).

    Mergers and Takeovers

    Independent Newpapers has become dominant in Ireland due to takeovers in the paper market

    Aggressive Tactics

    A monopoly may be obtained through bullying tactics which is the approach of the unions to the ministers plans to free up competition for the buses.

    To see how the firm reaches equilibrium under monopoly see diagram 3.

    The demands curve (AR) slopes down from left to right reflecting the fact that the price must be lowered for a firm (which is the industry) to sell more.

    The MR is less than AR (when AR is falling) and is drawn inside AR curve. (In other words AR can only fall if MR < AR). The AC curve is U - shaped (reflecting increasing returns (due to division of labour) over lower levels of output and then diminishing returns as output increases beyond a certain point. The MC curve is less than AC (when AC falls) and greater than AC (when rises) thereby cutting AC at lowest point.
     

    Profits are maximised where MR = MC.

    Typically with private monopoly, supernormal (excess) profits are made at this point (with AR > AC).

    Because there are barriers to entry these are not likely to be competed away. So the monopolist can make these profits for some considerable time.

    Monopoly is usually considered bad for the consumer.

    Firstly the firm makes excess profits which means that prices are above what they would be if perfect competition existed.

    Secondly the firm always produces less than the maximum efficient output resulting in higher costs. This also results in higher prices for consumer. Furthermore due to lack of competition, the monopolist can become very complacent and unwilling to launch cost saving initiatives.
     

    Comparison of Perfect Competition and Monopoly

    However there is a possible difficulty with perfect competition.

    If firms are very small they may not be able to achieve substantial economies of scale. This could put up costs unduly so that the consumer would lose out. So in some industries (e.g. motor cars) it is not really feasible to have perfect competition. However it is still possible to maintain significant competition as between the smaller number of suppliers (e.g. through international competition).

    Monopoly type conditions may not always be bad for the consumer.

    Firms may achieve their market dominance through being more successful than competitors.

    Monopoly power in itself is not wrong but rather abuse of a strong position. For example Microsoft would argue that it has achieved its market position through being good for the consumer and is determined to further improve its service in this regard. Others of course would disagree!

    A monopoly may use its supernormal profits to further research and needed investment which ultimately would be to the benefit of the consumer.

    Also a monopoly could be more stable in a business recession and be able to maintain output and employment.

    Finally there may be social reasons for maintaining monopolies (as in the public sector).