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Market Structures and Maximizing Profits

Essay by   •  February 25, 2012  •  Essay  •  1,266 Words (6 Pages)  •  2,533 Views

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A market structure describes the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry into and exit from the market (Tucker 2009). It also describes the state of the market with respect to competition. When discussing economics, there are four major market structures; Perfect Competition, Monopoly, Oligopoly and Monopolistic Competition. These market structures are the most common structures in our society. In this paper, the following questions will be addressed about the four major market structures: What are the characteristics of each market structure? How is price determined in each market structure in terms of maximizing profits? How is output determined in each market structure in terms of maximizing profits? What are the barriers to entry, if any? What role does each market structure play in the economy?

Perfect Competition is a market structure has these characteristics; a large number of small firms, a homogeneous product and very easy entry into or exit from the market. There are no barriers to entry, firms are free to come and go as long as they have the resources. A perfect competition is a price taker, which means it has no control over the price of the product it sells. Therefore, the price of its products is determined by market supply and demand conditions over which the firm has no influence. This means that an individual firm will set the price of a product according to what the buyer is willing to pay for it. Mankiw states that, "In order to maximize profit, a firm chooses a quantity of output that will ensure that the marginal revenue equals marginal cost." "Since the marginal revenue for a competitive firm equals the market price, the firm chooses quantity so that price equals marginal cost." Perfect competition markets are the cornerstones of capitalism and a market-oriented economy. The majority of today's current companies operate in a perfect competitive market.

The structure that is contrary to the perfect competition market is the monopoly structure. In a monopoly, the consumer has one choice, buy the monopolist's product or do without. Here are the brief descriptions of each monopoly characteristic: A monopoly is a single seller in which one firm provides the total supply of a product in a given market. It has a unique product which means there are no close substitutes for the product. Extremely high barriers make it very difficult or impossible for new firms to enter an industry. A monopolist has the ability to select the products price, which makes it a price maker. Tucker states, "As in a competitive firm, a monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost." "The monopoly then chooses the price at which that quantity is demanded. In contrast to a perfect competition firm, a monopoly firm's price exceeds its marginal revenue, so its price exceeds marginal cost." There are three barriers that restrict the entry to a market occupied by a monopoly. If someone has complete ownership or control of a vital resource will impede any new comer from entering an industry. Legal barriers such as government franchises and licenses can are an effective barrier to protect a firm from potential competitors. The last barrier is economies of scale, which means that a monopoly can emerge in time naturally because of the relationship between average cost and the scale of an operation. A monopoly exposes the lack of economic competition for a particular good or service resulting in no substitute for the good or service which are in question.

The next market structure is an oligopoly. This is a structure that consists of a few sellers that offer the same product such as tennis balls,

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