Comparing Market Structures

Below is a brief outline of the four market structures; perfect competition, monopolistic competition, oligopoly and monopoly.

Below are graphs and explanations of each market structure:

Perfect Competition:
In perfect competition, producers can decide how much or how little of a product to make.  The area between the break-even points and between the Total Cost (TC) and Total profit (T) is where the maximum profit lies.

Monopolistically competitive:
Economic profits are greatest when you subtract the costs from the revenue which is highlighted above in the blue box.

Oligopoly:

 Prices at the top part of the kink are prices not matched by competitors.  The prices at the bottom part of the kink are the prices matched by rival firms.  Prices in an oligopoly are very stable prices in spite of changes in the demand and costs as demonstrated in the graph above.

Monopoly:

In a monopoly, the price is not set by the intersection of marginal costs and demand.  Instead, it is set by intersection of marginal revenue and marginal costs.  The break even points are located at the where Total Revenue equals Total Costs.  The greatest profit occurs where the Marginal Costs and Marginal Returns intersect.

Game Theory – does it exist beyond the board games?

Game theory is discussed in economics in terms of oligopolies.  Oligopolies are markets that are dominated by a few large firms and includes industries such as tobacco, cement and motor vehicles.  The main ideas behind game theory is that the rivals are competing against each other and they make the best moves for themselves.  They will adjust to other’s strategies; however, the main point is that each rival wants to achieve the greatest profit in the end. 

Game theory was developed by john Neumann and Oskar Morgenstern in the 1940s and initially analysed strategic behaviour between firms.

Is game theory still valid in today’s economy?  I say yes!  The proof is in the price wars that you will see when four brand name gas stations are situated at each corner of an intersection.  Initially, all of the gas stations have the same price per litre listed and it appears that they are colluding.  Before long, you see the price at one of the gas stations lower in order to entice more business to that location.  The other gas stations follow suit by lowering their prices then the war is on.  What they do not realise is that eventually no one is maximizing the profits that could be made at that location.

Using the example above, I will explore how the payoff matrix works and how it would be beneficial for the gas stations involved in the price war.  The pay off matrix is a visual analysis of the decisions that these rivals can make as well as the ramifications of each of the decisions.  Each rival has the opportunity to cheat or not cheat.  The best overall revenue earned is when all rivals decide not to cheat with the lowest revenue achieved when all the rivals decide to cheat. 

I touched on collusion above.  Collusive actions are where rivals create an agreement or understanding in order to set the prices and split the market into fair portions.  In many countries, collusive actions are illegal and not tolerated.  Cartel actions are formal agreements between firms who are colluding.  An example of this would be the gas refineries as they regulate the supply they handle and do not increase supply when demand is high in order to manipulate the prices or perception of availability.

In conclusion, the game theory is alive and well in our economic system today and next time you see a price war going on at the gas pumps, you can think of the factors influencing the deal that you are about to receive.

Monopolistic Competition

Definition: 

A monopolistic competition is one that contains many small firms with easy entry and exit from competition offer differentiated products and has some control over the price. 

Analysis:

Perfect Competition: Starbucks

Starbucks has been considered to be a part of a perfect competition market as it meets the four conditions; many sellers and buyers, no preferences, easy entry and exit and market same information available to all.

(First Starbucks store located across the street from Pikes Place Market in Seattle, WA)

During the global recession of 2007/2008 Starbucks planned the closure of stores in America which meant exiting the market in those areas.  The plan was to boost the bottom line and to increase stock prices.  Starbucks also discovered that some technological changes had affected more than just the efficiency of the product – it also affected a cornerstone of the Starbucks experience which is the interaction with the barista.

So what is the impact of this decision?  Initially, this decision will result in higher short-run costs for the company due to pre-tax charges and costs associated with severance packages, breaking lease terms, etc.  By “trimming the fat” so to speak, Starbucks is looking at the long-run costs associated with operating the stores and able to plan how they want to expand the experience.

I personally enjoy Starbucks whenever I go into a larger centre and do not perceive that the coffee is too expensive.  Drinking a Starbucks is more than just what you are drinking – it is about the experience, knowledge that I am supporting an ethical company and the prestige associated with the brand.  Starbucks provides quality coffee, uses premium ingredients and also provides a company image of being environmentally responsible.

The following graph illustrates what would happen if Starbucks was to decrease the price for their products.  As you can see, there is no chance since Starbucks is part of a perfect competition market and does not have control of the prices.

Law of Diminishing Returns

In 2001 Pierre Lemieux studied the law of diminishing returns in his article “The Diminishing Returns to Tobacco Legislation” (Retrieved: January 11, 2012, http://www.pierrelemieux.org/artdiminish.html). Mr. Lemieux presents information that 77 countries had issued health warnings about tobacco products for the last 10 years. He also made a point that individuals who were close to quitting, decided to quit based on the addition of the warnings on the outside of the cigarette package and mild prohibition (i.e. smoking in front of businesses, etc.). Nowhere in his article did he explore other factors which may have lead to this small decline which could have included the increase in cost, increase in taxes, education, etc.

Using the information presented in Mr. Lemieux’s article, the point of diminishing returns for the government would be when the shock value wears off. The government may be able to make small “victories” by adding multiple shocking messages to the packaging of the product; however, once consumers have gotten over the shock of seeing the graphic depictions of tobacco use, the consumption rate would return to normal.

(Angus Reid Public Opinion - "Canadians Welcome New Graphic Warnings on Cigarette Packages". Retrieved February 3, 2012, from: http://www.angus-reid.com/wp-content/uploads/2011/01/tobacco1.jpg)

Other solutions that would increase the government’s success compared to their costs could include new legislation such as no smoking in cars with minors and creating programs that would make change from within. Increasing taxes and making tobacco a prohibited item would only put tobacco onto the black market and could lead to an increase in the demand of the product.

The implication on supply and demand with the inclusion of the pictures on the cigarette packages would at first lower the demand. The supply would decrease until a new equilibrium was reached then will increase again once demand stabilizes.

Increasing taxes, also known as “sin taxes” for tobacco would have no affect on the demand since the product is inelastic; however, it would increase the government`s total revenue.

In conclusion, I do not believe that adding graphic warnings to the covers of tobacco products would affect the demand. Initially, demand would decrease; however, would recover and stabilize. The shock factor of these graphics only last so long until the value wears off. The government should explore other creative ways to get the health messages across to the consumers of tobacco in order to create a steady decline of tobacco users.