Controlling Function of Management free essay sample

Markets and Market Structure One of the crucial elements to understanding how a market will function (though it will not explain everything) is its market structure. These are the key elements that determine the behavior of firms in the market and the outcome that will be produced by the market. One way of considering the market structure is to talk about the conditions that exist in the market. These conditions fall into (approximately) four categories: †¢ Actors in the market (both numbers of actors and the sizes of these actors †¢ The entry conditions (which includes the exit conditions) †¢ Information characteristics of the market Product characteristics Taken together, these factors provide a useful picture of a market, revealing how it is likely work and the results that one would observe in this market. We will examine a number of different theoretical market structures that help us understand the nature of actual markets. Three of these are of significant inter est to us, both from the standpoint of understanding the way that different types of markets operate, but also how this relates to interactions that arise within the legal system. These three types of market types or structures are: 1. Perfect Competition 2. Monopoly 3. Oligopoly This document only introduces each of these types and gives a basic description of their characteristics and the type of outcome one can expect in each of these types of markets. Separate materials are available to provided a more detailed discussion of each of these different structures. The first of these is the perfectly competitive market. Perfect Competition The outcome of this market structure is a situation in which firms (as well as consumers) act as price takers. This condition results from the circumstances that exist in these markets, with respect to the categories described above. As they apply to the competitive market, these conditions are: 1. Many buyers and sellers 2. No restrictions on entry or exit 3. No advantages to existing firms (no special knowledge or equipment) 4. Full information on the part of buyers and sellers 5. Products are homogeneous Taken all together, these factors imply that no single firm has any meaningful influence on the market. This is the essence of price-taking behavior: no firm can have any significant role in setting prices, so all firms must take the market price as given. What this, in turn, implies is that a firm can sell all of the output it wants at the going price. Whenever economists discuss the workings of the market, typically there is a focus on the interaction of supply and demand. This basic model starts with and generally is based upon the type of situation present in a perfectly competitive market. The diagram above illustrates the basic demand and supply diagram, and its workings are the basis for much of the analysis done with markets. The underlying presumption here is that you are considering a perfectly competitive market, where the interaction of buyers and sellers determines the market price and quantity. At the same time, firms in these markets take the information at hand about the market price to determine how much they will produce (which contributes—albeit minutely—to the supply in the market). When the conditions necessary to have a perfectly competitive market do not hold, then other market structures become relevant. The first that we want to consider is the exact opposite of the circumstances found in the perfectly competitive market—the monopoly market. Monopoly The central feature here is that for a monopoly firm, their behavior is one of a price maker. This means that the firm has (in this case, full) market power, or control over the market price. This arises out of the peculiar circumstances in which the monopolist operates. The following are the basic market structure conditions: 1. Many Buyers and a single Seller 2. Ability to Restrict Entry and Exit 3. Specialized Knowledge/Equipment 4. Lack of Complete or Full Information Possessed by Buyers and Sellers 5. Heterogeneous Products These structural factors imply that the firm faces the market demand curve, which we presume to be downward sloping. Unlike what we see in the perfectly competitive market, there is no distinction to be made between the activities at the market level and at the firm level; they are one in the same. So, the diagram below applies equally to the market and the firm. The primary thing to note here is that the monopolist wishes to maximize profit. Doing this in a market where there is but a single firm yields the situation depicted here: as compared to what we would observe in a competitive market, the monopolist chooses to restrict output, resulting in a higher price, and as a consequence, a higher level of profit. This, naturally, harms the consumer. Since many consumers are unwilling or unable to trade in the market, fewer units are bought and sold. We characterize this as being inefficient. (The concept of efficiency will be discussed elsewhere. ) Other details go beyond the scope of this short discussion, including different sorts of pricing behavior, the existence of economies of scale and the implications of economies of scale on the market, and interactions between single buyers and sellers. [Aside: These notions of inefficiency and harm to consumers are ostensibly the reasons for the existence and enforcement of federal antitrust laws. We will discuss these laws later in the course. ] Some markets fit neither the monopoly nor the perfectly competitive market structures that we have considered. They fall into the gray area in between—where there are a number of firms, each of which has some influence over the market. This influence is not, as you would expect, complete. For the economist, this type of market is particularly troublesome. Both competitive and monopoly markets yield clear results in terms of the behavior of buyers and sellers, the price that will result and the nature of the interaction between firms. These results are not well determined in the market described here. What we are talking about is generally referred to as Oligopoly. Oligopoly Markets For oligopoly markets, the familiar list of structural characteristics is less useful. Clearly, we could talk about the numbers of buyers and sellers, the product characteristics, and so forth. Yet this is much less informative than in the two other structures that we have described. There are typically a large number of buyers. The number of sellers is much less clear. At a minimum, there must be at least two firms, but this number can be higher (though how much higher is not really determined). The key idea here is that the number of firms is small, small enough that each firm’s actions has an important effect on the success and behavior of the other firms in the market. Because of this interrelationship, firms are said to be mutually interdependent, which is simply a more involved way of noting that any action by a firm has to be made by taking into account its effect on the others and the other’s effect on that firm. The key idea is that firms interact strategically with each other. There are many different ideas that have been developed to attempt to understand and predict the behavior of firms in oligopoly markets, but none of them is a general model. When we do not know precisely how firms will act and react, we cannot model this precisely. Basically, there are two ways that we can consider firms to interact. One is to act together, or cooperatively, to make decisions in the marketplace. In general, economists refer to this as collusion, or alternatively, as the formation of a cartel. The essential idea here is that the separate firms act collectively as if they were a single monopolist and share the profits earned by the monopolist. There are significant difficulties in maintaining such a relationship and most attempts to collude end, at least eventually, in failure. It should also be noted that such behavior is illegal, violating antitrust laws. The second way is to presume independent, or non-cooperative, interaction. This approach is where much work has been done, but, again, without the production of a universal approach. This analysis is quite similar to other types of non-cooperative interactions. The primary approach to this is GAME THEORY and we will devote some time to discussing these ideas in a different context. Nevertheless, the application to the analysis of markets is quite similar to what we will be focusing on. Other materials will be provided to assist your understanding of these ideas. Quantity Price Pm Q* Qe Pm S D Quantity Price MR D