Introduction
Market structure is defined based on the number of businesses operating in the market. These businesses may be producing identical products or operating in different lines of products. Based on the number of competitors in the market, various market structures have different amounts of market control. If competition is high, businesses tend to have limited control of the market (Monroe, 2003). Different market structures dictate how prices are set in the market. Some of the current market structures include monopolistic competition, oligopoly, perfect competition, and monopoly. This paper aims at looking at some of these market structures and analyzing their different pricing strategies.
Analysis of different market structures
Perfect competition
This refers to a market structure where no participants are large enough to take control of the market. Consequently, it is hard for an individual participant to dictate pricing strategies to be used for specific products. Since conditions for perfect competition are complex, it makes it hard to find this form of market structure in the market. Perfect competition acts as the yardstick against which imperfectly competitive markets are determined (Novshek & Sonnenschein, 1987, pp. 1281-1302).
Numerous features characterize this form of business. They include infinite buyers and sellers. In this form of market structure, numerous producers are capable and willing to manufacture and sell their products at a certain price. On the other hand, some infinite consumers are willing to buy the products at a certain price.
Also, the market is free for new businesses that are willing to enter and also existing businesses can leave the market if not satisfied by their performance. Normally, factors of production in this form of market structure are mobile making it possible for them to be changed based on the changing market conditions. All consumers and producers are assumed to have clear knowledge about the quality and cost of goods and services being offered (Novshek & Sonnenschein, 1987, pp.1302- 1304). Unlike other market structures, organizations in perfectly competitive market structures are found not to earn an economic profit. They only make money that is necessary to cover their economic costs.
Monopolistic Competition
This is a form of an imperfect competition where competing manufacturers offer goods that are differentiated from each other but not perfect alternatives. In this structure, organizations can act like monopolies in the short run thus using their market power to make a profit. Nevertheless, as time goes on more competitors get into the market thus reducing benefits associated with product differentiation. The market becomes more competitive making it hard for businesses to make an economic profit. If consumer originality is low and heuristics are used, monopolistic competition may turn to be a natural monopoly (Davies & Cline, 2005, pp. 797-801). However, if the government intervenes in such a situation, monopolistic competition may change to a government-granted monopoly.
A monopolistic competition market structure is characterized by a situation where there are numerous producers and consumers in the market and no producer has full control in setting the market price. In this structure, buyers believe that there are no price differences among the products offered by competitors. There are limited barriers to entry and exit from the market for interested producers. Unlike in perfect competition, producers have control over prices in this form of market structure (Davies & Cline, 2005, pp. 802- 814).
Oligopoly
This is a form of market structure in which a market is dominated by a small number of competitors. There is a limited number of competitors in the market, every business is assumed to know the actions of the other. Each player in the market greatly influences the decisions of the other. Hence, for any business to make a decision, it has to put into consideration the impacts the decision will have on other players. As there are few players in the market, organizations in the oligopoly market structure can set their prices.
Incumbent firms come up with barriers such as patents, complex technologies, and economies of scale to discourage other businesses that are willing to join the market (Vives, 1999, p. 75). Also, there are government regulations that favor existing businesses putting off other interested investors. Barriers to new entries make it possible for businesses in this market structure to enjoy long-run profits. Since the actions of one key player in the market affect others, there is high interdependence among the participants in this market structure.
Monopoly
This is a market structure where one enterprise is the sole supplier of a specific product. As a result, monopolies are characterized by the absence of economic competition concerning the production of goods. Also, there are no competing or substitute products in this market structure. If not controlled by the government, monopolies tend to maximize their profits by manufacturing a smaller amount of products and selling them at elevated prices. Monopolies may be government-owned, formed through mergers or established naturally (Ankerl, 1978, p. 138). Monopolies are price makers. Since they do not have competitors in the market, they are the ones who set prices for their products. Barriers to entry into this form of market structure are high making it hard for willing investors to enter.
Since monopolies sell goods that have no close substitutes, their demand is quite inelastic making it possible for businesses to make huge profits. One of the major powers of monopolies is that they have total control of resources used in manufacturing the products they offer. Hence, no other firms can have access to resources.
Analysis of pricing strategies for the different market structures
Perfect competition
Since perfect competition is characterized by numerous businesses offering similar products, it is hard for businesses to set prices for their products. As a result, participants in this market structure are said to be price takers and not price makers or setters. There is no collusion between businesses because there are new entries now and then. Organizations in these market structures are found to offer their products in a way that marginal profit equals marginal cost.
Prices are adjusted based on the demand and supply present in the market. Organizations in a perfect competition environment can sell all their products at market price without following any pricing strategy (Novshek & Sonnenschein, 1987, pp.1305 -1306). Organizations only put into consideration the cost incurred in manufacturing their products. In other words, organizations use a cost-plus pricing strategy where they just add a small percentage to the cost incurred in producing their products.
Monopolistic competition
Firms in a monopolistic competitive environment act as monopolists. Such firms can influence the market price of their products by changing the production rate. In this market structure, companies produce goods that are not perfect substitutes. Consequently, companies take advantage of having unique products to make a profit. A business can raise or lower the prices of its products based on demand and supply without affecting other businesses.
In other words, every firm in a monopolistic competitive environment has the power to set prices for its products as if it were a monopoly (Davies & Cline, 2005, pp. 815 – 826). At optimum production, firms in this form of market structure tend to set prices that are far much above the marginal costs. Skimming pricing strategy is mostly used in this environment especially when a firm introduces product differentiation.
Oligopoly
As aforementioned, there is interdependence among firms in this market structure. Consequently, they tend to collaborate when it comes to setting their prices. Some of the strategies used by these firms include a predatory pricing strategy. Oligopolies may keep their prices low to discourage new entrants or force rival companies out of the market. Besides, firms also employ limit pricing to deter new entrants. Prices are set lower such that new entrants can make no profit. This discourages other firms from focusing on the market thus allowing oligopolies to enjoy the market (Vives, 1999, p. 129). Apart from predatory and limit pricing, oligopolies also employ cost-plus pricing. This strategy is employed since most of the participating firms incur similar costs, a good example being petrol retailers.
Monopoly
In a monopolistic environment, a firm does not experience competition at all. This leaves it with the freedom of setting its prices based on demand in the market. To discourage new entrants, monopolists use limit pricing. This makes it hard for entrants to make a profit upon venturing into the market thus discouraging potential entrants. Since there are no substitute products, consumers are forced to bear with prices established by monopolists (Ankerl, 1978, p. 154). In some instances, monopolists use price discrimination strategy in setting their prices. In this approach, different market segments are charged differently based on their willingness to pay for the products or services.
Case Study
monopolistically competitive markets are mostly exhibited in fast-food restaurants and clothing industries. For instance, numerous companies produce hamburgers which include Burger King, McDonald’s and Wendy’s. The different companies have come up with strategies to differentiate their hamburgers in a bid to attract more customers. As a way of avoiding losing customers, McDonald’s uses a cost-plus pricing strategy. The company sells its hamburger at a cost that is slightly higher than the production cost (Davies & Cline, 2005, p. 813). This ensures that McDonald’s does not highly charge its customers thus making sure that it does not lose them to rival companies.
Conclusion
Depending on the number of players in a given market and nature of their products, the market can either be said to be monopolistic, oligopolistic, monopolistically competitive or perfectly competitive. A market structure is said to be monopolistically competitive if it is characterized by the presence of numerous competitors offering differentiated products that are not perfect substitutes. Competitors have control in setting prices for their products.
On the other hand, a perfectly competitive market structure is characterized by the inability of producers to set prices for their products. The oligopolistic structure exhibits interdependence among competitors when it comes to setting prices. In a monopolistic environment, a single firm serves the market and sets prices based on demand. Based on the nature of the interaction between participants in the various market structures, there are different pricing strategies used. These include limit pricing, cost-plus pricing and price discrimination.
Reference List
Ankerl, G. (1978). Beyond Monopoly Capitalism and Monopoly Socialism. Cambridge, Massachusetts: Schenkman Publishers. Web.
Davies, A. & Cline, T. (2005). A Consumer Behavior Approach to Modeling Monopolistic Competition. Journal of Economic Psychology, 26 (6), pp. 797–826.
Monroe, K. B. (2003). The Pricing Strategy Audit. Cambridge: Cambridge Strategy Publications.
Novshek, W. & Sonnenschein, H. (1987), General Equilibrium with Free Entry: A Synthetic Approach to the Theory of Perfect Competition. Journal of Economic Literature, 25(3), pp. 1281–1306.
Vives, X. (1999). Oligopoly pricing. Cambridge MA: MIT Press.