Question

Identify one or more firms and how their behavior affects the market structure of the market they are in. (behavior examples: limit pricing, non-competitiveness, advertising, etc) OR show how market structure affects a firm's behavior giving example(s) of a firm and the behavior. Explain in a minimum of 5-8 paragraphs (500-900 words).

Any market structure (Monopoly, Monopolistic competition, perfect competition, oligopoly) would work. The purpose of the exercise is to demonstrate that firm behavior affects market structure and market structure can affect firm behavior. PREFERRED DEADLINE: APRIL 16th 2018

Answer 1

The question, “Does market structure determine firm behavior, or does firm behavior determine market structure” can be answered in many ways.

Market Structure: It includes all the features which affect the behaviour / performance of the firms in a market. The analysis of market structures is of great importance when studying microeconomics. How the market will behave, depending on the number of buyers or sellers, its dimensions, the existence of entry and exit barriers, etc. will determine how an equilibrium is reached.

Features of market structure: It includes
> Number and size of sellers (concentration ratio);
> Ability of one firm’s actions to influence another firm;
> Degree of product differentiation;
> Degree of freedom of entry (including government regulation)

It is to be remembered that the greater is the ability of an individual firm to influence the market in which it sells its product, the less competitive the market structure is.

Types of market structures:

> Perfect competition;
> Monopoly;
> Monopolistic competition; and
> Oligopoly

Let us take up Perfect Competition. In situations where a large number of firms compose the market, such as in perfect competition, the actions of one firm can seldom be so profound as to effect the structure of the market.

In a perfectly competitive market for tomatoes, with 400 different sellers, each of whom holds an equal percentage of total output, it can be easily seen that one firm raising or lowering prices would have minimal effect on the actions of any other firms in the market.

An individual firm, composing only .25% of the total output of the market, would be hard pressed to make a decision that did not negatively effect its financial status. Raising prices would raise their price above equilibrium meaning fewer people would buy, given 399 cheaper options, still selling at equilibrium price. Lowering output, would also have a negative effect on the firm, as would lowering prices. Long story short, given a multitude of firms acting independently of each other, the decisions of a firm would likely have minimal effect on market structure.

1. Homogeneous product: all firms offer the same goods, with the same characteristics and quality as the others, without any variations.

2. Large number of agents: there should be a sufficient quantity of buyers and sellers, so that no action from a single agent will affect the market structure or its prices.

3. No entry or exit barriers: there has to be free entry and exit of agents in the market.

4. Price flexibility: price adjustments to changes happen as fast as possible. Usually, price changes are assumed instantaneous.

5. Free and perfect information: all agents have perfect knowledge of products and their prices, and everything else related to them, as well as free access to this information.

6.Perfect factor mobility: all factors should be able to change so adjustments processes can be carried out with the greatest efficiency.

7. No government intervention: markets should be left alone as government intervention would only lead to imbalances in perfectly competitive markets.

Perfect competition is the opposite of a monopoly, in which only a single firm supplies a good or service and that firm can charge whatever price it wants, since consumers have no alternatives and it is difficult for would-be competitors to enter the marketplace. Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Companies earn just enough profit to stay in business and no more. If they were to earn excess profits, other companies would enter the market and drive profits down.

Perfect competition describes a market structure, where a large number of small firms compete against each other. In this scenario, a single firm does not have any significant market power. As a result, the industry as a whole produces the socially optimal level of output, because none of the firms have the ability to influence market prices.

The idea of perfect competition builds on a number of assumptions: (1) all firms maximize profits (2) there is free entry and exit to the market, (3) all firms sell completely identical (i.e. homogenous) goods, (4) there are no consumer preferences. By looking at those assumptions it becomes quite obvious, that we will hardly ever find perfect competition in reality. This is an important aspect, because it is the only market structure that can (theoretically) result in a socially optimal level of output. Probably the best example of a market with almost perfect competition we can find in reality is the stock market.