You can no more build a successful portfolio without the right mixture of stocks any more than you can construct a skyscraper in Tornado Alley without the right mixture of building materials.
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If you want to invest in a way that keeps your savings safe in the storm of changing economic environments, you have to start with a sound structural foundation. That begins with understanding how companies and markets work, how they compete and how they respond to changes.
Understanding the four market structures provides a starting point for judging industry and market news, policy changes and legislation and how it shapes your investing decisions.
So what kind of structures and materials define companies and markets?
Generally, there are several basic defining characteristics of a market structure:
- The commodity or item that is sold and level of differentiation between them.
- The number of companies in the market, the ease or difficulty of entering the market and the distribution of market share of the largest firms.
- The number of buyers and how they work with or against sellers to influence price and quantity.
- The relationship between producers or sellers.
We can use these characteristics to guide our discussion of the four types of market structures.
1. Perfect Competition Market Structure
In a perfectly competitive market, the forces of supply and demand determine the amount of goods and services produced as well as market prices set by the companies in the market.
Perfect competition assumes the environment or climate cooperates with the buildings within it.
The perfectly competitive market structure is a theoretically ideal market; there is free entry and exit, so many companies move into the market and easily exit when it’s not profitable. With so many competitors, the influence of one company or buyer is relatively small and does not affect the market as a whole.
Buyers and sellers are referred to as price takers rather than price influencers.
The products within the market are seen as homogenous, there is little difference between them. Not only are the products identical, information regarding product quality and price is perfectly and openly given to the public. The model assumes each producer is operating at the lowest possible cost to achieve the greatest possible output.
The perfect competition model is difficult to find in operation. There are few agricultural and craft markets that may fit the theory. This model is primarily a reference point from which economists compare the other market structures.
2. Monopolistic Competition Market Structure
Unlike perfect competition, monopolistic competition does not assume lowest possible cost production.
That slight difference in definition leaves room for huge differences in how the companies operate in the market.
Companies in a monopolistic competition structure sell very similar products with small differences they use as the basis of their marketing and advertising.
This is completely different from the perfectly competitive market structure which excludes advertising. Consider bath soap — they are all pretty much the same as far as what makes it soap and its use, but small differences like fragrance, shape, added oils or color are used in advertising and in setting price.
In monopolistic competition producers are price maximizers.
When the profits are attractive, producers freely enter the market. The slight differences between the products also creates imperfect information regarding quality and price.
Monopolistic competition markets are a hybrid of two extremes, the perfectly competitive market and monopoly.
Examples of monopolistic competition markets are:
3. Monopoly Market Structure
Monopolies and perfectly competitive markets sit at either end of market structure extremes. However, both minimize cost and maximize profit. Where there are many competitors in a perfect competition, in monopolistic markets there’s just one supplier.
High barriers to entry into this market leave a “mono-” or lone company standing so there is no price competition. The supplier is the price-maker, setting a price that maximizes profits.
There are naturally occurring monopolies and those created through legislation, such as state-legislated liquor stores. However, several companies have been criticized as breaking antitrust laws including:
4. Oligopoly Market Structure
Not all companies aim to sit as the sole building in a city. Oligopolies have companies that collude, or work together, to limit competition and dominate a market or industry. The companies in these market structures can be large or small, however, the most powerful firms often have patents, finance, physical resources and control over raw materials that create barriers to entry for new firms.
Since this market structure discourages true competition, the producers are able to set prices, but the market is price sensitive. If the prices are too high, buyers will migrate to the market’s product substitutes.
- There are pure oligopolies with homogenous products, like the gasoline industry.
- Some firms function in differentiated oligopolies; selling products with small differences, like fast food or air transportation.
Understanding the definition of market structure and the differences within these four types allows you to be understand the context under which a company in question functions.
The dynamic relationships among and between sellers and buyers changes pricing, profits and production levels. Trading and investing requires researching how firms react to those relationships and changes and forecasting how their reactions will change their bottom lines, and yours.
* There is a single seller and large numbers of buyers that sell products that have no close substitutes. The entry and exit barriers are also high.
* No close substitutes – Monopolies firm would sell products in which there are no close substitutes.
* Restriction of entry of new firms.
* Advertising: Advertising in a monopoly market depends on the products sold. Advantages and disadvantages:
1. Stability of price
* In a monopoly market the prices are most of the times stable. This happens because there is only one firm involved in the market that sets the prices if and when it feels like. In other types of market structures prices are not stable and tend to be elastic as a result of the competition that exists but this isn’t the case in a monopoly market as there is little or no competition at all.
2. Source of revenue for the government
* The government gets revenue in form of taxation from monopoly firms.
3. Massive profits
* Due to the absence of competitors which leads to high number of sales monopoly firms tend to receive super profits from their operations. The massive profits realized may be used in such things as launching other products, carrying out research and development among many other things that may be beneficial to the firm. 4. Monopoly firms offer some services effectively and efficiently.
1. Exploitation of consumers
* A monopoly market is best known for consumer exploitation. There are indeed no competing products and as a result the consumer gets a raw deal in terms of quantity, quality and pricing. The firm may find it easy to produce inferior or substandard goods if it wishes because t the end of the day they know very well that the items will be purchased as there are no competing products for the already available market.
2. Dissatisfied consumers
* Consumers get a raw deal from a monopoly market because quality will be compromised. Therefore it is not a wonder to see very dissatisfied consumers who often complain about the firm’s products
3. Higher prices
* No competition in the market means absence of such things as price wars that may have benefited the consumer and as a result of this monopoly firms tend to charge higher prices on goods and services hence inconveniencing the buyer.
4. Price discrimination
* Monopoly firms are also sometimes known for practicing price discrimination where they charge different prices on the same product for different consumers.
5. Inferior goods and services
* Competition is minimal or totally absent and as such the monopoly firm may willingly produce inferior goods and services because after all they know the goods will not fail to sell.
* Having only a limited number of companies controlling a large proportion of a particular industry reduces the likelihood of one of the members making unjustified price increases. Should such an increase not be adopted by the remaining companies, the first supplier will simply lose its share of the limited market, as consumers will turn to the other providers for the identical product at the lower rate. Although the profit margin of the other companies may be slightly smaller, they will, of course, benefit from the subsequent increase in demand. Disadvantages
* In a normal market, it is supply and demand that mostly affect price. Should a consumer find a similar product offered by another provider at a cheaper price, he will make his purchase from that other provider. Suppliers will not, therefore, over-inflate their prices because they will simply lose customers. In an oligopoly, there is little choice for consumers and this will negate any influence they may have had over price control. By the very nature of an oligopoly, providers in an industry with limited members are able between them to dictate the price of their product, as consumers are unable to find alternatives or substitutes elsewhere. Since in many countries collusion or conspiracy between companies to inflate prices is illegal, members of an oligopoly may follow signals given by its industry leader as to any imminent changes it proposes to implement.
1. Resources are allocated in the most efficient way to meet market demand and maximise consumer satisfaction. This means that market mechanism works better. 2. It is the cheapest way of using the factors of production we have. Which says that we are at the lowest part of the AC curve? 3. There is no cost of advertising, selling, marketing, or motions. These are often a form of waste to society as a whole, though beneficial for individual firms. 4. Rapid change is possible to meet new consumer demands – it is very flexible. The interests of producers are the same as for consumers. 5. Freedom to choose exists.
6. It avoids all the wastes of monopoly.
7. It prevents the emergence of a few rich and powerful people .There are a lot of firms, all small, so that no major powerful personality can rise and dominate others.
1. It produces what is demanded under the given distribution of income. We can imagine a scenario with a very few rich people with pet dogs or cats which dine extremely well on chicken and the like, while the masses starve.
2. Spill overs and externalities can exist. These are costs caused to others, e.g. the disposal of nuclear waste or toxic chemicals by dumping them in streams. 3. No economies of scale possible – all the firms are too small. 4. Perfect competition is consistent with a limited choice of range of goods; monopolistic competition may have a much wider range. An example is motorcars – there are an awful lot of different models and competition is much less than perfect. 5. Little or no research and development is possible because there are no funds for it. Under perfect competition there are no surplus profits (in the long run they are whittled away!) R&D is possible under monopoly because of the surplus profits available.
1. There are no significant barriers to entry; therefore markets are relatively contestable. 2. Differentiation creates diversity, choice and utility. For example, a typical high street in any town will have a number of different restaurants from which to choose. 3. The market is more efficient than monopoly but less efficient than perfect competition – less allocatively and less productively efficient. However, they may be dynamically efficient, innovative in terms of new production processes or new products. For example, retailers often constantly have to develop new ways to attract and retain local custom. Disadvantages
Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive. As the diagram illustrates, assuming profit maximisation, there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases. In the long run the firm is less allocatively inefficient, but it is still inefficient.
http://knownai.hubpages.com/hub/Advantages-And-Disadvantages-Of-A-Monopoly-Market http://www.ehow.com/info_8181651_advantages-disadvantages-oligopoly.html http://wiki.answers.com/Q/What_are_the_differences_between_perfect_competitve