CHAPTER 18: COMPETIVE MARKETS

Types of Market:

* Perfect Competition (Large number of buyers and sellers of goods and services)

* Monopoly (One seller and large number of buyers of goods and services)

* Monopolistic (One buyer and large number of sellers of labour)

* Oligopoly (More than two or few large sellers and large number of buyers of goods and
services)

* Duopoly (Two large sellers and large number of buyers of goods and services)

Competition: Competition is the rivalry that exists between firms when they trying to sell
goods in a particular market. In some markets there is a lot of competition. In other markets
the competition is very little.

Characteristics or Features of Competitive Market:

• A large number of buyers and sellers.

• The product sold by each firm are close substitutes for each other.

• Low barriers to entry. It means it is fairly easy to break into the market or it is not
difficult to enter into the market.

• Each firm has virtually no control over the price charged. If a firm tries to charge
more than its rival it is likely to lose business.

• There is a free flow of information about the nature of products, availability of

different outlets, prices, methods of production, cost and availability of factors of
production.

Competition and the Firm: Generally firms do not welcome competition. Most firms would
prefer to dominate the market and operate without the threat of rivals. If there is no threat
from competitors, a firm can usually charge a higher price. There is also less pressure to be
efficient and innovative.

If a firm faces competition then the functions or objectives will be,

• Operating efficiently by keeping costs as low as possible.

• Providing good quality products with high levels of customer service.

• Charging prices which are acceptable to customers.

11
• Innovating by constantly reviewing and improving the products.

The main disadvantage to a firm operating in a competitive market is that the amount of
profit made will be limited.

Competition and the Consumer: If competition exists in the market consumers get
advantages from this. Sometimes there are some disadvantages too that consumers face.

Advantages to Consumers

• Lower prices: In a competitive market firms cannot over charge consumers. If one firm
tries to raise its price, it will lose a lot of its business. This is because the market is full of
substitute goods and consumers can easily switch from one supplier to another.

• More choice: Competition means there are many alternative suppliers to choose from.
Where possible each supplier is likely to differentiate its product from the rivals.
Competitive markets will also have a constant stream of new entrance offering fresh ideas
and even more choices.

• Better quality: Firms that offer low quality goods in a competitive market will lose
competitiveness. Consumer considers both the price and the quality of products when
deciding what to buy. Modern consumers are more aware and better informed than ever
before.

Disadvantages to Consumers

• Market uncertainty: It could be argued that there may be some uncertainty or disruption
in competitive markets. Because unprofitable firms eventually leave the market.

• Lack of Innovation: It could be argued that innovation in competitive market might be

lacking. Because firms make less profit in competitive markets. As a result they invest lower
profit in product development.

Competition and the Economy:

There are some advantages and some disadvantages to the economy of competitive market.

Advantages of Competition:

• Most efficient allocation of resources.

• Less wastage of resources.

• Increase the standard of living.

• PPC will shift to right.

12
Disadvantages of Competition:

• Sometimes resources are wastages.

• Factors are immobile.

CHAPTER 19: ADVANTAGES AND DISADVANTAGES OF LARGE AND SMALL FIRMS

Size of a Firm: Several methods can be used to measure the size of a firm. Three of them are
given below,

• Turnover

• Number of Employees

• The Amount of Capital Employed

Advantages of Small Firms

• Flexibility: Small firms can adapt to change more quickly. This is because the owners who
tend to be the main decision makers are actively involved in the business and can react to
change.

• Personal Services: As firms get bigger it often becomes difficult to offer customers an
individual personal service. Some people prefer to deal with the owner of the firm directly
and are prepare to pay a higher price for the privilege. Owners are far more accessible in
small firms than larger ones.

• Lower Wages: Many workers in small firms do not belong to trade unions. As a result their
negotiation power is weaker and the owners are often able to restrict wages to the legal
minimum wage.

• Better Communication: Since small firms have fewer employees, communication trends to
be informal and more rapid than in large organizations. The owner will be in close contact
with all staff and can exchange information quickly. As a result decision making will be faster
and workers may be better motivated.

• Innovation: Although small firms often lack resources for research and development, they
may be surprisingly innovative. One reason for this because small firms face competitive
pressure to innovate. It may also be because small firms are more prepared to take a risk.
Perhaps they have less to lose than large firms.

Disadvantages of Small Firms

• Higher Costs: Small firm can’t exploit economies of scale because their output is small.

13
Consequently their average cost will be higher than their large rivals. This means small firms
often lack a competitive edge.

• Lack of Finance: Small firms often struggle to raise finance. Their choice of sources is
limited. They are also considered to be more risky than larger firms by financial institutions
and other money lenders.

• Difficulties Attracting Right Staff: Small firms may find it difficult to attract highly qualified
and experienced staff. One reason is they lack resources.

• Vulnerability: When trading condition become more challenging small firms may find it
more difficult to survive than the large firms. This is because they do not have enough
resources to cope with the condition of the economy when it turns.

Advantages of Large Firms

• Economies of Scale: The main advantage to large firms is that their average costs are likely
to be lower than their small rivals. They can operate large scale plants and exploit
economies of scale.

• Market Domination: Large firms can often dominate a market. They have a higher profile
in the public eye than small firms and benefit from such recognition. They can charge higher
prices which will enable them to make higher profit.

• Large Scale Contracts: There are both small and large firms in the industry. But the small
firms can’t get large scale contract like large firms because they do not have the resources
to carry out the works.

Disadvantages of Large Firms

• Too Bureaucratic: Large firms sometimes become more overwhelmed by their

administration system. Decision making can be very slow because a lots of people have to
consulted to make a decision. The communication channel is also too long.

• Co Ordination and Control: Avery large business may be difficult to control and co
ordinate. Thousands of employees billions of money and lots of plants are working together.
Sometimes supervision costs increases.

• Poor Motivation: In very large organization people can become alienated. The
organization may become so large that the effort made by a single employee seems
insignificant. The personal contact in the large organization may be lacking and this can
result in poor worker motivation.

14
CHAPTER 20: MONOPOLY

Monopoly: A pure monopoly exists when a market is supplied by just one producer. Pure
monopolies are not common but they do exist. In UK if a firm has 25% or more of market
share it is said to be monopolist.

Features of Monopoly

1. Barriers to Entry: Monopolies exist because competition is discouraged. In some markets

there are obstacles that prevent new entrants from trying to compete. Barriers to entry are
a common feature in monopoly.

a. Cost Barriers: In some markets the cost of setting up a firm to compete with the
existing operators is too high. New competitors may find it difficult to match such
financial commitment.

b. Legal Barriers: In some markets it is possible to exclude competition legally. One

way is to obtain a patent. A patent is a license that prevents firms copying the design
of a new product or new price of technology. The new product developer can be the
sole supplier in the market for a period up to 20 years. This allows the firm to change
a higher price and recover the costs of research and development.

c. Economies of Scale: An established firm might dominate a market because it has

grown and is now able to exploit economies of scale. As a result its average costs will
be lower and it will have a cost advantage over any new entrant. A new entrant
would struggle to keep costs down trying to supply a relatively small section of the
market.

d. Marketing Barriers: Monopolist often have strong brand names. This makes it
difficult for new entrants to compete because their products will be unfamiliar and
may not be trusted by consumers. Dominant firms always spend a lot of money on
advertising to reinforce their brand names. This makes it even harder for new
entrants. A monopolist might lower prices temporarily if it thinks a new entrant is
about to join the market. This is called predatory pricing. It is very hard for new
entrants to compete.

2. Unique Product: The product supplied by a monopolist will be highly differentiated. There
will not be another exactly like this. The product supplied is the only one available, there is
no choice whatsoever for the consumer.

3. Control over Price: Although monopolists face a downward sloping demand curve, they
are able to control the price they charge. Monopolists are called price makers. They can
force price up by restricting the quantity supplied in the market.

Advantages of Monopoly
15
• More Research and Development: Since monopolies are often large and make high profits,
they have the resources to invest in research and development. As a result they are able to
develop the new product and new technology from which consumer will be benefited.

• Economies of Scale: Since most monopolists are large they can exploit economies of scale.
This means that their average cost is lower. As a result they may be able to supply product
to the consumer at a lower price.

• Natural Monopolies: In some markets natural monopolies exist. These are markets where
just one firm supplies all the consumers. In these markets it is often the case that the sole
supplier is unable to exploit all economies of scale.

• International Competitiveness: It is argued that if a firm has a monopoly in the domestic

market, it can build strength and compete more effectively with the competitors from
overseas. This will help to increase employment and national income in the domestic
economy.

Disadvantages of Monopoly

• Higher Prices: A firm that dominates a market is able to charge more for its products.
Monopolists will trend to restrict output in order to force up the price.

• Restricted Choice: If there is just one supplier in the Market, consumer choice is obviously
restricted. If the consumers are unhappy about the quality and price of the product and the
level of service they can’t switch to another provider.

• Lack of Innovation: It is sometimes argued that the monopolists do not spent enough
money on product innovation. If they dominate the market and are able to prevent or
restrict entry, there is no need to develop new product. This is because the consumers are
forced to buy the existing products. If monopolists are making higher profits without
innovating, they may consider that resources invested in ‘research and development’ are
wasted.

• Inefficiency: It is possible to argue that monopolists may be inefficient. If a firm does not
face any competition there is no intention to keep costs down. As a result a monopolist may
adopt a sloppy approach to business and incur unnecessary costs. If monopolists are too big
it may suffer from diseconomies of scale. Their average costs will rise. Finally some
monopolists have been criticized for offering poor customer services.

16
CHAPTER 21: OLIGOPOLY

Oligopoly: A market that is dominated by a few very large producers is called an oligopoly. A
small fraction of the market is served by the other small firms.

Features of Oligopoly

• Interdependence: Firms in oligopoly are said to be interdependent. For example, if one

firm invest heavily in a television advertising campaign to increase sales, other firms are
likely to lose sales.

• Barriers to Entry: The firms that dominate the market are likely to benefit from barriers to
entry. Without barriers to entry the high profits enjoyed by the dominant firms would
attract new entrants. As a result their dominance would be reduced.

• Price Rigidity: In many oligopolistic markets, price remains same for the long periods of
time. The price is often set by the market leader and other just follow. One reason for this
pattern is because firms are afraid of a price war. If one firm cuts price, others in the market
have to do the same or they will lose the sales. As a result revenue and profits would be
lower for all firms.

• Non Price Competition: Since firms are keen to avoid price war, they compete using
advertising and promotion such as coupons, loyalty cards, competition and free offers.
Branding is a common feature in some markets. Product differentiation is also common in
the market.

• Economies of Scale: The dominant firm in an oligopoly benefit from economies of scale
because they are large scale producer. As their output increases average costs fall. This
helps them to increase the profit. The smaller rivals in the market can’t exploit economies of
scale. They often survive because they do not directly compete with the dominant firms.

Collusion: In some oligopolistic markets collusion may take place. This is where the
dominant firms in the industry set up agreements to restrict competition. In many countries
collusion is illegal because it harms the consumers.

The ways of making collusion are,

• Market sharing.

• Price fixing.

• Restricting output.

17
Advantages of Oligopoly

• Economies of Scale: If the dominant firms are able to exploit economies of scale their
average costs will be lower. Therefore it is possible to charge low price of the product for
the consumer.

• Price Stability: In some oligopolistic markets price are fairly stable for quite long periods of
time. It is helpful for the consumers. However consumers might benefit from the price war.
Once a firm cuts price aggressively others in the market are forced to follow. As a result
consumers benefit to the lower price.

• Choice: Competition in the oligopolistic markets ensures that consumers are provided with
some choice. One of the ways in which oligopolistic compete is by launching new brands.
These new brands provide consumers with new products.

Disadvantages of Oligopoly:

• There is no competition in the market as a result consumers are not likely to be benefited.

• The temptation of firms to collude.

• If firms restrict competition by price fixing consumers will not pay the high price.

• Consumers will also suffer if a market is shared out geographically.

• Lack of choice by the consumers.

• If oligopoly firms spent too much on advertising the consumers will suffer.

18