Market structure is defined as the particular environment of a firm, the characteristics of which influence the firm's pricing and output decisions. There are four theories of market structure. These theories are: o Pure competition o Monopolistic competition o Oligopoly o Monopoly Each of these theories produce some type of consumer behavior if the firm raises the price or if it reduces the price. The theory of pure competition is a theory that is built on four assumptions: (1. ) There are many sellers and many buyers, none of which is large in relation to total sales or purchases. (2.
) Each firm produces and sells a homogeneous product. (3. ) Buyers and sellers have all relevant information about prices, product quality, sources of supply, and so forth. (4. ) Firms have easy entry and exit. A pure competitive firm is a price taker.
A price taker is a seller that does not have the ability to control the price of the product it sells; it takes the price determined in the market. The pure competitive firm is a price taker because a firm is restrained from being anything but a price taker if it finds itself one among many firms where its supply is small relative to the total market supply, and it sells a homogeneous product in a an environment where buyers and sellers have all relevant information. Examples of perfect competition include some agricultural markets and a small subset of the retail trade. The stock market, where there are hundreds of thousands of buyers and sellers of stock, is also sometimes cited as an example of pure competition. The theory of monopolistic competition is built on three assumptions: (1. ) There are many sellers and buyers.
(2. ) Each firm produces and sells a slightly differentiated product. (3. ) There is easy entry and exit. The monopolistic firm has no rivals, and it produces a good for which there are no substitutes. In a monopolistic competition, it has a downward slope.
This means that it has to lower price to sell an additional unit of the good it produces. Just like the pure competition, monopolistic firm charges the highest price it can possibly charge for its product. Examples of monopolistic competition includes retail clothing, restaurants, and service stations. The theory of monopoly is a theory of market structure based on three assumptions: (1.
) There is one seller. (2. ) The single seller sells a product for which there are no close substitutes. (3.
) There are extremely high barriers to entry. A monopolist is a price seeker, that is, it is a seller that has the ability to control to some degree the price of the product it sells. A price seeker can raise its price and still sell its products-Although not as many units as it could sell at the lower price. With the raising of prices by a monopoly, there is no regulatory system or price ceiling. Examples of monopoly include many public utilities and the U.
S. Postal Service. The utilities includes, gas, electric, and water. Unlike perfect competition, monopoly, and monopolistic competition, there is no one theory of oligopoly. The different theories of oligopoly have the following common assumptions: (1. ) There are few sellers and many buyers.
(2. ) Firms produce and sell either homogeneous or differentiated products. (3. ) There are significant barriers to entry.
The three theories of oligopoly that effects its price and output are: the cartel theory, the kinked demand curve theory, and the price leadership theory. The key behavioral assumption of the cartel theory is that oligopolist's in an industry act as if there were only one firm in the industry. In short, they form a cartel in order to capture the benefits that would exist for a monopolist. A cartel is an organization of firms that reduces output and increases price in an effort to increase joint profits.
The problem with forming a cartel is that it can be costly, especially when the number of sellers is large. Another behavioral assumption is the kinked demand curve theory. This is a theory of oligopoly that assumes that if a single firm in the industry cuts price, other firms will do likewise, but if is raises price, other firms will not follow. It has been argued that firms match price cuts because if they do not, they will lose a large share of the market.
They do not match price hikes because they hope to gain market share. This theory predicts price stickiness or rigidity. The key behavioral assumption in the price leadership theory is that one firm in the industry determines price, and all other firms take their price as given. At one time or another, the following firms have been price leaders in their industries: R. J. Reynolds, General Motors, Kellogg, and Goodyear Tire and Rubber tires.
By analyzing the four theories of market structure, one is able to see the differences and similarities of each. One may also see the type of consumer behavior that each firm presents when prices are increased or decreased.