Pricing Under Different Objectives and Different Market Structures

PRICING UNDER DIFFERENT OBJECTIVES AND DIFFERENT MARKET STRUCTURES

Perfect Competition

Economists in general recognize four major types of market structures (plus a larger number of subtypes):

•  Perfect Competition

•  Monopoly

•  Oligopoly

•  Monopolistic competition

Perfect Competition

where “p” stands for perfect, pure or price, whichever you may like.

A p-competitive structure is defined by four characteristics. For an industry to have a pcompetitive structure, it must have all four of these characteristics, which are as follows:

•  Many buyers and sellers

•  A homogenous product

•  Sufficient knowledge

•  Free entry

These all are characteristics that favor price competition.

Many Buyers and Sellers

The idea is that the sellers and buyers are small relative to the size of the market, so that no one of them can "fix the price." If there are "many small sellers," it makes it much harder for any seller or group of sellers to "rig the price." Similarly, if there are "many small buyers," there is little opportunity for buyers to "rig the price" in their own favor.

Homogeneity

If the product (or service) of one seller differed significantly from that of another seller, then each seller would probably be able to retain at least some of the customers, even at a very high price. These would be the customers who just prefer this seller's product (or service) to that of someone else. The assumption of homogenous products serves to rule that out.

Knowledge

Some versions of the "perfectly competitive" structure include "perfect knowledge" as one of its characteristics. But, of course, "perfect knowledge" never exists in reality. Perfect information is little less clear than the other assumptions-- we can hardly assume that people know everything there is to know.

Free Entry

Free entry means that new companies can set up in business to compete with established companies whenever the new competitors feel that the profits are high enough to justify the investment. This is, first and foremost, a legal condition. That is, in a "perfectly competitive" market, there are no government restrictions on the entry of new competition.

Let us sum up the four characteristics of p-competition:

1. Many small sellers-- The more the sellers, the more substitutes the consumer has.

2. Homogenous products-- When the product is homogenous, then  the substitutes are "perfect substitutes."

3. Sufficient knowledge-- When customers know the prices offered by other sellers, they will be better able to switch, increasing elasticity further.

4. Free entry-- In the long run, companies may even enter the market to provide still more substitutes.

Other Market Forms

The other three market structure models can be defined in terms of the ways in which they deviate from the characteristics of p-competition.

In a “monopoly,” there is just one seller of a good or service for which there is no close substitute.

In an “oligopoly,” there are two or more, but only a few firms.

In “monopolistic competition,” the products are not homogenous but are "differentiated."

We do not have a standard model for "insufficient knowledge," but, at least in some cases, that seems to work similarly to "product differentiation."

The correct sequence of the market structure from most to least competitive is perfect competition, imperfect competition,oligopoly, and pure monopoly.

The main criteria by which one can distinguish between different market structures are: the number and size of producers and consumers in the market, the type of goods and services being traded, and the degree to which information can flow freely.