Market definition is essential for various reasons; In a company’s perspective, it is critical to understand both the current and potential competitors in regards to the product line. It is also important to establish the characteristics as well as the boundaries of operation. This will assist in setting the price and establishing advertising budgets. Making capital investment resolutions will also be enhanced (Pindyck, 2001). The definition of market is also important from a public policy perspective. It enables Justice Department to determine the merger or acquisition that involve firms which produce products that are similar and those that are likely to produce similar products in nature. The determination on whether the practice should be challenged or not is arrived at in the most convenient way. The answer mainly depends on the impact the merger on the anticipated competition as well as the prices. In most cases, it can be assessed based on proper definition (Cline, 2005).
In defining a market, it is important that the firm decides what products to be included. For instance, is there a single market for digital cameras that includes expensive single-lens reflex cameras as well as the simple point shoot cameras, or is these separate markets? Likewise is there single market for bicycles, or does it make more sense to think of ‘private label’ bicycles for example Fuji, Cannondale, Trek and so forth, which are sold by dealers? In answering all these questions, it is important that one consider both demand substitutability and supply substitutability (Goodwin and Ackerman, 2009). Similarly, one has to take into consideration that a market is the collection of buyers and sellers that determine price of a product or a set of products. In our case industry A is placed in a monopolistic competition. The market structure is quite similar to a perfect competition. This kind of market presents a vigorous pricing completion among large rival market suppliers and individual business is present.
However, the industry that is different between these two market structures is that at least some degree of product differentiation is present in monopolistically competitive markets. As a result, firms have at least some discretion in setting prices. However, the presence of many close substitutes limits the price-setting prices ability of individual firms and drives profit down to the normal profits are only possible in the short -run before rivals are able to take effective counter measures. Examples of monopolistically competitive market structures include a broad range of industries producing clothing, consumer financial services, professionals and so forth (Goodwin and Ackerman, 2009).
According to Perloff (2008), Locksmith industries are placed in a monopolistic competitive market. Firms in this industries exercise a degree of market power, albeit less than that exercised by an oligopoly or monopoly industry competition. As in the case of competition an oligopoly, profit maximization monopolistically competitive and oligopolistic firms will produce at an out put level where MR=MC.
The industry characteristics of an imperfect competitive industry are a large number of sellers acting independently, differentiated products, partial control over product price and relatively easy entry into and exit from the industry. Product differentiation refers to real or perceived differences in goods or services produced by different firms in the same industry. Product differentiation permits market segmentation enabling individual firms to set their own prices within limits. The short term profit-maximizations condition for a monopolistically competitive firm is P>MR=MC. As in the case of a perfect competition, the firm earns economic profit when enter the industry while the existing firms lose market share. This is explained in the diagram below.
Few firms are attracted into the industry, with increased supply moving the supply curve from S1 to S2.
Monopolistic Competition with Economic Profits
Since the demand is downward-sloping, the marginal revenue is below the demand curve. This is a situation an in any perfect competitive industry market (Perloff, 2008). The goal of the company is to maximize profits. As first indicated this occurs where the marginal revenue equals marginal cost (at point ‘a’ in the diagram below) shows that the price is P1. At long-run, companies will enter. The company would perceive that new competitors were taking a way its business. The demand for its product would fall shifting to the left. Economic profits will fall. When the economic profits fall to zero, there would be no reason for new competitor to enter. This is a situation that is normally referred to as the ‘long-run equilibrium’ in the diagram below this is depicted at point ‘f’.
In an imperfectly competitive market, excess profits are eliminated in the long-run. Often this is achieved through imperfect emulation of successful product design, production systems and marketing efforts by both established and newly found competitors (Perloff, 2008). The excess profits are eliminated in a perfectly competitive industry through expansion through established firms and the entry of new firms both of who are offering identical products that are perfect substitutes. For this type of markets, product demand will always be more elastic after the excessive profits are eliminated. On the contrary, it is conceivable that increased competition simply implies parallel leftward shift in the firm demand curve applies.
Industry B (Oil and Lube)
The least competitive industry structure is an oligopoly and there is only one firm in the industry. The most competitive industry structure is identified to be a perfect competition (Laury, 1999). Many of small firms, each with a very small share of the market, most industries lie somewhere between these two extremes, perfectly competitive industry may have thousands of the firms. While in a monopoly an identified firm in the industry is able to control a large portion or the entire supply of raw materials that can not be afforded by other firms.
The oligopoly market on the other side is different compared to perfectly competitive market and the imperfect markets that consist of large number of sellers. The market competitiveness in an oligopoly is characterized by three main features, this include a small number of firms, presence of differentiated goods and lastly the market structure creates a barriers to free entry of other product or service supplies (Laury, 1999).
Firms in an oligopoly competitive market like the monopoly, face barriers (Pindyck, 2001). There are few critical barriers that influence the number of firms in this market. The small number of firms enables each firm to make enough sales in order to achieving an economic scale. For new firms, they only control a small portion of market share. This means they can barely achieve economies of scale. Similarly, firms in this form of market run production with a high average cost and eventually fail to coup up in the industry.
Economies of scale in an oligopoly Market
This means firms in the industry can produce output with a high average cost as a result of large quantities produced cost involved. The out put produced is able to accommodate almost all the demand in the market. Consequently, it prevents new firms from entering this market, considering the long time period needed for these firms to achieve economic scale. For a new firm that intends to enter the market, it needs to sell its output at a price as low as the price of the firm that already experiences economies of scale. More often this is a probable; new firms in the industry end up in a loss and soon have to leave the market.
Demand curve for oligopoly industrial market
In the figure below, the relationship between demand curve and revenue curve, which responds to fluctuation of either supply or demand of product-service, this is well illustrated (Pindyck, 2001). Total revenue curve of an oligopoly similar to the total revenue curve achieved in a perfectly competitive market, which begins at the origin indicating that no revenue is gained when there is no output produced.
Total Revenue Curve, Total Costs Curve and Oligopoly competitive market profit
In an oligopoly competitive market, economic profit is calculated based on the biggest difference in distance between total costs curve (Laury, 1999). The kinked curve DD indicates that demand when one firm in the industry alters its price and the firm’s action is not followed by market rivals. For instance in the figure given below, it indicates that the biggest distance is when output is equivalent to 150 units. Similarly, it is indicated that in the condition, the gradients of the two curves are equal. It therefore remains evident, any output between 50 – 290 units will still attract an economic profit to an oligopoly market however, the total profit is not achieve to the maximum. On the other hand is the firm decides to increase prices, it is assumed that other rival firms will not follow this decision. This will cause the firm to sale at loss considering the market share, thus facing demand curve DD as illustrated in the figure above indicating the demand curve of an oligopoly (Cline, 2005).
Reaction Curve and the Industry equilibrium
Small business firms can easily survive in this business considering that products sold in the oligopoly market are homogenous, which results to only one price in the market. Firms present in this market are assumed to have marginal costs curve that are similar and constant. In addition, each firm determines its output based on the output produced by the competing firms. This makes it possible for price and output to be determined. This is illustrated in the figure below.