Market Structures, Demand, Supply, and Price Determination
Chapter 3: Market Economic Structure
Perfect Competition
Perfect competition is characterized by a product market where there are many buyers and sellers. Because each market participant’s share is very low, they cannot influence prices. The product is identical and homogeneous, there is perfect mobility of resources, there are no barriers to entry or exit, and operators are fully informed of market conditions.
Monopoly
In a monopoly, there is only one vendor that sells a product for which there are no perfect substitutes, and there are significant barriers to entering the industry. Monopolistic competition is characterized by numerous sellers of a differentiated product, and because in the long run there is no difficulty in entering or leaving the industry.
Oligopoly
An oligopoly features few sellers of a homogeneous or differentiated product. Entering or exiting the industry is possible, albeit with difficulty.
The Demand for a Product
The quantity demanded of a product or service depends on its price, the consumer’s income, the price of substitutes or complementary goods, and consumer preferences. In the feasibility study of a project, the proper definition of the demand for the commodity to be produced is vital.
As the price lowers, the quantity demanded increases. This depends on the price elasticity of demand. One of the determinants of price elasticity of demand is the ease of replacement of the good in question. In general, those goods whose replacement is more difficult are those that show lower values of price elasticity. A high elasticity indicates a high degree of response of quantity demanded to changes in price, and a low elasticity indicates low sensitivity to price changes.
- Perfectly elastic demand: if Ep = – infinity
- Elastic Demand: if Ep > 1
- Inelastic demand: if Ep < 1
- Unitary elasticity: if Ep = 1
- Perfectly inelastic demand: if Ep = 0
Substitution effect: Increased consumption of a substitute good because it is cheaper than the one that was consumed earlier.
Income effect: Lowering the price of a good allows consumers to buy more of the product because with the same income they can purchase more.
Change in quantity demanded: Changes along the demand curve caused by a change in price.
Change in Demand: Shifting of the entire demand curve caused by something other than price.
Price Determination in Natural Monopolies
Given the inefficiency of imperfect markets, whether due to a lack of pressure from barriers to entry or for any other reason, a model company can be created that operates efficiently in the allocation of resources. Based on this model, alternative development of bidding can be evaluated for the successful implementation of outsourcing certain tasks outside of the organization, thus allowing for allocation and distribution of resources in an optimal manner.
The monopolistic company decides how much to produce at the point at which marginal revenue equals marginal cost.
Supply
Supply can be defined as the number of units of a particular good or service that sellers are willing to offer at certain prices. Increases in supply, increased prices, and improved technology mean lower prices. The optimum quantity of production is the one that maximizes the net income of the company.
Knowledge of supply and its behavior in relation to goods or services that the project aims to produce is imperative in the evaluation process.