Market Structures Simulation

Differentiating Between Market Structures Simulation University of Phoenix ECO/365: Principles of Microeconomics November 9, 2009

Market Structures Simulation Differentiating Between Market Structures Simulation In the University of Phoenix simulation (2003), Differentiating Between Market Structures, a situation is presented concerning cost and revenue curves in the different market structures by a freight transportation company. Throughout the simulation scenarios are presented and decisions must be made to maximize profits or to minimize losses (University of

Phoenix, 2003). This paper will summarize and address the advantages and limitations of supply and demand the simulation, analyzing how market structures maximize profits, identify the market structure of a selected organization, and include a table that compares and contrasts the various characteristics of the four market structures. Advantages and Limitations of Supply and Demand All firms strive to obtain their objective of maximizing profits, to get as much for itself as possible (Colander, 2008, p. 242). All firms regardless of the market structure in which they operate will maximize profits when marginal cost (MC) equals marginal revenue (MR). Scenario One In the first scenario, East-Wests Consumer Goods Division operated in a perfectly competitive market structure. A perfectly competitive market is a market in which economic forces operate unimpeded (Colander, 2008, p. 238). The division had been recording losses for the past few years and was considering exiting that line of business. A decision was made to continue operations and limit output to 6.75 million hundred weight shipments at $55 per hundred weight shipment to minimize losses at $150.03 million. In a perfect competition, many sellers exist and all sellers take the market price (P) because no seller can control the market price. Profit is maximized for each seller at the output where marginal revenue (MR) equals marginal cost (MC) (University of Phoenix, 2003). In a

Market Structures Simulation

perfect competition price equals marginal revenue for the sellers because the price is the revenue the seller expects to earn for each additional unit; P=MR=MC. When price is between average total cost (ATC) and average variable cost (AVC), producing at this level will minimize losses and cover variable costs but not fixed costs. If price decreases below average variable cost, neither ATC nor AVC can be recovered and operations should cease. In the long run, firms make zero economic profits because all costs are variables. Scenario Two In the second scenario, Fast Forward Transport exited the business resulting in EastWests Coal Division to operate in a monopoly market structure. A monopoly is a market structure in which one firm makes up the entire market (Colander, 2008, p. 261). As a regional monopoly East-West could set the price for their services, but would also need to increase their services to meet the entire market demand. A decision was made to increase price to $7.85 per short ton and reduce output to 8.28 million short tons to maximize profits at $2.67 million. In a monopoly, output is less than it would be in a perfect competition, and it is possible for monopolists to earn economic profits if barriers to entry exist for new firms (University of Phoenix, 2008). In a monopoly, the firm is not a price taker and can control the price and output. However, at high prices quantity demanded will decrease and not ensure maximum profits. Profit is maximized for a monopolist where marginal revenue (MR) equals marginal cost (MC). If MR does not equal MC, adjustments can be made by increasing or decreasing production to find equilibrium. Scenario Three In the third scenario, East-Wests Chemicals Division operated as a regional monopoly until Far & Wide expanded its network resulting in a duopoly, a special case of oligopoly market

Market Structures Simulation structure. An oligopoly is a market structure in which there are only a few firms and firms explicitly take other firms likely response into account (Colander, 2008, p. 282). Far & Wide

announced across-the-board price cuts in its freight services to gain market share. A decision was made to increase price to $3,300 per carload to maximize profits at $23.13 million giving each company 50% of the market. In an oligopoly, pricing and output decisions are strategic (University of Phoenix, 2003) because undercutting the competition would lead to a price war that may reduce profits and affect market share. Once prices have been fixed, they change very little. Oligopolistic firms can make some profits in the long run. Scenario Four In the fourth scenario, East-Wests Forest Products Division operated in a monopolistic competition market structure. A monopolistic competition is a market structure in which there are many firms selling differentiated products and few barriers to entry (Colander, 2008, p. 282). The divisions profits had been decreasing over time and had to consider investing in a new lumber car. A decision was made to purchase a lumber car to provide better service and chose to increase output to 109,400 carloads of shipments at $3,330 per carload to maximize profits at $38.76 million. The price for profit maximization is determined by finding the point where marginal revenue equals marginal cost and extending a quantity line to the demand curve. Monopolistic competition firms earn zero economic profit because of the free entry and exit into of the market. In a monopolistic competition, differentiation and improving production processes will give a firm a competitive advantage in increasing profits.

Market Structures Simulation Selected Organization

Delta Air Lines operates in an oligopoly market structure where the industry is dominated by a small number of large sellers. Operating in an oligopoly is effective for the airline industry due to the significant barriers to entry of high of start-up and operational costs. Airlines decisions on pricing and flight schedules are strategic because they consider the reactions of other airlines while making their decisions. Starting a price war could cause Delta to lose revenue and market share to low-cost carriers such as Southwest, so they tend to charge similar prices as other mainline carriers and differentiate themselves with the service they provide. Conclusion The simulation provided valuable insight in distinguishing the types of market structures. Market structures are defined by the number of firms in a market, the barriers of entry or lack of into the market, and the interdependence of firms in determining price and output to maximize profits. The price and output at which firms maximize profits will depend on the factors of supply and demand, marginal cost, marginal revenue, average total cost, and average variable cost.

Market Structures Simulation Table 1 Market Structures

Perfect Competition Consumer An example of an Goods Division/ organization. Simulation/Actual: Hard to find in the real world

Monopoly

Monopolistic Competition Forest Products Division/ Consumer goods like soap and toothpaste Differentiated

Oligopoly

Coal Division/ Utility Companies

Chemicals Division/ Grocery stores

Goods or services produced by the organization Barriers to entry Numbers of organizations Price elasticity of demand

Identical

Limited

Identical or Differentiated

None Many

High One

Few Many

Significant Few

Yes

No

Yes

Yes

Economic profits (Is there a presence of economic profits? Yes or no.

No

Yes In the long run.

No

Yes In the long run.

Market Structures Simulation References Colander, D. C. (2008). Economics (7th ed.). Burr Ridge, IL: Irwin/McGraw-Hill. University of Phoenix. (2003). Differentiating between Market Structures. Retrieved November 6, 2009, from University of Phoenix, Simulation, ECO365 - Principles of Microeconomics website.