Market Structures, Negative Externalities, And Government Intervention

Characteristics of Different Market Structures

Question:

(a) Identify the key characteristic of four market structures (ie. Monopoly, oligopoly, perfect competition or monopolistic competition). Give a case study example of each market structure?

(b) Explain what negative externalities are, and why there may be a case for government intervention to address them. Describe some of the ways to correct the negative externalities and the pros and cons of each method. Provide real life examples.?

(c) Choose a case study from your home country where an externality exists in a current market. Illustrate the situation with externalities in your case study and the resulting deadweight loss in a diagram and discuss ways that your government has addressed the presence of negative externalities in the market?

According to Kuenne (2000), market structure helps in providing a model with reference to the number of competitors in the market, degree to which the products are different, the ease of entry of new competitors in the market (Mateosian, 2007). This section will focus on discussing the major characteristics of the four different market structures along with examples.

A perfectly competitive market is a hypothetical situation in which the level of competition is highest. According to the Neo-classical economists, the market which has perfect competition will deliver best possible result for the consumers as well as society. In the perfectly competitive market, there will be no market leader for setting the price of the homogeneous market. In real world very few markets are perfectly competitive (Ameringer, 2008). This concept can be applied in case of thee auction type market for commodities such as Bitcoin. The perfectly competitive market has some distinct characteristics which will be discussed in the following section:

In the perfectly competitive market, there are many sellers in the market and it will meet the demand of the market. It is evident that the sellers will not have any choice or ability to influence the market price ( Roo, Visser and Zuidema, 2011).

One of the most important characteristics of the perfectly competitive market is the homogeneous product which sold by all the competitors (Benabou and Tirole, 2013).

According to Cincera and Noury (2004), in the perfectly competitive market, no entry or exist barrier exist which can influence the entrance as well as leaving the market.

The organizations operating in the perfectly competitive market are price takers as there is no market leader who can influence the market price. Every organization has to agree with the market price as they do not have any control over the price.

In case of perfectly competitive market, the demand curve is not perfectly elastic. In this case, the economic profit can be calculated with the aid of the following formula:

Economic Profit = Total Revenue (TR) – Total Cost (TC)

In the perfectly competitive market, productive efficiency takes place when the price coincides with the minimum average total cost (ATC). On the other hand, allocative efficiency is obtained when price is equal to the marginal cost (MC) etc (McKenzie and Lee, 2008).

Perfect Competition and its Characteristics

In reality, perfect competitive market does not exist. However, in some markets, the attributes of perfectly competitive market is present to some extent. For example, in case of the auction market for Bitcoin industry is a perfect competition exists (Benabou and Tirole, 2013). An example of perfectly competitive market with the cost function can be used in order to analyze the concept clearly. In the following table the cost function of an organization operating in a perfectly competitive market is presented.

Quantity	Average Fixed Cost	Average Variable Cost	Average Total Cost	Marginal  Cost
1	60	45	105	45
2	30	42.5	72.5	40
3	20	40	60	35
4	15	37.5	52.5	30
5	12	37	49	35
6	10	37.5	47.5	40
7	8.57	38.57	47.14	45
8	7.5	40.63	48.13	55
9	6.67	43.33	50	65
10	6	46.5	52.5	75

The following table will demonstrate the calculation of profit in case of different level of demand and different price.
 

PRICE  ($)	Qs (1 firm’s output)	PROFIT	Qs(1500 firms in the market)  / market supply	Qd  ( market demand )
26	0	-60	0	17000
32	0	-60	0	15000
38	5	-55	7500	13500
41	6	-39	9000	12000
46	7	-8	10500	10500
56	8	63	12000	9500
66	9	144	13500	8000
(assuming identical cost function for all firms)

From the above tables, it can be implied that when the price is less than 37 dollars, the output of the organization will be zero and in that case, the company will encounter economic loss of 60 dollars. Additionally, when the price will be greater than 37 dollars, the output level of the firm will enhance. For example, when the price is 66 dollars, the quantity will be 9 units. Therefore, the economic profit will be = (66 * 9) – (50 * 9) = $ 144

Monopoly market consists of a single supplier and it will have the maximum control over the market. In this market situation the single producer or a group of producers controls the supply of goods and services in the market and the firms operating in the monopoly market focuses on maximizing the profit (Roo, Visser and Zuidema, 2011). Monopoly exists in different degrees such as patent, intellectual properties, copyrights etc. In reality, globalization has threatened the monopoly markets.  In this section, the characteristics of the monopoly market will be discussed.

In case of monopoly market, there is single producer or supplier. In this case, the business firm and industry are considered as the identical (Pirayoff, 2004).

In the monopoly market the business firm offer unique product which is not available to the other business firms etc (McKenzie and Lee, 2008).

As there is only one seller or producer in the monopoly market, the organization has the entire control over the price. The single seller is the market leader and determines the supply as well as price of the product (Shashi Kumar, 2004).

The entry and exit in the monopoly market is restricted.

Generally, the marginal revenue (MR) curve remains below the demand curve. In case of monopoly market, profit is maximized while marginal revenue is equal to the marginal cost.

An example can be cited ere for explaining the concept of monopoly market. Let XYZ be a firm operating in the monopoly market. The cost function can be same as the cost function presented in the perfectly competitive market. On the other hand, the level of output and the market price is different due to the market structure (Pirayoff, 2004). The output level will be less than the perfectly competitive market. Additionally, the price will be greater as the product is unique and sold by single seller. The table for cost function is presented below:

Quantity	Average Fixed Cost	Average Variable Cost	Average Total Cost	Marginal Cost
1	60	45	105	45
2	30	42.5	72.5	40
3	20	40	60	35
4	15	37.5	52.5	30
5	12	37	49	35
6	10	37.5	47.5	40
7	8.57	38.57	47.14	45
8	7.5	40.63	48.13	55
9	6.67	43.33	50	65
10	6	46.5	52.5	75

Monopoly and its Characteristics

The following table will calculate the profit for different price and demand levels:
 

Price ($)	Quantity Demanded	Total Revenue	Marginal Revenue	Economic Profit
115	0	0		0
100	1	100	100	-5
83	2	166	66	21
71	3	213	47	33
63	4	252	39	42
55	5	275	23	30
48	6	288	13	3
42	7	294	6	-35.98
37	8	296	2	-89.04
33	9	297	1	-153
29	10	290	-7	-235

From the above two tables, the marginal revenue and marginal cost can be compared. At the point when quantity will be 4 and the price will be 63 dollars. At this point, the business firm will be able to maximize its profit with the economic profit of 42 dollars.

Monopolistic market is a specific market structure in which large number of sellers is involved in selling the similar but not the same product (Pirayoff, 2004). In this section, the characteristics of the market are presented along with example.

In case of the monopolistic market large number of business organizations participates. It is evident that the market share of each company is less due to large number of participatory organizations (Wang, Li and Ma, 2012).

In monopolistic market, the business organizations offer similar but differentiated products in terms of quality, availability, purpose, branding, packaging, price, place, advertisements etc. Presence of the diversified product helps in making the market different from the perfectly competitive market (Smith and Tremore, 2008).  

In case of monopolistic market, the business firms can easily enter into the market as well as leave the market.

In case of monopolistic market, profit will be maximized when marginal revenue is equal to the marginal cost.

Example of monopolistic market includes, clothing stores, restaurants, coffee shops, fitness clubs etc.

The following diagram depicts the characteristics of the monopolistic market (Smith and Tremore, 2008):

Oligopoly is a market structure in which few organizations participate and operate in harmonized manner for producing standardized as well as distinct products in order to have control over the market. This section will include the characteristics as well as example of oligopolistic markets (Chen, 2013).

In an oligopolistic market, few numbers of large organizations operate. Each firm focuses on developing strategy in order to address the strategy adopted by its competitors. The strategies include production design, promotional strategy, pricing strategy etc (Rossi-Hansberg, Sarte and Owens, 2008).

Each business firm has specific and distinct product range.

The entry and exist in the oligopolistic market is difficult. The major reason is the organizations will encounter barriers while entering the market. The companies need to achieve economies of scale for effectively competing in the market. Additionally, the oligopolistic market includes highly capital intensive industries.

The demand curve of oligopoly market is slightly kinked. 

The example of oligopolistic market includes automobile industry, aircraft manufacturing industry etc.

Externality takes place when the activities of a party affect another party directly or indirectly and in this situation the first party does not bear any cost or enjoys benefit from that particular activity. Basically, it is an example of market failure and it occurs when the utility of a particular party or agent is directly dependent upon the activities of another part. Negative externality occurs when the activities of a party significantly affects other party (Rossi-Hansberg, Sarte and Owens, 2008). There are two types of negative externalities: negative production externality and negative consumption externality. If the production activities of an organization is negatively correlated with the well being of the other party who are not compensated by the organization, it can be termed as negative production externality. On the other hand, when the consumption of an individual negatively affects that well being of the other party who cannot be compensated by that consumer, it can be termed as negative consumption externality (GarciÌÂa Delgado, 2010).

Negative Externalities and the Case for Government Intervention

Eternality takes place due to market failure and it is evident that the economy has to bear greater marginal social cost against the marginal private cost. Consequently, the society has to pay for the additional cost due to the externalities occurred from the operational activities of the business organizations. It has been found that negative externality is responsible for diminishing the efficiency level of the market as well as it imposes additional cost on the society. Hence, the social welfare experiences the adverse impact of the externalities. In this situation, the government intervention is necessary for resolving the issue (Hite, 2008). The government focuses on addressing the problem so that the society does not encounter the adverse impact of business activities. It is observed that the government plays a major role in addressing the externalities through adoption of effective strategies. Thus the government intervention significantly contributes in trimming down the negative impact of externality on the economy and society (Jordaan, 2009). There are various approaches adopted for diminishing the negative externalities in the economy. In this section some techniques along with its pros and cons will be discussed.

Taxation policy is an effective mechanism for addressing the issues related to negative externality. The government can impose direct as well as indirect tax for diminishing the negative externality. Different environmental tax such as landfill tax, plastic bag tax and carbon tax can be imposed on the manufactures which is affecting the environment and local community through its business activities. The tax amount will depend on the extent of the negative eternality produced by the business firm (Heijman, 2007).

Pros and Cons

The major benefit of this approach is it helps in encouraging the organization to take measure for minimizing the negative impact of their business activities. The business firms would not like to pay the additional tax and will alternate its activities accordingly. Additionally, it helps to enhance the government revenue which can be capitalized in different environmental protection activities and social welfare activities (Rossi-Hansberg, Sarte and Owens, 2008).

In contrast, some limitations of this measure have been identified. It is evident that, estimating the degree of negative externality and setting the amount of tax is a difficult task. Additionally, it has been found that some organization may find that the cost of making amendments for reducing the negative eternality is greater than the tax amount. In this case, the organizations prefer to pay tax instead of modifying its activities.

In order to minimize the negative impact of eternality, the government can impose quantitative restriction. The government policy will restrict the level of production for reducing the negative externality occurred from the production activities of business firms. This policy will be applicable for the organizations which are involved in the production activities which produce significant waste which pollutes the air, soil and water. Thus, the government will be able to control the pollution level in the environment (Wang, Li and Ma, 2012).

Pros and Cons

This measure has both advantages as well as limitations. The major advantage of this measure is, it will help in controlling the production activities which is helpful in managing the pollution level as well as impact of negative externalities. In contrast, reducing the level of production will have negative impact on the economy of nation. The capacity of the producer will be wasted and the cost will be borne by the producer. Additionally, it may lead to increase the issues regarding unemployment.

Ways to Correct Negative Externalities and Pros and Cons

A real life example can be cited here for explaining the negative externality. Fossil fuel burning leads to air pollution due to the production of CO₂ gas and the solid waste of fossil fuel is channelized to the river or other water resources and it get polluted (Endres & Fraser, 2011). Additionally, irresponsible consumption of oil and gas and conventional fuels lead to air pollution and excessive depletion of the natural resources (Krugman & Wells, 2009). The negative externality can be explained with the aid of following diagram:

The readymade garment industry is one of the most important industries of the economy of Bangladesh. The growth rate of the industry has been estimated to be approximately 12% per annum. Presently, 4 million workers are involved in the industry which implies one out six people in Bangladesh is associated with the garment industry. The garment industry of Bangladesh is involved in the manufacturing activities as the cost of labor is cheap. The activities of the garment industry in Bangladesh are significantly threatening the environment. This industry is responsible for extensive use of water resources for cleaning and dyeing. Additionally, the industry produces huge amount of liquid waste (Singh & Shishodia, 2007). Moreover, extensive consumption of energy for heating water and running the equipments has a major negative impact on the environment and the society. The manufacturing activities of the garment industry of Bangladesh are also responsible for emission of the hazardous elements in the environment leading to increasing level of pollution. The following diagram depicts the negative environmental impacts of different activities in the garment industry of Bangladesh:

Different activities such as dyeing, washing and finishing of the garments are required to utilize large amount of clean and fresh water depending on the efficiency of the production procedure. The efficiency of the garment industry of Bangladesh is quite low due to poor educational level of the workers and infrastructure. The impact of the over-exploitation of the water resource is significant (Singh & Shishodia, 2007). The water supplies are becoming scarce in different regions of Bangladesh and the demand for freshwater is rapidly growing in the urban regions of the nation. The following diagram depicts the demand and supply of groundwater in Dhaka, Bangladesh.

The manufacturing activities in the garment industry of Bangladesh lead to water pollution. The chemicals used in the manufacturing process will pollute the water resources leading to water pollution and affect the ecosystem of rivers and ponds (Tietenberg, 2000).

The government of Bangladesh has adopted a set of policies and legislative framework for providing addressing the negative externalities in the garment industry of Bangladesh. The policies focus on controlling the environmental pollutions for protecting the environment. The government of Bangladesh has set environmental standards in order to regulate the activities of garment industry in Bangladesh. Forest act 1927, the environmental conservation act, 1995 and the Environmental Conservation Rule, 1997 are the major legislative frameworks for addressing the environmental issues. There is a specific standard which regulates the discharge of treated wastewater into the environment. According to the Bangladesh Environmental Conservation Act (1995) was amended in 2002 which emphasizes on the prevention of the industrial pollution. The Ministry of Environment in Bangladesh is responsible for enforcing the regulation.  It awards the factories with environmental clearance certificates by undertaking inspection in order to monitor whether the manufacturing activities complies with the environmental standards (The World Bank, 2014).

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