How do market structures determine the pricing decisions of businesses?
A monopoly market structure is characterized by the existence of a single seller. The concept of differentiation is inapplicable in such a market structure. The product or service offered is standardized for all buyers. The market does not provide any substitutes, and customers are restricted to one provider. The seller strongly controls the pricing decision in such a structure.
An oligopoly market structure is characterized by the existence of few sellers. The sellers collude to reduce competition and entry into the industry. A price leader often determines prices for products or services in such a structure.
A monopolistic competition structure is characterized by a high number of sellers. The vendors provide goods and services that differ enough that no good or service is a perfect substitute for another good or service. In monopolistic competition, sellers are free to set their prices.
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Market structures are defined as the interconnections of the several elements binding buyers, sellers (agents) and products together. These elements are:
- number of agents, buyers or sellers or both
- buying/selling strength of agents and ability to influence prices
- potential collusion among agents
- levels of production
- forms of competition
- degree of product differentiation
- ease of entry to or exit from the market
What your question is asking is how does this market structure, this interconnected structure of agents, strengths and products determine a business's decisions about pricing.
A business's pricing decisions are made under the determining influence of other agents in the market. For instance, if the market has strong competitors generating strong brand loyalty and the market is a difficult one to make entry into, a competing business will not decide to compete by setting higher prices on the presumption that a higher value good (giving greater rpoduct value to the customer, for example, shoes made of leather uppers and insoles) will generate a competitive clientele. The existing strong competitors will continue to pull customers based on brand loyalty and "competitive" pricing.
A business's pricing decisions are determined by taking into account all the influences and strengths of the all the market structure elements and adjusting their internal product pricing decisions accordingly.
The type of market structure a firm faces has some impact on its pricing. However, firms are never simply free to set their own prices if they want to make the maximum possible profit.
In perfect competition, firms have no choice but to charge the market price. They are price takers in this market structure and must charge the same as everyone else.
In all other market structures, firms have some control over their pricing. In oligopolies, they must pay attention to the pricing decisions of competitors, but they do not really need to do this in monopoly or monopolistic competition. However, in all of these cases, firms must (to maximize profit or minimize loss) produce the quantity were their marginal revenues equal their marginal costs. They must then charge a market clearing price--the price that will clear exactly that quantity of their product.
Market structure does affect firms' pricing decisions, but firms are never simply free to set their own prices if they want to maximize profits.
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