Maximizing Profits in Different Market Structures

There are three major types of market structures: the Free Market, the Monopoly, and the Oligopoly.   The Free Market structure is a state where there is perfect competition.   No one company dominates the other, and every seller competes with the other for greater profit.   Expect aggressive pricing.   Monopoly is a state where a seller has no competition to its target market.   Practically, its price sets the market price.   Oligopoly is a state where there is only competition between large firms who share the market with one another but otherwise has no other smaller or larger competition.

To understand profit, one must remember that rational people think in margins.   That is, they will not decide between one level or another, but how much one can adjust the price or cost to accommodate the maximum level of profit.   Marginal revenue, thus is how much profit can be made by increasing sales by one unit, or adjusting from the margins.   Marginal cost is how much total cost can be had by producing one unit of supply, or adjusting from the margins.   There is profit existing but to maximize it you have to squeeze at the margins.
Let us first turn to the Free Market.   The perfect example of a Free Market structure is the market for food.   There is no one company that monopolizes or controls the production of food.   No one company controls the supply of food.   Food is also a diverse product, so not only can you have a general competition with other companies in your food outlet, you also have competition with the specific food you serve.   For example, while Popeye’s will compete for the market with a McDonald’s round the corner, it will also compete with a KFC Branch nearby or even just within the area.

A free market is dominated by the principle that maximum profit is equal to total revenue minus total cost.   That is, the expense in generating supply must be less than the revenue that it generates from that supply.   In this sense, if the marginal cost or the cost of incremented supply is greater than the incremented revenue, then there is no profit.   There is too much supply and less of demand.   To meet that, a company decreases its production since there is a surplus of supply.   It is ideal for there to be a high demand which means higher revenue, and a lesser supply level or lower costs.

A monopoly is one where a company has no competition for its market.   It, therefore, does not need to entice the market with aggressive advertising or prices.   It only needs advertising that assures loyalty of the clients or customers.   Basic services, or fundamental needs are generally monopolized.   For example, one company can provide the only telecommunications service in that country, or a more common case is when a poor country has only one company that controls the energy-generation service that powers thousands of homes.

A monopoly has the same strategy of maximizing profit as with competitive markets: marginal cost must be less than marginal revenue.    If the cost of creating additional supply is too high, then production must decrease.   However, there is one distinct difference: demand generally goes down as price goes up.  While a monopoly once to maximize profits while increasing supply, it just cannot control the level of demand.   So it must sell its product less than the initial price as supply increases.  In this way, the company meets the demand of the market.   So, apart from balancing between the marginal cost and the marginal revenue which should be higher, it must then set its marginal revenue lower than the price.

Finally, an oligopoly usually involves a service that is hard or impossible to enter because the costs are too great and the established competition is too powerful.   Two major examples of oligopolies are in the oil and tobacco industries.   The major providers of fuel do not have any small competitions, because the market generally gravitates towards the more known seller.   And the infrastructure in providing the supply is a costly requirement.   This is the same with tobacco industries, whose major companies generally kill smaller industries.

Oligopolies generally have the danger of collusion and conspiracy.  When the competing companies secretly cooperate in terms of pricing and supply, they form cartels.   An example of one such oligopoly and cartel is the OPEC, the major suppliers of oil.   In 1973, they cooperated to force the artificial raising of price in oil which resulted into a major economic crisis globally.

This is one way of maximizing profit: to come to an agreement on a set price.   If there is no collusion, and no cartel is formed, then the logic is as follows: the price is set as higher than marginal cost.   If you sell one more unit at the same cost, there is profit.   However, if you increase production, it will lower the price of all units sold.   If the cost of increasing production is higher than the profit for selling more units at the same price, then production will decrease.   If this is the opposite, then production will increase.   Eventually, equilibrium will follow where price comes near to marginal cost.   Therefore, the marginal revenue usually equals the marginal cost.