The price variation between a can of drink in a train or an ice-cream in a cinema and that in ordinary is due to the difference in the target market. Even though the two scenarios involve a commodity possibly from a similar producer, the difference in prices is due to the prevailing market structure. Ordinarily, the price of a commodity should be a factor of demand and supply forces in the market. However, there are other factors beyond the two forces that determine the prevailing price. For example, the nature of the product, market structure, and government policy among others. Luxury goods usually experience an increase in demand despite a rise in prices as they are a symbol of social status. Similarly, government policy like price regulation interferes with the market forces thus creating a predetermined price regardless of supply or demand.
Market structure refers to the organization and characteristic that defines a particular market (Stackelberg, 2010). The features primarily focus on competition and pricing. The competition component is determined by the market share controlled by given a company. Based on the two factors, market structures are broadly classified as perfect competition, oligopoly, monopoly, and monopolistic competition. Each structure has its unique characteristics that differentiate it from others.
Perfect Competition Market
Perfect competition market structure is a free market where several firms producing similar products compete for the market share (Stackelberg, 2010). In this structure, no single firm has control of market share and other dynamics like pricing (Stackelberg, 2010). Besides, the structure is associated with minimal interference from external factors like price regulations. Essentially, the equilibrium prices in a perfect competition market structure are determined by the forces of demand and supply. An increase of supply of goods with no corresponding rise in demand results in a fall of commodity prices. On the other hand, when the demand exceeds supply then the price goes up.
Perfect competition market structure gas four key characteristics that make it unique. Firstly, it is associated with many sellers with no significant control over the market (Stackelberg, 2010). As a result, a pricing decision by one of the sellers has an effect on the prevailing market prices. Secondly, the firms in perfect competition market deal with homogenous products (Stackelberg, 2010). In other words, the sellers offer products with the same quality and purpose to customers making pricing the only key factor that persuades buyers. Thirdly, firms in this type of market are price takers as they do not have the capacity to influence the prevailing cost of the commodities (Stackelberg, 2010). Individual firms are hence bound by the market equilibrium prices. Finally, firms in the free market enjoy the freedom to enter or exit the market. Perfect competition does not have significant barriers to bar companies from exiting or incoming into the market.
The individual organizations in the market experience a perfectly elastic demand curve. A perfect elastic demand curve is represented by a line horizontal to the x-axis at a given price. Conversely, the industry’s demand curve is a horizontal line but a normal demand-supply curve. The difference between the industry’s curves at that of a single firm is that the latter takes the market price whereas the former sets the equilibrium cost.
Pure monopoly market is where one company is the sole producer of items in the market (Stackelberg, 2010). The company enjoys the freedom of fixing the prices regardless of the forces of demand and supply. In the monopolistic market, the product offered by the sole company does not have a substitute thus limiting the customers’ choices. Examples of monopolistic market structures include public utilities and professional sports leagues. The sports federations have a monopoly of organizing leagues within their jurisdiction. For instance, England’s Football Association (FA) has the sole mandate of running football in the country.
The pure monopolistic market has four unique characteristics. Firstly, the market has barriers to entry or exit (Stackelberg, 2010). These barriers exist in various forms including huge capital for initial investment and government legislation. Companies in a monopolistic market enjoy an economy of scale making it possible to produce minimize their marginal cost. Consequently, the resulting product has very low prices per unit making it unprofitable for new entrants. Secondly, the monopolistic market has a single seller dealing in products (Stackelberg, 2010). The firm thus enjoys total control over the market since it does not have a competitor. Thirdly, the monopoly firm produces a unique product with no substitutes (Stackelberg, 2010). In other words, the customer does not have a choice but to consume the product. Finally, the producer sets the market price as opposed to the market forces. As a single producer, the firm controls the supply of the commodity which means it can create an artificial shortage to push the prices up.
Monopolistic competition market structure with significantly large farms selling similar but differentiated products (Stackelberg, 2010). For an instant, fast food joints are good examples of monopolistic competition markets. This market structure has three primary characteristics that distinguish them from others. Firstly, it has several firms with each having control of a small segment of the market. Secondly, companies offer similar but differentiated goods (Stackelberg, 2010). The differentiation could be in the location, brand name, pricing strategy, and packaging among others. Finally, the market has an easy exit and entry.
The demand curve for monopolistic competition is high but not perfectly elastic (Stackelberg, 2010). The curve elasticity is lower than the pure competition but higher compared to monopoly. The curve elasticity is due to the existence of competitors and substitute for the products.
It is a market structure dominated by a few companies producing differentiated or homogenous products (Stackelberg, 2010). For example, the gasoline or automobile industries are an oligopoly. The market structure has three key features. Firstly, it is dominated by a few large organizations that have strong control of the market (Stackelberg, 2010). Secondly, the market has differentiated but standardized goods (Stackelberg, 2010). Thirdly, it has entry barriers such as high initial capital investment.
The demand curve for the oligopolistic market is inelastic due to price reductions but elastic for the increases- kinked demand curves. The elasticity of the curve due to the price increase is due to the existence of alternatives.
In the brief, the two sellers enjoy a monopolistic competition thus able to charge higher for the same product available at a cheaper price elsewhere. A restaurant uses its brand value and targeted market thus sell at relatively higher prices. Similarly, an ice-cream vendor in the cinema enjoys a monopoly due to the customer’s limited choices. Essentially, the ice-cream vendor has the cinema as its market share thus enjoy elements of control.
Inflation and unemployment have a direct but inverse relationship. A decline in the unemployment rate leads to demand for higher wages by the employees. The employers thus increase the prices of their products as they pass the additional cost of production to the consumers (Macharia & Otieno, 2017). Consequently, the country realizes an increased inflation rate. On the other hand, high rates of unemployment mean that the workers are likely to accept lower wages thus keeping the overall cost of production low. As a result, the inflation rate remains low due to stable prices of the commodities.
The curve was developed by Professor A.W Philips in 1958 to show the relationship between unemployment and inflation rates in an economy (Forder, 2014). The curve has since then become an instrumental tool in analyzing macro-economic policy. In drawing the curve, inflation takes Y-axis whereas unemployment takes X-axis as shown in figure.
Fig 1: Philips Curve
From Philips curve in figure 1 above it is evident that when government adopts fiscal stimulus policy, then the aggregate demand increases. Consequently, labor demands increases creating a decline in the unemployment pool forcing the company’s to start offering better wages attract the best employees. Workers also begin to push for better pay which raises the marginal cost forcing the firms to increase the prices of their products.
The curve was adopted by economic policy makers in various by exploiting the trade-offs between inflation rates and unemployment. Adjusting the unemployment rates upwards reduces inflation and vice versa (Forder, 2014). However, the issues of balancing trade-off came into focus in recent past where countries experience stagflation despite the falling unemployment rates. The unusual behavior between the two variables is attributed to the supply-slide policies adopted by various governments (Forder, 2014). Supply-slide policies allow the government to expand their economies while experiencing stagflation. In other words, trade-off between unemployment and inflation rates is hardly used currently as government opts for supply-slide policies to expand their economies.
Short-term and Long-term Application
Suppose economy starts at equilibrium point A with unemployment of 10 percent (NRU =10) with zero inflation rate but the government makes fiscal stimulus to reduce unemployment while adjusting inflation. Then, the economy shifts to B while unemployment declines to three percent due to the short-term effect. However, begins to advocate for higher wages resulting in increased of production pushing the prices of the commodities to P1. The short-term effects of the fiscal stimulus declines with time resulting in inflation which pushes the curve back to NRU hence the shift from SRPC1 to SRPC2.
Case Study, Kenya
Kenya is an East Africa country having among the fastest growing economies in the region. The country currently experiencing an impressive economic rate averaging above five percent in the past five years. For example, it had 5.63 percent growth in 2014 followed by 5.72, and 5.87 percent in 2015 and 2016 respectively (Statista, 2019). However, the growth declined to 2017 by one percent to 4.87 before rising again to 5.96 percent in 2018 (Statista, 2019).
On the other hand, the country’s unemployment rate above ten percent for the ten year period ranging from 2008 to 2018. In 2008, the country’s unemployment rate stood at 10.39 percent followed by 12.17, 12.09, 11.99, and 11.88 percent in 2009, 2010, 2011, and 2012 respectively (Statista, 2019). The rates between 2013 and 2017 ranged from 11.74 to 11.47 percent (Statista, 2019). Ironically, the unemployment rate has remained relatively the same in the ten-year period despite the country experiencing a steady economic growth of more than five percent over the same period.
Similarly, the country has experienced inflation rate between 15.10 percent in 2008 and 4.69 percent in 2018 (KNBS, 2019). The inflation rates have had higher fluctuations compared to the country’s unemployment rate and GDP growth. For instance, the country’s highest inflation rate occurred in 2008 at 15.10 percent (KNBS, 2019). In the same year, the country experienced an unemployment rate of 10.39 percent. The graph below compares the trend in inflation and unemployment rate in the country from 2008 to 2018.
Figure 2. Graph comparing inflation and unemployment rates in Kenya from 2008-2017
From the above graph, it is evident that the increase in inflation rates result in declining unemployment rates in the country. However, the relationship between the two variables is not inversely proportional. For example, a sharp decline in inflation rates between 2008 and 2010 did not have a similar sharp response in the rise of unemployment rates. The inflation drop between 2008 and 2010 was eleven percent whereas the resulting unemployment rate increase was only 1.16 percent. Additionally, the changes in the unemployment rate in the country remain fairly constant ranging between ten and thirteen percent. Conversely, the country’s inflation rate undergoes sharp changes ranging from a minimum of 4.1 to 15.10 on the upper end.
However, the overall trend in both the unemployment and inflation rates indicate that relevance of Philip curve in explaining the relationship between the two variables. The two line graphs show that the two variables have a negative relationship. In other words, when unemployment rates increase, the inflation rates go declines and vice versa. From 2013 to 2016, the country experienced a relatively stable economy with minimal fluctuations. Similarly, the unemployment rate remained relatively the same as indicated by the downward slope curve.
Forder, J. (2014). Macroeconomics and the Philips Curve Myth. Oxford University Press.
KNBS. (2019). INFLATION TRENDS 1961-PRESENT. Retrieved from KNBS: https://www.knbs.or.ke/download/inflation-trends-1961-present/
Macharia, M. K., & Otieno, A. (2017). Effect of Inflation on Unemployment In Kenya. International Journal of Science and Research 6(6), 1980-1984.
Stackelberg, H. v. (2010). Market Structure and Equilibrium. Springer.
Statista . (2019). Kenya: Unemployment rate from 2007 to 2017. Retrieved from Statista : https://www.statista.com/statistics/808608/unemployment-rate-in-kenya/
Statista. (2019). Kenya: Growth rate of the real gross domestic product (GDP) from 2014 to 2024 (compared to the previous year). Retrieved from Statista: https://www.statista.com/statistics/451108/gross-domestic-product-gdp-growth-rate-in-kenya/