Oligopoly and Monopoly - Essay Example

Micro Economics Introduction This paper seeks to broadly define the various kinds of market structure thatexist in our economy; mainly perfect competition, monopolistic competition, oligopoly and monopoly. While all these structures are different from one another, the one thing common between them is how they define the workings of various companies that operate within one of these structures. This paper further focuses in depth on perfect competition and monopoly, as it looks into the concepts of allocative and productive efficiency to determine if they are being achieved under these two structures. This paper ends by skimming through the concepts discussing in the body of the paper and also real life examples have been used throughout this paper so as to aid understanding of the audience. The main characteristics of each market (the four markets: Perfect competition, monopolistic competition, Monopoly and Oligopoly) Perfect Competition Before we start off, it is essential to explain that perfectly competitive markets only exist in theory. It is a purely hypothetical market structure where competition amongst market participants is at the highest possible level. It is often believe by various economists, neo-classical to be precise, that perfect competition would result in the best possible outcomes for the consumers and the society as a whole. In a perfectly competitive market, it is believed that market participants have perfect knowledge about the products and there is essentially minimal delay in information transmission. The structure implies that market knowledge is available to all concerned, and thus there is no risk taking. Moreover, in a perfectly competitive environment there are no barriers on entry and exit from the market. The structure also assumes that firms participating in the industry produce homogenous, identical and non-branded products. A perfectly competitive market is made up by a lot of firms who produce similar products like mentioned above, while no firm has pricing power and firms are price-takers as the price is determine from the market equilibrium levels. The main thing about perfectly competitive markets is the fact that firms that make up a part of the market can only make hefty or abnormal markets in the short run; while in the long run profit making is limited to normal profits. Generally, perfectly competitive markets do not require a lot of regulation from the government, besides ensuring that that market remains competitive at all time and no anti-free market factors come into play. Perfectly competitive markets yield that maximum positive consumer surplus and economic welfare. Moreover, the achievement of normal profits ensures that producers are just able to cover their opportunity costs to be able to stay in business. Consequently, firms in such an environment do not spend on advertisement because there is already perfect knowledge amongst market participants and advertisement would be of no use as all firms sell similar non-differentiated non-branded products. Perfect competition also results in maximum attainment of allocative and productive efficiency. More about productive and allocative efficiency would be discussed at a later stage in this paper. Monopolistic Competition A monopolistic competition structure entails a market structure where there are a lot of firms producing similar goods, which are slightly differentiated from each other. In a monopolistic competitive structure every firm has the power to decide the price and output of its products. Like a perfectly competitive structure, provision of knowledge is a common amongst market participants with a little imperfection. For instance where a competitive market structure would mean all restaurants would sell a particular item for the same price, in a monopolistic market structure diners would get the same item in slightly different variations with variable prices, thus enabling a little competition between market participants based on slightly differentiated products. Like in perfect competition, there are no barriers to entry and exit in a monopolistic competitive structure as well and entrepreneurs and business leaders have a slightly significant role than that of people in a similar position in a perfectly competitive market structure as decision making and product differentiation is what matters here. Like mentioned before, product differentiation is key feature of this structure. Differentiation can be achieved through many means, but mainly involves physical product differentiation (difference in features & performance), marketing differentiation (differentiation achieved through packaging and promotion) and differentiation through distribution (delivery though mail orders versus going to stores and shopping). In such a structure firms are price makers and are faced with demand curves that are downward sloping. Moreover, since products are different here the firms do get involved in advertisement so as to inform consumers of their products. Finally, in this structure there are a lot of independent firms that operate within the market and also they are profit maxi misers as such firms are generally smaller in size and managers keep a close eye on the business. Real life examples of monopolistic competition include restaurants, hotels and various consumer service providers like hair cutting saloons amongst others. Monopoly A monopoly exists where there is only a single supplier of a product in the market. In a monopolistic structure, there is no other company making substitute products in the market and the monopolists generally make super normal profits. There are high barriers of entry and exit within this structure, which again makes it possible for a monopoly to continue earning profits without any competitor entering in the market to disturb the profitability. Monopolies can exist for various reasons like a firm having an exclusive ownership of a particular resource, the government granting such a status to a company, producers having patents on their concepts and designs thus making it impossible for others to produce the same besides being natural monopolies. Monopolies can benefit from economies of scale given the large scale of production that they do. Monopolies are often criticized for supplying limited products in the market in a bid to boost up their prices, producing inefficiently, charging exorbitant prices and thus reducing consumer surplus and maximizing producer surplus. Moreover, monopolies are generally productively and allocative inefficient and result in reduced employment as higher prices of monopoly products means less demand and thus limited production (Sloman & Sutcliffe, 2014). Oligopoly An oligopoly is characterized by a few firms making up the industry. A real life example could be Air France and British Air that are the only airlines that operate on a few routes. A high concentration market is where the market share is split amongst a few firms. Oligopolies maintain their market share by ensuring there are high barriers to entry and exit. Barriers to entry often exist in the form of high setup costs, whereas other barriers include high research and develop costs to be a part of industry and keeping going at profitable levels and having ownership or control of key resources. Another example of oligopoly includes telephone services; whereas 170 telephone providers provide service in the UK, the fixed line market is caught up by Virgin Media and BT having a three firm concentration ratio of almost 86%. In oligopolies firms are interdependent on each another and price making decisions are often taken with mutual consent. Strategy is critical to oligopolies such as whether to work in collusion with competitors or not, whether to increase prices or not etc. Oligopolies often include in predatory pricing so as to force out rivals from the market. There are various pricing strategies that oligopolies may follow including predatory pricing, limit-pricing strategy, collusive pricing and cost plus pricing. Oligopolies face a kinked demand curve and demand is found to be curved at the kinked price. Profit maximization output is reached where MC=MR. Oligopolies also result in loss of economic welfare and oligopolies are often productively and allocative inefficient. Comment upon and contrast the economic efficiency of the outcomes under perfect competition and monopoly. It is essential to understand that perfect competition results in maximum productive and allocative efficiency being achieved. In the short run perfect competition equates price to marginal cost, thus enabling allocative efficiency. It needs to be noticed that in such a scenario both producer and consumer surplus are maximized, thus resulting in allocative efficiency. The attainment of productive efficiency entails the provision of equilibrium output at the least possible cost. In perfectly competitive markets, production in the long run is often carried out at the least possible cost, thus enabling productive efficiency. Moreover, it is critical to understand that firms with extra high costs won’t even be able to survive in a perfect competition structure as there is cut throat competition between competitors. Monopolies are both allocative productively inefficient. Allocative efficiency exists as price is above costs, both marginal and average. Here the prices being taken from consumers include high profit margins thus enabling the non-satisfaction of consumers need and resulting in under consumption of goods (Parkin, 2014). Conclusion Various market structures have existed throughout centuries. At one end of the scale is cut throat competition in the face of perfect competition, while at the other end is monopoly with there being no competition at all. When entrepreneurs come in to do business, it is essential that they first understand what market they are entering in to, to be able to understand how would they perform and what their strategies would be. References Parkin, M. (2014). Economics. Boston: Pearson. Sloman, J., & Sutcliffe, M. (2002). Economics. Harlow, England: Prentice Hall/Financial Times. Read More