all caught up now. (Chapter 10 Q & A)

14/01/2013 § Leave a comment

#5. 25 marks.

a) Explain the differences between monopolistic competition and oligopoly as market structures.

The main differences to point out between a monopolistic competitive market structure and an oligopoly are the number of firms, the concentration of market power for those firms, and the barriers of entry and exit. While monopolistic competitive markets are markets with many firms producing differentiated products, oligopolies are markets with a select few firms dominating that market for identical or differentiated goods. If we recall perhaps the scale of the concentration ratio (which measures the market power of the firm), perfect competition and monopoly are at the ends of the scale – they are the very end of the spectrum. Monopolistic competition is closer to perfect competition and oligopolies are closer to monopolies. In this sense, monopolistic competitions try to be more competitive with more firms striving to be more efficient and more like a perfect competitive market, but oligopolies are closer to being a monopoly and would rather try and be the number one firm in the market with all the power. In terms of power and since we’re on the topic of the concentration ratio, oligopolies have more market power than monopolistic competitive markets, in general. Finally, while monopolistic competitive markets have no barriers to enter or exit the market, oligopolies do, and their barriers are quite similar to a monopoly’s barriers (which adds in again to the statement that an oligopoly aims to be more of a monopoly), like high initial fixed costs and access to resources.

 

b) Discuss the differences between a collusive and a non-collusive oligopoly.

The biggest difference between a collusive and a non-collusive oligopoly is whether or not the firms in the market are helping each other or learning from other firms and then reacting from that. The number of firms and amount of market power each firm has in an oligopoly is just enough so that they competition is tight and all of the competitors watch each other’s moves. Oligopolies are interdependent and unlike other markets, like a perfect competitive market, the firms’ actions in an oligopoly can indeed affect the market.

That being said: a collusive oligopoly is one where firms work together with the biggest aim to maximize profits for the entire industry. There are formal collusions, where the agreements are explicit and firms come to a consensus of the plan of attack, per se. They may all choose to avoid advertising or refrain from producing to bring the prices up, resulting in an increase in total revenue. The other type of collusion is informal, or a tacit, wherein one dominant firm makes all the moves and establishes their price leadership. This firm usually has lots of market power (or else establishing the price wouldn’t really work out for them). Smaller firms follow lead and set considerably close prices but they don’t dare to cut down too much or threaten the price of the leader because that would be economic suicide. These smaller firms know that the dominant leader would be the only one who would survive moving prices down.

So those are collusive oligopolies. Non-collusive oligopolies are quite different in that the firms don’t work together. What did I say earlier? The biggest difference is whether or not the firms help each other (one way or another, explicitly or implicitly) or learn from studying their competitors behavior and then react from there. Price wars can occur with oligopolies and – as we know – this means that the demand curve is kinked, the upper half is more elastic, and the lower half is more inelastic. This means that firms can’t raise their price or else no one will follow and they would murder themselves. It also means that firms can’t lower their price or a price war would occur and everyone’s revenue would diminish. This is why oligopolies tend to focus on methods of non-price competition (ways to maximize profits via service, design, quality, brand power, etc.) and forces them to strive to maintain stable prices.

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