Economics for Managers: Perfect Competition, Monopoly, Oligopoly, and Australian Supermarket Industry

This document discusses the features of perfect competition and monopoly, short and long-run profits, and comparison in terms of price, quantity, and surplus. It also covers oligopoly, role of advertisement, and impact on the Australian supermarket industry.

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ECON20039- ECONOMICS FOR MANAGERS

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Contents
1.0 Question (a)..........................................................................................................................3
A feature of perfect competition................................................................................................3
A feature of monopoly...............................................................................................................3
Changes in the short run and long run profits............................................................................3
Short and long-run profit of a competitive firm.........................................................................3
Short and long-run profit of a monopolist..................................................................................5
Comparison in terms of price, quantity and surplus..................................................................6
Price Comparison.......................................................................................................................7
Quantity Comparison.................................................................................................................7
Surplus comparison....................................................................................................................8
2.0 Question (b)..........................................................................................................................8
Oligopoly and its features..........................................................................................................8
Role of advertisement in oligopoly............................................................................................9
Australian supermarket industry................................................................................................9
Impact of advertisement in Australian supermarket industry..................................................10
3.0 Question (c)........................................................................................................................11
Housing affordability crisis in Australia..................................................................................11
Solutions...................................................................................................................................12
Effects of first home owners’ subsidy......................................................................................12
Reference..................................................................................................................................14

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1.0 Question (a)
A feature of perfect competition
The perfect competition is a market structure where the number of sellers and the buyers are
huge in number. The size of the seller and buyer in a perfectly competitive market is so huge
that none of the individual buyer or seller has control over the price. One of the important
features of a perfectly competitive market is the homogenous products which are sold by all
the sellers in the market (Friedman, 2017). That means products are identical in nature and
hence sellers do not have the option to mark their price upon the basis of the nature of the
product they sell. The entry and exit into a perfectly competitive market are free. Therefore,
whenever there is a supernormal profit, a new firm may enter and extract that.
Feature of monopoly
Monopoly rests at the other extreme position of the same spectrum as perfect competition
does. In a monopoly market, there is just one seller who produces and supplies goods and
services to all the customers of the market. There are no alternative options in terms of good
for the customers of the market and hence monopolist enjoys a huge power over the price of
the product. Unlike a perfectly competitive market, where sellers are price takers, a
monopolist is a price setter and sets the price above the marginal cost in order to earn a higher
profit for the company (Dean & Green, 2017). Entry to and exit from the market is restricted
either by the structure of the market or by the policies of the government. The government
can sometimes use policies to restrict entries into a monopoly market in order to keep a low
average cost of production.
Changes in the short run and long run profits
Short and long-run profit of a competitive firm
The profit maximising condition of a competitive firm in the short run is MR=MC. Now as a
competitive firm is a price taker, it faces a horizontal demand curve. That means, if the firm
increases price just a little, it will lose its entire customer base to the other identical sellers of
the market. Now if the cost is lesser than the revenue as shown in figure 1, firms make a
supernormal profit.

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Figure 1: The supernormal profit in the short run
(Source: Jensen & Pareja-Eastaway, 2018)
In the long run, if the incumbent sellers make a profit, more and more seller enters the market
until; each of the firms makes only a normal profit. If the incumbent sellers make losses, a
number of sellers exit the market until the profit becomes normal. The figure 2 shows the
profit maximising output is determined by the interaction of LRMR=LRMC= LRAC, at this
point the firm's cost including the time cost is equal to the revenue and hence the firms earn
no supernormal profit.

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Figure 2: The profit in perfect competition in the long run
(Source: Leskaj, 2017)
Short and long-run profit of a monopolist
The cost and the revenue of a monopolist do not differ much between the short run and the
long run as there are no other sellers and in the market. A monopolist also determines the
profit maximising point though MR=MC. However, the monopolist is a price setter and
hence the demand curve it faces is a downward sloping curve. Figure 3, depicts the profit
maximisation of a monopolist in the short run. From the average cost curve, and the profit
maximising point, it can be said that the firm is making a supernormal profit.

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Figure 3: The profit maximisation of a monopolist
(Source: Nwankwo, Olabisi & Onwuchekwa, 2017)
In the long run, no other firm can enter the market and hence most of the curves are the same
as in the short run. A monopoly firm makes a supernormal profit even in the long run.
Comparison in terms of price, quantity, and surplus
The power of the seller and buyer in two different markets is different. While, in a perfectly
competitive market, the seller is a price taker, it becomes a price setter in a monopolistic
market setting.

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Figure 4: The price and quantity in two different markets
(Source: MacGill, 2017)
Price Comparison
Figure 4 shows the prices in both perfect competition and monopoly market. Pm and Pc denote
the price in monopoly and perfect competition respectively. The price in case of a perfectly
competitive market is lower than the prices in a monopoly market. This is due to the fact that
a seller in a perfectly competitive market has to set the quantity at P=MR=MC. If it sets the
price above that, all the customers of the market would move to the other sellers of the
market (Canoy Jr & Bernarto, 2018). On the other hand, the seller in a monopoly market has
the power to set the prices above cost.
Quantity Comparison
The marginal cost curve of the firm is considered as the supply curve for the seller.
Considering that and the demand being faced by the firm, the equilibrium in the monopoly M
and that for the perfectly competitive is C. The quantity produced is Qm and Qc for monopoly

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and perfect competition respectively. Thus, the seller in a monopoly market produces less
than that of a perfectly competitive market.
Surplus comparison
Again, from the demand and supply from figure 4 show that welfare is shared equally
between the consumers and the sellers in case of a perfectly competitive market. Now, as a
perfect competition moves to a monopoly market, the number of sellers reduces and the price
rises to Pm to Pc. Now due to the movement from perfect competition to the monopoly the
consumers’ surplus reduces by PmPcCM rectangle. The producers surplus reduces by (Qm-
Qc)*Pc and increases by the orange square shown in figure 4. Thus, while the surplus reduces
for the consumers, surplus for producers depend on the elasticity of that product being sold in
the market (Rao, 2018). If the demand for the product is inelastic then producers’ surplus
increases and if the demand is elastic, the producers' surplus reduces after moving to a
monopoly from perfect competition.
Figure 4 also highlights a blue area is a deadweight loss which is commonly lost by both the
sellers and consumers of the market. In perfect competition, there was no deadweight loss
and hence movement to a monopoly would result in a loss of welfare for the society.
2.0 Question (b)
Supermarket chain industry of Australia is a clear example of oligopoly where around 76% of
the market is controlled by Coles and Woolworths. The rest of the market is captured by
small sellers and local market.
Oligopoly and its features
Now, oligopoly is a market structure where the numbers of sellers are very small but more
than two. The number of the buyer in an oligopolistic market is high same as a perfectly
competitive market. The products being sold in an oligopolistic market can either be
homogenous or heterogeneous. In the case of the Australian supermarket chain industry, the
products and services are slightly different from each other. Pulker, Trapp, Scott & Pollard
(2018) stated that the position of the oligopolistic market is between monopoly and
monopolistic competition as a small number of sellers dominate the market while others have
no power over the prices. Apart from that, the action of one seller is highly dependent on the

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strategy of the other seller. There are a still moderate entry and exit barrier that makes it
tough for the sellers to enter and exit the market in the short run.
Role of advertisement in oligopoly
As discussed above, products sold in the market may either be homogenous or
heterogeneous. In the case of the supermarket chain of the Australian market, the goods are
generally slightly different from the other. Each of the products of both the companies is
different in extra additives, flavours and many more. Therefore, it is important for the firms
to make the customers aware regarding the description of their respective products. The
advertisement also allows the firms to stay connected with the customer base of the market as
well (Azavedo & Walsh, 2018). For example, among the two players, if one advertises
heavily and the other does not, customers would think the firm which does not advertise has
gone out of business or scaled their production down.
Australian supermarket industry
As stated above, the Australian supermarket industry presented in this study is a close
example of an oligopoly. Most of the market share is captured by two of the biggest
organisation in the industry, Coles, and Woolworths. Both the giant organisations often
compete through the price war. Undercutting the prices of each other is a common mean of
increasing market share. Grimmer (2018) highlighted that the respective market share keeps
on changing from time to time; however, they stay mostly the same throughout the year. One
of the important features of the industry is that price levels have reduced significantly since
the large player started operating in this industry. According to the data, the overall prices
have reduced by 2.4% in the third quarter of 2018 since the second quarter.
Woolworths, in the year 2018 has mainly concentrated on improving the customers' service
while Cole tried to refurbish the stores in order to increase customer satisfaction. However,
Bray, Buddle & Ankeny (2017) pointed out that, aggressive policies and heavy marketing
strategy from the side of Woolworths cost the annual revenue of Coles. The annual revenue
of Coles reduced by 7% compared to the annual revenue of the previous year. Apart from
that, the expansionary strategy of Woolworths has also put pressure on the sales of Coles that
have grown only by 0.3% over the years. Therefore, the market share of Coles is expected to
reduce in the year 2019, owing to greater market activity and brand recognition of
Woolworths.

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Apart from Coles and Woolworths, there are other small and medium-sized companies are in
the market as well. However, these companies have a very low share and hence have limited
control over the prices of the products being sold in the market. Aldi, for example, is the third
largest company in the supermarket chain industry of Australia with a market share of 9.2%
(Fels & Lees, 2018). In the last year, the company has increased the number of stores amount
which has reached around 500. In addition to that, individual and other small players of the
market operate in the market through Metcash Network Stores. However, these small players
are consistently losing the market share due to the excessive power of Coles and Woolworths
over the prices of the market. According to the data, the market shares of Metcash Network
Stores have reduced by 0.7% in the year 2018 and the group of stores has lost a huge number
of individual sellers in the last year due to lack of profitability.
Impact of advertisement in the Australian supermarket industry
The advertisement is not only an impressive tool to promote the products of the company, but
it also a great way to put across the company message to the customers of the market. In the
Australian supermarket industry, both the giant companies have spent heavily on
advertisement over the years. However, interestingly, both Woolworths and Coles have been
reported to reduce their advertisement spending by 27% and 19% respectively. Miller (2018)
in this context commented that the large players like Coles have already developed a brand
reputation in the industry and therefore, it gives them the opportunity to spend on other
aspects of the business. Both the company spent heavily on customer satisfaction in the year
2018.
Nevertheless, before that year, both Coles and Woolworths spent heavily on the
advertisement. Woolworth’s market share in the year 2006 was way more than Coles.
However, with the advertisement, Coles managed to be at par with the operation of
Woolworths within the next few years. In the year 2008, both the company had almost the
same market share in the supermarket industry of Australia. Advertisement helped Coles to
put across a message that they strongly exist in the market and they have the capability to
combat a big player like Woolworths. Parker, Carey & Scrinis (2018) stated that price wars
between the two companies were fruitful due to advertisements. Both the companies
increased awareness among the customers regarding their offers and reduction in prices of
goods. Aldi has also benefitted from the advertisements as well. At the point of time, there
were only Coles and Woolworths dominating the market and Aldi had only 4.2% of the
market share. Aldi significantly increased their advertisement spending in the subsequent

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years and matched recognition of the giant firms. According to the data, Aldi managed to
increase their market share to 9.7% within 3 years. However, Ariyawardana, Ganegodage &
Mortlock (2017) highlighted that the small scale of operation of Aldi did not allow them to
increase their competence further to match with the dominance of Coles and Woolworths.
3.0 Question (c)
Housing affordability crisis in Australia
Housing affordability crisis was a problem regarding the shocking increase in demand for
housing in Sydney and Melbourne. The demand in these areas increased as affordability of
the customers increased heavily. Gurran & Phibbs (2017) stated that following a decrease in
the interest rate, most of the customers of the Australian market wanted to buy their home in
the city. Therefore, the demand for the housing in the city and its outskirts increased sharply.
However, the supply of housing remained the same due to the lack of availability of areas.
Therefore, the prices of housing increased in the housing market of Australia. The higher
prices did not reduce the demand for housing in the city due to the increased income and
wealth of average citizen of Australia. Subsequently, the volume of borrowing increased
putting pressure on the government and the financial sector of the country.

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Figure 5: The demand and supply in the housing market of Australia
(Source: Birrell & Healy, 2018)
In terms of economics, the demand curve for the housing shifted to the right side mainly due
to the reduced interest rate and increased affordability of the consumers of the market.
Meanwhile, the supply-side of the market remained the same as new housing development
takes time. The new equilibrium showed a higher price for housing which was followed by
the customers of the market. This pressure in the demand and the supply market for housing
then transferred to the financial market and led to pressure in the credit market of the country.
Solutions
To tackle the increased demand for housing and the rising prices in Australia, the government
of Australia immediately allowed foreign investment in the housing industry of the country.
Foreign companies started investing in the housing projects and in within a few years, the
supply of housing increased. Chappell & Campbell (2018) stated that the government also
introduced specialised policies to improve infrastructure in suburban areas of the cities. As a
result of the supply curve also shifted to the right side leading to a reduction in the prices of
housing in the country. Apart from that, the government of Australia also provided housing at
a subsidised rate for a selected income group in order to reduce the pressure from the demand
side (Bennett, 2018). This resulted in a temporary reduction in the demand for housing and
the demand curve shifted to the left and led to decreased housing prices in the cities of
Australia. The government of Australia also reduced the paperwork for the housing
registration in the city which not only increased the time of possession but also the cost of
owning a house in the city. Therefore, more and more company, owing to the low cost of
production started to invest in the housing development that paced up the supply side
changes. Morris (2018) highlighted that the outskirts during that time grew rapidly and more
and more foreign funds flew into the economy.
In addition to that, the government of Australia also decentralised a few of the governing
mechanisms in order to save the cost for the sellers of the market. However, this
decentralisation of governing mechanism in the city led to huge revenue loss for the
government. Wetzstein (2017) criticised that this strategy from the side of the government in
the future may contribute to loan default and illegal possessions in the cities. However, this
decision hugely impacted the supply side of the market and housing development increased
within a few months.

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Effects of first home owners’ subsidy
First home owners subsidy is a special subsidy by the government that was introduced during
the crisis in Australia. Under this policy of the government, first-time homeowners were
provided houses at a subsidy. The government provided the extra prices to the sellers of
housing in the city.
Figure 6: The housing subsidy for the first time homeowners
(Source: Rangel, Ng, Murugasu & Poon, 2017)
Figure 6 shows the decrease in the price of houses in the city following the subsidy of the
government. Although the number of houses sold in the market reduced and many of the
entitled customers did not get the houses, the pressure from the demand side reduced
significantly (Li, Dodson & Sipe, 2018). In this case, the housing demand is mainly inelastic
demand and hence, the benefit of subsidy is mainly enjoyed by the customers who bought
their first home under this scheme of the government. The result would have been different
in other times if the demand for the housing was elastic which the general case is. In this
case, the demand curve would have been more flat than what is depicted in figure 6 and
subsidy would be enjoyed mainly by the sellers of the market. The reduction in price in case
of an elastic demand for the house would not have been significant to benefit the customers
of the market.

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