This presentation discusses the characteristics, equilibrium, merits, and demerits of monopolistic competition and oligopoly markets. It also covers the efficiency in these markets and how internal and foreign competition can eliminate inefficiencies.
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MONOPOLISTIC COMPETITION AND OLIGOPOLY MARKETS INTRODUCTION •Market structure: Refers to the market characteristics which are interconnected (Horstmann & Markusen, 2012, p.109). •The interconnected characteristics include: the number, level and forms of firm’s competition, the number and power of buyers and sellers in the market and their overall ability to collude, the scope of product differentiation and the barriers to entry and exit from the market
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Categorization of market structures •Based on the interconnected characteristics, market structures are classified into four categories namely(Slade, 2016, p.347): Perfect competition Monopoly Monopolistic competition and Oligopoly market structures
Monopolistic competition market structure Definition:Itis an imperfect competition whereby many firms in the market sell products which are differentiated from each other and this therefore means that the products are not each other’s perfect substitutes but are close substitutes (Blanchard, O.J. and Kiyotaki, N., 2011, p.647). Characteristics Large number of buyers and sellers Product differentiation (Eaton & Lipsey, 2009, p.723) Free entry and exit (Bresnahan & Reiss, 2011, p.977) Some control over price (Neal, 2015, p.317) High costs of advertizing and selling (Comanor & Wilson, 2012, p.25)
Equilibrium in the monopolistic competition Short run equilibrium •Firms make supernormal profits •Production is done at the equilibrium point E, where the marginal cost (MC) equals the marginal revenue (MR) (Dixit & Stiglitz, 2013, p.297) •profitmaximizing quantity is Q where MC=MR. Long run equilibrium •Firms make normal profits •Firms still produce commodities at the equilibrium point E, where the marginal cost equals the marginal revenue •profit maximizing quantity is Q while the profit maximizing price is P
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Merits and Demerits of monopolistic competition Merits •The market is free for entry •Product differentiation in the market enables the creation of utility, diversity and choice •Monopolistic competition market structure is more efficient than monopoly but less efficient than perfectly competitive one (Peteraf, 2013, p.179) Demerits •Some product differentiation measures may be wasteful e.g excess packaging •Firms in the monopolistic competition are allocatively inefficient both in the short and long run periods
Oligopoly market structure Definition •Market structure which is dominated by only a few firms that mutually depend on each other (Brander & Lewis, 2016, p.956) Characteristics Few number of firms The products are either homogeneous or differentiated Control over price Barriers to entry (Fee, Mialon & Williams, 2014, p.461)
Equilibrium in oligopoly market structure Equilibrium in a competitive oligopoly •Is explained by use of kinked demand curve •Demand is elastic above the kink (equilibrium point E) •Below the kink, the demand is inelastic •Firms maximize their profits at quantity Q1 and price P1 where the marginal revenue equals the marginal cost (Mazzeo, 2013, p.221) Equilibrium in Collusive oligopolies •Collusive oligopolies are cartel like. •Firms join together to hike prices for supernormal profits (Tribble, 2015, p.95) •Firms still produce at the equilibrium point E, where the marginal cost (MC) equals the marginal revenue (MR). •The maximizing profit quantity where MC=MR is Q while the price maximizing quantity is p
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Merits and Demerits of oligopolies Merits •Benefits associated with competitive oligopolies •Oligopolies are highly innovative •Price stability Demerits •Disadvantages associated with collusive oligopolies e.g high prices •Oligopolies are inefficient in terms of resource allocation and productivity •Oligopolies involve various barriers to entry •Oligopolies mat be associated with high concentration and this minimizes the consumer choice
Efficiency in monopolistic competition and oligopoly markets Efficiency in monopolistic competition •Both allocative and productive inefficiency •Prices are set high above the marginal cost •Underutilization of available resources leading to underproduction and hence excess capacity to produce Efficiency in oligopoly markets •Both allocative and productive inefficiency •Prices are set high above the marginal cost •Underutilization of available resources leading to underproduction and hence excess capacity to produce
Conclusion •Four main types of market structures according to interconnected characteristics are: the perfect competition, monopoly, monopolistic competition and oligopoly market structures •Monopolistic competition and oligopoly markets are both imperfect •Elimination of inefficiency in both markets Internal and foreign competition for markets in international trade eliminates the inefficiency involved in monopolistic competition and oligopoly (Behrens & Murata, 2012, p.17) In the context of international trade, both firms have to be efficient to remain competitive otherwise they will be forced to exit the market