Oligopoly versus monopoly competition Essay

Differences Between Oligopoly and Monopolistic Competition Market Structures Market structure refers to the interconnected characteristics of a market, which include the number of firms, level and forms of competition and extent of product differentiation (Business Dictionary, 2012). Based on these parameters, several market structures are defined and this essay will focus on two of them, namely monopolistic competition and oligopolistic markets, by discussing the differences among them and their impact on the customers. Oligopolistic market is defined as a market that is dominated by few large firms, and that these firms are mutually dependent, where they have to monitor the actions of other competitors closely and act accordingly in response to that (Ison and Wall, 2007). These firms target bigger markets, at regional, national and even international level. Examples of oligopolistic markets include airline, petroleum and bank industries (Economics Online, 2012). On the other hand, monopolistic competition market refers to a market with large number of firms, each producing slightly different product, i. e. their products are unique in its own right and hence the firms have a certain degree of monopoly power (Ison and Wall, 2007). In general, these firms target a smaller market size, say at a local or regional level (Economics Online, 2012). For example, restaurants, hair saloons and boutiques are all examples under this market structure. Firms in oligopoly market have a certain degree of control over the price of their products (Ison and Wall, 2007). However, there is interdependence in price making between the firms. For non-collusive oligopoly, any price making decision will have to take into account the likely reaction of the other firms to ensure market share (Economics Online, 2012). Hence, there is a potential for price war, where the firms try to beat each other by lowering the price, without any increase in demand for their products, as illustrated by the Kinked Demand Curve (Figure 1; Economics Help, 2012). Such circumstance is undesirable as their profits might be diminished and the consumers will be the only beneficiaries. In contrast, in the case of collusive oligopoly, the firms collude among themselves by agreeing on a price of products to avoid price war. Owing to the significant market share they own, they can set the price high to gain supernormal profit (Geoff Riley, 2006). Figure 1. Kinked demand curve (Economics Help, 2012). In monopolistic competition, the firms have only little control over the price (Ison and Wall, 2007). This is because the extensive differentiation of products means the firms face constant competition from others, and may easily be replaced if their price is deemed unreasonable, despite certain unique features of their products. Oligopoly and monopolistic competition market structures also differ in term of profit making. Firms in oligopolistic can make supernormal profit all the time and there are several reasons to this (Ison and Wall, 2007; Amos Web, 2012). Firstly, they own significant market share in a huge market, therefore the sales volume is high. Secondly, average cost of production is low as they produce in bulk. Thirdly, as discussed before, they have the ability to set price, especially in the case of collusive oligopoly (Amos Web, 2012). For instance, Tesco is a chain supermarket that is found everywhere in the UK (hence huge market size) and as they purchase their products from suppliers in bulk, the cost is kept at minimum, thereby maximising their profits (Mearday, 2009). In contrast, for monopolistic competition, profit making is not for sure. However, theoretically speaking, there are two stages to the profit making by firms in monopolistic competition (Ison and Wall, 2012; Bized, 2001). In short run, the firms can set the price high to obtain supernormal profit (represented by shaded region in Figure 2A). As the abnormal profit they make in short run attracts many potential rivals, the firms must then set the price low to stay competitive in long run (Figure 2B). For example, in Canada, the price of personal computers was very expensive when they were first introduced into the market, but as the number of computer manufacturers increased, the price of personal computers has been declining over the past decade (Figure 3; Statistics Canada, 2011). B B A A Cost Cost Price Price Figure 2. (A) Profit maximisation in short run in monopolistic competition. (B) Normal profit making in long run in monopolistic competition (Bized, 2001). Figure 3. Change of computer price by different purchasers. (Statistics Canada, 2011). Mode of competition is also different between the firms in oligopoly and monopolistic competition. Oligopoly is characterized by imperfect competition, mainly due to high barriers for entry to market (Economics Online, 2012). This is due to various reasons including exclusive resources ownership, extensive relevant knowledge, patent and copyright, other government restrictions, managerial challenge and high start-up cost. (Economics Online, 2012; Amos Web, 2012). Airline industry is a typical example of that, as setting up an airline companies requires huge financial resource and compliance to strict rules and regulations imposed by the authority (Amos Web, 2012). For example, in Malaysia, the second airline, AirAsia was only established in 2001 (AirAsia, 2012), 46 years after the establishment of Malaysia Airline in 1947 (Malaysia Airline, 2012). In contrast, there is near perfect competition in monopolistic competition market, as there is freedom to enter or exit the market due to low entry barrier (Economic Online, 2012; Amos Web, 2012). As opposed to oligopolistic market, the start up cost for firms in monopolistic competition market is much lower, as the market size they target is smaller (Ison and Wall, 2007; Economic Online, 2012). Also, as discussed before, product differentiation in this market means each firm has a somewhat unique product, fulfilling the demand of a certain group of consumers in the market. Moreover, there is less restriction from the government and starting firm does not require exclusive knowledge. For example, one can easily open a restaurant, as long as he or she has a unique menu to offer. In conclusion, oligopoly and monopolistic competition represents two distinct market structures. From consumers’ point of view, monopolistic competition is more preferable. Through monopolistic competition among the firms, consumers enjoy to choose from a wider range of products, which are available at more competitive prices. This is because the firms always try to enhance their products with better innovation and keep their prices down to attract customers. Oligopoly on the other hand is less desirable for consumers as products can often be overly-priced since the firms have a greater control over price. References: 1. Business Dictionary (2012) Market Structure. BusinessDictionary. com. Retrieved on 6th March 2012, from: http://www. businessdictionary. com/definition/market-structure. html#ixzz1olN7AqYq . 2. Mearday, J. (2009) Characteristic of Monopolistic Competition – Welker’s Wikinomi. Retrieved on 2nd March 2012, from: http://welkerswikinomics. wetpaint. com/page/Characteristics+of+Monopolistic+Competition 3. Riley, G. (2006) Oligopoly – Overview. Tutor2u. Retrieved on 5th March 2012, from: http://tutor2u. net/economics/revision-notes/a2-micro-oligopoly-overview. html. 4. Riley, G. (2006) Monopoly & Economic Efficiency. Tutor2u. Retrieved on 12th March 2012, from: http://tutor2u. net/economics/revision-notes/a2-micro-monopoly-economic-efficiency. html. 5. Amos Web Encyclonomic (2012) Oligopoly, Characteristics. AmosWeb Encyclonopic Webpedia. Retrieved on 7th March 2012, from: http://www.amosweb. com/cgi-bin/awb_nav. pl? s=wpd&c=dsp&k=oligopoly,+characteristics . 6. Amos Web Encyclonomic (2012) Monopolistic Competition, Characteristics. AmosWeb Encyclonopic Webpedia. Retrieved on 8th March 2012, from: http://www. amosweb. com/cgi-bin/awb_nav. pl? s=wpd&c=dsp&k=monopolistic+competition,+characteristics . 7. Ison, S. and Wall, S. (2007) Economics (Fourth Edition), Prentice Hall, London. 8. Malaysia Airline (2012) Cooperate Info – Our Story. Malaysia Airlines. Retrieved from 12th March 2012 http://www. malaysiaairlines.com/uk/en/corporate-info/our-story. html 9. AirAsia (2012) Company Profile. Airasia. com. Retrieved on 12th March 2012. http://www. airasia. com/gb/en/corporate/corporateprofile. page. 10. Economics online (2012) Oligopoly. Economics Online. Retrieved on 12th March 2012, from: http://economicsonline. co. uk/Business_economics/Oligopoly. html. 11. Economics online (2012) Monopolistic Competition. Economics Online. Retrieved on 12th March 2012, from: http://economicsonline. co. uk/Business_economics/Monopolistic_competition. html . 12. Statistics Canada (2011) Computer prices continue their decline. Statistics Canada. Retrieved on 13th March 2012, from http://www. statcan. gc. ca/pub/11-402-x/2011000/chap/information/information02-eng. htm . 13. Economics Help (2012) Oligopoly. Economics. Help. Retrieved on 13th March 2012, from: http://www. economicshelp. org/microessays/markets/oligopoly. html . 14. Bized (2001) Monopolistic Competition – Short run to long run. Biz/ed. Retrieved on 13th March 2012, from http://www. bized. co. uk/reference/diagrams/Monopolistic-Competition—Short-Run-to-Long-Run.