Market Structures

Monopolistic Competition & Oligopoly

Chapter 7 Section 3

Market Structures We have studied the two extremes of the

range of market structures. Perfect Competition and Monopoly Very few markets fall into either of these

categories. Most fall into two additional categories that

economists call monopolistic competition and oligopoly.

Market Structures Monopolistic Competition – a market

structure in which many companies sell products that are similar but not identical.

Each firm holds a monopoly over its own particular product.

This is a modified version of perfect competition.

Market Structures Differences between the two are

a. Monopolistically competitive firms sell goods that are similar enough to be substituted for another but not identical. It does not involve identical commodities. i.e. jeans – a variety of color, brand names, styles, and sizes.

b. Monopolistic competition is a fact of everyday life. i.e. bagel shops, ice cream shops, gas stations, and retail shores.

Market Structures Four Conditions of Monopolistic Competition:

a. Many firms – these firms can start selling goods and earning $ after a small initial investment.

b. Few artificial barriers to entry – they do not face the high barriers to entry. Patents do not protect anyone from competition, because most firms sell a product that is distinct enough to fall outside the patent protection.

Market Structuresc. Slight control over price – they have some freedom to raise or lower price because each firm’s goods are little different from everyone else’s.

Some people are willing to pay more for the difference.

There is limited control over price, people will substitute a rival’s product if the price is too high.

d. Differentiated products – firms have some control over their selling price because they can differentiate or distinguish their goods from the other products in the market.

Market StructuresNon-price Competition

Firms try not to compete on price alone.The alternative is non-price competition –

competition through ways other than lower prices.

Market StructuresForms:

1. Physical characteristics- Simplest way to distinguish its products is to offer a

new size, color, shape, texture, or taste.- i.e. running shoes, pens, cars, and toothpaste- People will use a pen as a writing tool- They will pay extra $ for a pen that writes differently or

looks different from other pens.

Market StructuresForms:

2. LocationReal Estate agents say the three most important

factors when buying property is location, location, location.

Gas stations, movie theaters, and grocery stores succeed or fail based on their location.

i.e. Motel 6, Days Inn, Super 8, and etc. don’t have people that do “R & D” – research and development. They build next to a Holiday Inn and do a great business.

Market StructuresFirms:

3. Service levelSome sellers can charge a higher price because

they offer their customers a high level of service. i.e. Conventional restaurants provide servers to

bring your food to your table. Fast-Food restaurants offer a more barebones, do-it-yourself atmosphere. Both sell the same types of foods.

Fast-food restaurants sell their meals for less.

Market StructuresFirms:

4. Advertising, image, or statusSome firms try to create an apparent difference

between their own products and other companies’ products.

i.e. A designer can apply his name to a t-shirt and charge a lot more money for that t-shirt. Tommy Hilfiger. Customers are willing to pay extra for a designer t-shirt because of the image or status that go with the designer’s name.

Market StructuresEconomists find a lot of similarity

between monopolistic competition and perfect competition just by looking at price, output, and profits.

PricesWill be higher under Mon. Comp. than

under Perfect Comp. because firms have some power to raise prices.

Market StructuresOutput

total output falls somewhere between that of a monopoly and that of a perfect competition.

Market StructuresProfit

Monopolistic Competitive firms earn just enough to cover all of their costs, including salaries for the workers.

If they make too much money, fierce competition would encourage rivals to think of new ways to differentiate their products and try to lure customers.

Secondly new firms would enter the market.

Market StructuresOligopoly

A market structure in which a few large firms dominate a market.

These firms may set prices higher and output lower than in a perfectly competitive market.

i.e. air travel, breakfast cereals, and household appliances.

Market StructuresBarrier to Entry

These firms try to keep new companies from entering the market to compete with existing firms.

High start-up costs can scare firms away from the market.The biggest airlines compound the problem because they often own the most desirable gates at the airport, and already enjoy name recognition and the trust of the consumer.

Market StructuresMany firms will cooperate with each other

limit the number of firms in the market.Price leaders can set prices and output for

the entire industry as long as member firms go along with the leader’s policy.

Disagreement leads to price wars – when competitors cut their prices very low to win business.

Market StructuresCollusion – an agreement among firms

to divide the market, set prices, or limit production.

One outcome of collusion is price fixing – an agreement among firms to charge one price for the same good.

Market StructuresCartel – a formal organization of

producers that agree to coordinate prices and production.

i.e. OPEC Cartels only survive when all producers

keep working together for the benefit of the group.