Market Structures and Competition: Key Concepts
Monopoly
In a monopoly, a single producer or seller dominates the market, giving them significant control over price. Due to a lack of competition, monopolies often engage in promotional activities to maintain or expand their market dominance, though they might not need to heavily promote due to their market power. They can set prices higher than in a competitive market, aiming for profit maximization.
Oligopoly
In an oligopoly, a few large firms dominate the market. Products in oligopolies are often differentiated but similar, leading to non-price competition such as advertising and product differentiation. In the long run, oligopolies may engage in collusion or strategic decision-making to maintain their market share and influence prices.
Deadweight Loss
Deadweight loss refers to the loss of economic efficiency that occurs when the equilibrium quantity and price of a good or service are not at the levels that maximize total surplus. It represents a loss of potential value to society and is significant because it indicates a market failure, where resources are not allocated efficiently.
Natural Monopoly
A natural monopoly occurs when a single firm can produce the entire output of the market at a lower cost than two or more firms. This typically arises in industries with high fixed costs and low marginal costs, such as utilities like water or electricity. Regulation is often necessary to prevent monopolistic pricing and ensure fair access to essential services.
Demand Curves in Oligopoly
In an oligopoly, demand curves may be kinked or have discontinuities due to strategic interactions between firms. The kinked demand curve model suggests that firms will match price decreases but not price increases by competitors, resulting in a relatively flat demand curve above the current price and a steep demand curve below it.
Monopolistic Competition
In monopolistic competition, firms differentiate their products through branding, packaging, or other means. Promotion often focuses on highlighting these differences to attract consumers, rather than price competition. Product differentiation allows firms to have some degree of market power, but competition from similar products keeps prices in check.
Profit Maximization
In perfect competition, firms maximize short-run profits where marginal cost equals marginal revenue. In the long run, they achieve zero economic profit due to free entry and exit. Monopolies maximize profits where marginal revenue equals marginal cost, potentially leading to higher prices and lower output compared to perfect competition. Monopolistic competition falls between the two, with firms maximizing profits where marginal revenue equals marginal cost but also considering the degree of product differentiation.
Collusive Agreement
A collusive agreement occurs when firms in an industry agree to coordinate their actions to achieve mutual benefits. This often involves setting prices or output levels to maximize joint profits. An example could be OPEC, where oil-producing countries agree to limit production to support oil prices.
Increasing Profits in Perfect Competition
In perfect competition, firms can increase profits by reducing costs through efficiency improvements, innovating to differentiate their products, or by benefiting from external factors such as technological advancements.
Demand Curve in Perfect Competition
The main characteristic of the demand curve in perfect competition is that it is perfectly elastic, meaning the firm can sell all the output it wants at the market price. This is because individual firms are price takers and have no influence on the market price.
Barriers to Market Entry/Exit
Barriers to entry/exit include high initial investment costs, legal barriers such as patents or licenses, economies of scale that favor larger firms, and brand loyalty or customer switching costs.
Controlling Monopoly
Regulation and antitrust laws can control monopolies. Governments may regulate prices, set output quotas, or break up monopolies to promote competition. Alternatively, they may nationalize the monopoly, putting it under public ownership and control.
Types of Companies in Monopolistic Competition
Companies in monopolistic competition produce similar but differentiated products. They may range from small local businesses to larger regional or national brands.
Setting Prices in Competitive Markets
In a competitive market, firms are price takers, meaning they take the market price as given and cannot influence it. They adjust their output to maximize profits at the given market price.