Market structures (cont'd)
Yvonne Harvey, Contributor

This is the last section in our lesson on market structures. As promised, it will cover monopolistic competition and oligopoly.

Monopolistic competition

This describes an imperfect market structure in which there are a relatively large number of producers offering slightly differentiated products.

Characteristics/features of monopolistic competition

1. A relatively large number of sellers. This makes the market highly competitive. In addition, each firm's market share is small and collusion (coming together to act as a monopoly in order to gain more profits) is difficult.

2. Independence. Each firm acts independently of the others. That is, no firm takes into account the reaction of its rival firms.

3. Freedom of entry into the market and exit out of the market. In the long run, firms will enter and leave the industry due to the lack of significant barriers to entry.

4. The product is differentiated. Each individual seller has a product which is slightly different from the product of the other producers. This product differentiation is mainly through brand names, but can also be through physical and chemical differences.

5. Advertising takes place. Each seller seeks to increase brand loyalty for his/her product and thereby increase profits.

6. Firms are price makers/fixers. Therefore, their demand curve is downward sloping. It is also fairly elastic because of the relatively large number of firms in the industry.

Examples of monopolistic competition in the Caribbean: hairdressers, restaurants, taxi drivers and gas stations.

Short-run profits

The short-run profits situation is similar to that of the perfect competitor. It is possible to earn supernormal profits. Subnormal and normal profits are also possible.

Long-run profits

In the long run, the similarity between perfect competition and monopolistic competition becomes more obvious. Through entry of new firms and exit of some existing firms, profit will tend towards normal in the long run for all the firms in the industry.

We move on now to yet another market structure, oligopoly.

Oligopoly

Oligopoly refers to a market structure in which a few firms dominate the industry in the sense that between them they share a large proportion of the industry's output. Some oligopoly firms produce virtually identical products (for example metals, chemicals, sugar) and are known as perfect oligopolies, and some produce differentiated products (for example, cars, soap powder, cigarettes, electrical appliances) and are known as imperfect oligopolies.

Duopoly is a special form of oligopoly in which there are only two firms in the industry.

Characteristics/ features of oligopoly

1. There are only a few firms in the industry. With only a few firms in the industry, each is big enough to influence price. Firms are, therefore, price makers/price fixers.

2. Interdependence of firms. Since there are only a few firms in the industry, each firm will have to take into account the actions of rival firms in the industry, for example, if one airline announces discount fares, generally, all the other airlines will try to match the lower prices.

3. The product is either identical or differentiated. Where the product is identical, there is no need for advertising or non-price competition. However, if the product is differentiated, advertising and non-price competition will take place in order to make consumers believe that one brand is better than the other.

4. There are barriers to entry. These barriers may not be as strong as the barriers for the monopolist; however, the effect is still the same. Barriers will make it virtually impossible for others to enter in the long run.

5. Prices tend to be stable. This is because firms realise that decreases in price can lead to 'price wars' and they can end up losing so much profit that they are eventually driven out of the industry. They also know that raising prices will be of no advantage to them since others will not copy them.

6. Firms may be collusive or non-collusive. When they are collusive, they may, for example, formulate an agreement to set prices for everyone at a certain level.

7. Oligopolies may price discriminate in order to earn more profit.

Profits in the short-run

Like the monopolist, many oligopolistic firms will earn supernormal profits in the short run.

Long run

If the barriers to entry are strong, supernormal profits will be maintained. Where a firm is earning less-than-normal profits in the short run, it will leave the industry in the long run.

Now for your practice question:

(a) Define 'monopolistic competition' and 'oligopoly'.

(4 marks)

(b) Compare the market structures named in (a) above, under the following headings:

(i) the number of firms in the industry

(ii) the existence or non-existence of barriers to entry

(iii) type of product

(6 marks)

(c) Give TWO examples of oligopoly industries and TWO examples of monopolistic industries in the Caribbean.

(4 marks)

(d) "A monopolistic firm is earning supernormal profits in the short run." What do you understand by this statement?

(2 marks)

(e) Assume that firms under monopolistic competition and oligopoly are earning supernormal profits in the short run:

(i) How will their long-run profits differ?

(ii) Give reasons for the differences in their long-run profits.

(4 marks)

Total marks: 20

This completes market structures. I urge you to do some reading on the topic. You will find some interesting facts if you consult texts in economics.

See you next week. Bye.

Could it be that Manning's School's principal, Gloria Wagstaff (centre), is getting some computer lessons from one of her past students from class of 85? Another of her former students is in the background while a little girl looks on. They are at Westmoreland Curry Festival 2009. - Photo by Dalton Laing

Yvonne Harvey teaches at Glenmuir High School.