ECONOMICS TOPIC 4 LESSON 3

ECONOMICS TOPIC 4 LESSON 3

MONOPOLISTIC COMPETITION AND OGILOPOLIES

ESSENTIAL QUESTION

How does competition affect markets?

Characteristics of Monopolistic Competition

In monopolistic competition, many companies compete in an open market to sell products that are similar but not identical. Each firm is monopolistic—it holds a monopoly over its own particular product design. You can think of monopolistic competition as a modified version of pure competition with minor differences in products.

While monopolistic competition is similar to pure competition, oligopoly describes a market with only a few large producers. These are the market structures most familiar to consumers.

Four Conditions of Monopolistic Competition

Many firms 

Few artificial barriers to entry

Little control over price 

Differentiated products

Multiple Choice

Recall A monopolistically competitive firm has some control over price because

• its output is large enough to affect the demand.

• it can work with a rival firm to set prices in the market.

• there are many competing firms.

• it can differentiate its goods from other products.

Non-price Competition

 non-price competition, or competition through ways other than lower prices. Non-price competition takes several different forms.

Physical characteristics

 The simplest way for a firm to distinguish its products is to offer a new size, color, shape, texture, or taste. 

Location 

Some goods can be differentiated by where they are sold.

Service level 

Some sellers can charge higher prices because they offer their customers a high level of service.

Advertising, image, or status 

Firms often use advertising to point out differences between their own offerings and other products in the marketplace. These product differences are often more a matter of perception than reality.

Multiple Choice

Categorize A hotel that offers a complimentary fruit basket and a concierge who will help you plan your activities is an example of what kind of non-price competition?

• advertising, image, or status

• service level

• location

• physical characteristics

Prices, Output, and Profits

Economists study prices, output, and profits when comparing market structures. They find that under monopolistic competition, the market looks very much as it would under pure competition.

Prices

Prices under monopolistic competition will be higher than they would be in pure competition, because firms have some power to raise prices. However, the number of firms and ease of entry prevent companies from raising prices as high as they would if they were a true monopoly. 

Open Ended

Analyze Charts How are pure competition and monopolistic competition similar? How are they different?

Output

The law of demand says that output and price are negatively related. As one rises, the other falls. Monopolistically competitive firms sell their products at higher prices than do purely competitive firms, but at lower prices than a monopoly. As a result, total output under monopolistic competition falls somewhere between that of monopoly and that of pure competition.

Profits

Like purely competitive firms, monopolistically competitive firms earn just enough to cover all of their costs, including salaries for the workers. If a monopolistically competitive firm started to earn profits well above its costs, two market trends would work to take those profits away.

Profits

First, fierce competition would encourage rivals to find new ways to differentiate their products and lure customers back.

Second, new firms will enter the market with slightly different products that cost less than the market leader’s. If the original good costs too much, consumers will switch to these substitutes.

Production Costs and Variety

Firms in monopolistic competition may not be able to produce their goods at the lowest possible average cost. Monopolistically competitive markets have many firms, each producing too little output to minimize costs and use resources efficiently. But consumers in these markets benefit from having a wide variety of goods from which to choose.

Multiple Choice

Identify Cause and Effect Why can’t a monopolistically competitive firm raise prices as high as a true monopoly can?

• because, like a monopoly, their output is extremely limited

• because new firms will enter the market with identical products

• because monopolistically competitive firms already earn profits well above their costs product

• because competition would ensure that customers buy a rival firm’s cheaper

Characteristics of Oligopoly

Oligopoly describes a market dominated by a few large, profitable firms. Oligopoly looks like an imperfect form of monopoly. Some economists call an industry an oligopoly if the four largest firms produce at least 70 to 80 percent of the output.

Barriers to Entry

An oligopoly can form when significant barriers to entry keep new companies from entering the market to compete with existing firms. These barriers can be technological, or they can be created by a system of government licenses or patents.

Cooperation and Collusion

Oligopoly presents a big challenge to government, because oligopolistic firms often seem to work together as a monopoly, even when they are not actually doing so. Many government regulations try to make oligopolistic firms act more like competitive firms.

Collusion refers to an agreement among members of an oligopoly to illegally set prices and production levels.

price war

disagreements among companies can spark a price war, when competitors cut their prices very low to win business. A price war is harmful to producers but good for consumers because they will pay less for a good or service.

Open Ended

Analyze Graphs Are the music companies in this graph an example of an oligopoly? Why or why not?

Cartels

Stronger than a collusive agreement, a cartel is an agreement by a formal organization of producers to coordinate prices and production. Although other countries and international organizations permit them, cartels are illegal in the United States. 

Multiple Choice

Interpret Why is a price war harmful to producers?

• If prices go too high, then the producers will have too many competitors.

• If prices go too low, then the producers won’t be able to make a profit.

• If there is a price war, then there can no longer be a price leader.

• If prices go too high, then the producers will have too few competitors.

Open Ended

How does competition affect markets?