ECON-Module-Columbia

Week 5 Instructional Materials

Week Five: Monopolistic Competition/Oligopoly and Market Power

Understanding Market Structures and Consumer Behavior

Last week, we delved into the world of relatively non-existent market structures. This week, we jump headlong into the two most prevalent market structures in modern economies: monopolistic competition and oligopolies.

These two structures have similarities and can be difficult to distinguish. One firm may sell various brands of a product, creating the illusion of choice while still capturing all consumer spending.

As we discussed, monopolies are not very consumer-friendly. Anytime there’s less competition, consumers are disadvantaged. To counter this, governments enact laws to reduce monopoly power as industries consolidate.


Weekly Objectives

  • Identify key traits of monopolistic competition, including product differentiation and market entry conditions.
  • Compare and contrast oligopolistic market structures, focusing on firm behavior, pricing strategies, and barriers to entry.
  • Analyze factors that reduce market competition, such as mergers, acquisitions, and regulatory shifts
  • Assess the role of government in controlling monopoly power, including antitrust laws and public policy tools.

    • Readings

    Greenlaw, S. A. & Shapiro, D. (2018). Principles of Microeconomics (2nd edition).

    OpenStax: Principles of Microeconomics 2e

  • Chapters 10 & 11

Activities

Learning Resources

  • Chapter 10
  • Chapter 11

Required Activities

  • Discussion 5
  • Exercise 3

 

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If you have questions regarding any of these activities, make sure to post those questions in the Open Forum.

Lecture 1

Monopolistic Competition

There are three main characteristics of a monopolistically competitive market. There are large amounts of buyers and sellers, there is relative ease of entry and exit into the market, and there are heterogenous products. As you can see, the characteristics of the monopolistically competitive market and the perfectly competitive market are very similar. The only major difference is that the products are heterogenous product rather than the homogenous product.

Let’s look at an example. The fast food industry is a very good example of a monopolistically competitive market. There are many different places in most areas where one can go get a hamburger. However, there is only one place to get a Big Mac. There is only one place to go get a Whopper. Thus the overall market is competitive, i.e. many places to get a burger, but monopolistic in that there is only one seller of any particular type of burger.

Within the monopolistically competitive market, the way that firms distinguish themselves from their competitors is through product differentiation. There are various ways that firms try to differentiate their products from their competitors.

  • Product attributes. As mentioned with the Big Mac vs the Whopper. McDonalds and Burger King offer a different style of burger to have consumers buy their products.
  • Service. Look at grocery stores. Some stores bag your groceries when you are finished, while others require customers to bag their own groceries.
  • Location. Convenience stores are located throughout an area and at times, closer to residential areas than large grocery stores.
  • Brand names and advertising. Firms spend lots of money to create a brand name that consumers want to purchase based on advertising.

    • Based on these product attributes, monopolistically competitive firms do have some control over price. If you want a Big Mac, you will pay what McDonalds charges. However, since there are other places to get a burger, McDonalds does have some restrictions on what it can charge.

    Because of this, firms in the monopolistically competitive earn can earn a very slight economic profit even in the long-run. If firms are earning economic profit in the short- run, more firms will enter the market, that will create downward pressure on profits. One way that firms try to maintain those economic profits is to continually advertise to keep customers coming back and profits rolling in.

    Unlike the perfectly competitive firm, monopolistically competitive firms are neither productively or allocatively efficient.

    Monopolistic Competition (MJM)

    Lecture 2

    Oligopoly

    The characteristics of the oligopoly market are as follows:

  • A few large supplier
  • The product may be homogenous or heterogenous
  • There are barriers to entry
  • Firms have control over price, but there is mutual interdependence

    • Thus, as you can see, oligopolistic markets differ from monopolistically competitive markets by the fact there are fewer companies to purchase the products from and that those firms can offer the same type of product. Further, due to the size of the firms, it is very difficult for new firms to enter the market.

    There are three basic oligopoly models. One is kinked-demand theory. This theory is based on the fact that when oligopolies compete, price increases are not matched by competitors, but if a firm does lower price to attract more customers, its competitors will match price. Another is cartels and collusion. A cartel is a situation where firms from an illegal alliance to keep output low and prices high. The most famous cartel is OPEC, which is made up of various oil producing countries. The final basic model is the price leadership model. This occurs when there is one large firm that sets the price for the rest of the market.

    As one can imagine, based on these models, oligopolies are neither allocative or productively efficient.

    Oligopoly (MJM)

    Lecture 3

    Market Power

    As you can tell, consumers prefer the perfectly competitive or monopolistically competitive markets. Firms, on the other hand, prefer the oligopolistic or monopoly structures. This is because when there is good competition, we get more of the products at lower prices. With less competition, we get fewer products and higher prices.

    This is because firms in less competitive industries can have market power. A monopolist has the ultimate market power. In a perfectly competitive industry, no firm has any market power.

    In most situations, market power doesn’t just exist. So, how do markets go from competitive to less competitive? The main way is by mergers. There are three types of mergers, horizontal, vertical, and conglomerate. The type of merger that hinders competition and can create market power is the horizontal merger. A horizontal merger is a merger between firms in the same industry selling similar goods. An example of a horizontal would be if McDonalds and Burger King would merge.

    In the late 1800s, many industries in the US were moving towards or had already turned into monopolies. Seeing the societal harm to these large companies, anti-monopoly laws were enacted to break up monopolies and to prevent monopolies from forming. The first, and most famous, act was the Sherman Antitrust Act of 1890. Since that time, many other laws have been passed to try and limit monopolies.

    In certain situations, some industries lead themselves to monopolistic behavior. Those firms are called natural monopolies. These occur when one firm can continually produce and sell more output at a lower average total cost then having two or more firms. These firms are generally utility companies, such as electric companies. To soften the negative impact of these monopolies, they are usually price regulated by a state regulatory board.

    Mergers (MJM)

    Review

    Cartoon illustration of a woman wearing a green outfit, standing and holding an open book in front of her. 1. What distinguishes monopolistic competition from perfect competition?
    2. Why is a monopolistically competitive firm not allocatively efficient?
    3. What is the prisoner’s dilemma, and how does it relate to oligopoly behavior?
    4. What is the difference between a merger and an acquisition?

     

    ECON 294: Microeconomics