Published by admin on Wednesday, September 5th, 2012 in Economics
 
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This article presents an insight into some of the most relevant forms of competition. Competition can be good or bad. Most people take it to be good. Competition amongst individuals or organizations is generally the source of all progress. Its opposite is monopoly, which is considered to be bad.

MONOPOLY

Monopoly

What is a Monopoly?

A market, which is wholly, owned by one company or at least most of it is referred to as a monopoly. No other organization sells a similar product. Consequently, there is a lack of competition. A monopolistic firm has the whole market control because its output equals the market demand. It can be regarded as a price maker because it has the liability to set any price, even if it does not equate with the marginal cost.

If a firm has the lowest production costs and is a sole supplier, then it takes on the natural monopoly structure. In this case, there is only one efficient provider. Public service companies such as the US Postal Service and US gas distribution in a region are examples.

What factors lead to a Monopoly?

A monopoly may come into existence because of the following factors.

  • Economies of Scale
    The average cost is considerably decreased when mass production is utilized. A single firm then becomes capable of providing products at a lower cost per unit. The efficiency is also increased this way, e.g. Pfizer.
  • Government Decree
    At times, the government licenses only one organization as the sole provider of a service or good, e.g. US Postal Service. The authority is justified in most of the cases. However, at times the cause may be political influences.
  • Resource Ownership
    If an organization executes complete control over a fundamental resource, it can adopt a monopolistic structure, e.g. Alcoa.

Pros

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and Cons of Monopoly:

The benefits of monopoly structure are:

  • Opportunities for Innovation
    A monopolistic firm continues to enhance its products in order to earn a better customer satisfaction. This introduces new technologies in the market.
  • Long – Term Planning
    Monopolistic firms plan better on a long – term basis and take on deeper project financing when compared to other structures. This is because of the vision to be the sole supplier.

The shortcomings are given below.

  • Greater Prices
    In monopolies, organizations may sell products at a rate higher than the average market price.
  • Discrimination
    Monopolistic firms may charge different prices when catering to different customers.
  • Undeserved Profits
    Some critics believe that monopolies still earn profits even if they are not implementing anything new. This makes them contented and they fall back on the innovation forefront.

How to Test for Monopoly?

The Department of Justice (DOJ) has determined three tests for analyzing monopolies and monopoly pricing:

Lerner index:

The Lerner index is a measure of the power an organization has in the market. It is calculated using the formula

(Price – marginal cost)

Price

The lowest value is 0 for perfect competition and the highest is 1 for monopoly.

Herfindahl – Hirschman index (HHI):

The Herfindahl – Hirschman Index defines the competition which exists in the market using the size of organizations. The value can be calculated by summing the squares of market shares of the top fifty organizations. HHI is directly proportional to the market competition.

M-Firm Concentration Ratio:

This test is used to evaluate the concentration of the market. It is calculated by accumulating shares of the top four or top eight firms. If the sum is more than 70% of the market, then it is concentrated.

Famous Monopoly Cases:

The most famous example of monopoly is Microsoft. Though other brands exist, Windows OS dominates the market by large. Hewlett Packard (HP) is also a monopoly in the sense that it is the most preferred company for printers. So many people would not even know of other printer manufacturing companies. More typical cases are government controlled service organizations, which are truly monopolistic. These include gas providers such as Exxon and the landline service companies such as Bell.

OLIGOPOLY

What is Oligopoly?

Oligopoly is a market structure in which a few large organizations sell an identical or marginally different product. For example, there are four break cereal manufacturers: Kellogg, General Mills, Post and Quaker. There exists an oligopoly in the Android App store for Finance/Business apps that help perform Valuations. One of the apps in this category is Valuation App, a tool for financial analysis, which I released last month.

Oligopolistic organizations account for more than half of the market supply. Oligopolistic industries can sell any product be it an everyday use item like or a sophisticated gadget. The diverse range also includes food, automotive parts, electronic items and pharmaceuticals. HP and Dell are oligopolistic firms.

oligopoly

The number of organizations in an oligopolistic structure can be anything in between two and twenty. If there is just one company in the market, it is considered monopoly as discussed above. If there are more than twenty companies, the structure becomes monopolistic competition. All the companies in oligopoly dominate the market and have a high degree of control. The market supply and the capital produced are less than a monopolistic industry because a few competitors are present. Nevertheless it is considered better than a monopolistically competitive firm.

If oligopolistic structures are merged, their market penetration and power increases. Such organizations are likely to be the subject of regulation.

Businesses existing in oligopoly have a lesser market share than monopoly but it is more than in a competitive system. Unlike monopoly, there is still some competition. Airlines are an example in this regard. The air fares are almost the same for similar routes. All the automobiles are sold at approximately same prices in the fall season, when new models are launched. Consequently, interdependence is increased creating competition in other areas as well such as the packaging and advertising campaigns.

Common examples of oligopolistic organizations are tobacco companies and soft drink manufactures. Oligopolistic industries include steel and aluminum producers. Film production, satellite TV providers, gas suppliers and cell phone companies fall in the same category. For instance, Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group have a combined market share of 80%. Book publications are divided between six organizations: Random House, Pearson, Hachette, HarperCollins, Simon & Schuster and Holtzbrinck. The beer manufactured by Anheuser-Busch and MillerCoors is mostly seen on the shelves. The telecommunication industry in India is an Oligopoly and consists of a few major players such as Airtel, Reliance Telecom, BSNL, Vodafone Essar, IDEA, Aircel, MTNL and Loop Mobile.

Strategy:

Strategy plays a very important role in oligopoly since there is no independency. Firms must be able to successfully anticipate the reaction of their rivals beforehand if they are planning to change their price or introduce a new media campaign. They need to conceive a proper strategy with multiple options based on their competitors’ response. This is just like a game plan, but in a somewhat difference sense. As an example, pricing strategies can be of three types: raise price, lower price or keep it constant. The selected option depends on other factors as well such as risks and pay – offs.

Pros and Cons of Oligopoly:

Oligopoly structure has its good and bad. The advantages are as follows.

  • Product Innovations
    Oligopoly is the best of all market structures when it comes to innovations. Due to the strong competition existing among the few industries present, each one strives to be better than others and aims at achieving the status of a monopolistic firm. Newer and improved versions incorporating the latest technologies are launched continuously. This plays an important role in improving the economy and overall lifestyle.
  • Economies of Scale
    Oligopolistic industries play a significant part in the economies of scale, reducing manufacturing costs and selling prices. They bear a large percentage of market supply so the demand is always high. Taking advantage of this fact, organizations use mass production to develop products at a low average cost.

The disadvantages have been highlighted below.

  • Inefficient Allocation of Resources
    Oligopoly offers the lowest efficiency in terms of distribution of resources. The price is always set high because it has sufficient market control. However, the output produced is much less than the efficiency standard of perfect competition.
  • No improvements
    The organizations have a notable share in the market so their products are still sold even if they are not up to the standard. The products are not enhanced much because there is less competition.

PERFECT COMPETITION

What does Perfect Competition mean?

Perfect competition is market structure which does not exist in the real word. It only serves as an exemplary model and has been designed as an idealization to which other structures can be compared and analyzed. If the market consists of many small firms which sell identical products, the structure is referred to as perfect competition. The advantage of this structure lies in the fact that it allocates resources efficiently and serves as an efficiency benchmark. The basic characteristics of perfect competition are

  • There are many small industries with insignificant sizes in the market.
  • The products sold by all organizations are identical.
  • Organizations can freely enter and exit the market. There are no restriction barriers of any sort.
  • Firms have a vast knowledge about the latest technology and prices.

In perfect competition, no firm has any effect on the price. The goods are produced according to the price, which is set by the market itself. If the price is altered, the manufacturing processes are also changed to match the new price.

Pros and Cons:

The advantages of perfect competition are:

  • Excellence Standard
    Perfect competition provides a standard for efficiency which is generalized as ideal. Firms in other structures can use this to evaluate their progress. The closer their efficiency is to the standard value, the better their products are.
  • Economical Prices
    All the products are identical and so are the prices, which are known to everyone. If companies start charging more, they start loosing out on customers.
  • Equal Supply and Demand
    The supply never falls short of the demand because so many similar products are available. If a firm decides to shut down its business or decreases its productions, the market won’t be affected in any way.
  • Efficient Allocation of Resources
    The resource pool is shared among all firms in perfect competition. So they can be easily switched from one use to another. This results in efficient utilization.

The drawbacks of perfect competition are summarized as follows.

  • Lack of Economies of Scale
    The firms have a low product supply so their economies of scale are not significant.
  • No Variety
    All the products are essentially the same. This leaves the customer little or no choice.
  • Little Motivation
    The companies are not motivated to incorporate new technologies because all technical knowledge has to be shared with other organizations. There would not be any incentive in it for them. Neither can they increase the price nor would their product be better than others’.
  • Production Externalities
    The government does not set any safety standards for people or environment, and overlooks manufacturing procedures. This can cause extreme damage.

Conclusion

Market structure plays a very important role in economics. In monopoly, there is just one firm which has most of the market share. In oligopoly, four or five organizations are in a competition and together control most of the market. In perfect competition, a large number of companies exist and provide identical products at the same price. The most competitive of these is perfect competition, followed by oligopoly and then monopoly.

The following table effectively summarizes all three forms.

Characteristics

 

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