Question

How do characteristics of firms in the marketplace change as it evolves from Pure Competition through Monopolistic Competition, to Oligopoly to Monopoly.

Answer 1

When the market belongs to pure competition, the market price is lowest among all market structure and the quantity produced by the market is the highest. Each firm is selling identical product and facing horizontal demand function. There are no economic profits in the long run. Entry and exit is free. this market structure is typically associated with a large number of buyers and sellers

As the market structure is transformed into a monopolistically competitive one, the number of sellers is reduced but it is still very large. Products are now differentiated in terms of packaging and design. This becomes a source of market power where each individual firm has some market power by establishing its own brand. To promote their product advertising is done. Long run economic profits are still zero. Entry and exit is still easy. However demand function faced by each firm is now downward sloping due to which profit maximizing level of output is reduced and price increased relative to competitive market.

The next case belongs to the oligopoly market structure in which number of firms is reduced further. Strategic pricing and decision making is one of the special feature of this market structure where every firm incorporates the expected decision by the rival in its own decision making. demand function is download sloping for every firm. Compared to the monopolistically competitive firm price is increased and quantity is reduced. However there are various other interactions between firms due to which there are different price and output combinations. Entry and exit is made difficult buy potential entry barriers in the long run due to which long run economic profit is possible. Product sold can be differentiated or standardized

The last case belongs to monopoly that charges the highest price of all and produces the lowest quantity. The product is sold is unique and due to this reason demand is relatively inelastic. Strong market power helps in preventing potential entry of rival firms by maintaining entry barriers such as economies of scale and ownership over key resources. Legal barriers are also used as licensing and patent. Long run profit is therefore sustainable.

Out of all market structures, only pure competition has productive efficiency as well as allocative efficiency. There is excess capacity with a monopolistically competitive firm. Collusion is possible in oligopoly.