Question

Q1. Firms in oligopoly must constantly think in terms of how other firms in the industry will react to whatever they do. Why do they have to do this? Why is it that firms in perfect competition and in monopoly don’t have to worry about how other firms will react?

Q2. Governments are frequently tempted to introduce price ceilings in markets. Use an example to explain why this is not such a good idea, at least when markets are competitive. Give some ideas as to what the government could do instead in order to help consumers in these markets.

Answer 1

1. Firms in oligopoly constantly think of how other firms in the industry will react to whatever they do is because of the market structure of oligopoly. In this, there are a small number of firms. Due to this, the decisions of one firm influence the decisions of other firms. Therefore, strategic planning is required in this market structure.

Firms either decide price level or quantity level.
Suppose firms compete by setting the price level. So, if one firm increases its price above the marginal cost then other firms have an incentive to charge a price little lesser than the first one and gather the entire market share. This is how the price war starts. Every firm wants to capture the maximum market share that they can.
Similarly, if the firms compete by setting the quantity levels, then they would produce the quantity that would maximize their profit, given what the other firms are producing. Thus, the decision made by one firm in an oligopoly influence the decisions of other firms.

Firms in perfect competition don't have to worry about how other firms will react because firms are price takers in perfect competition. They can supply unlimited quantity at the given price. Each firm is a small proportion of the entire market. So, it has no power to influence anyone's decisions

In the case of a monopoly, there is only one firm. so, there is nobody who will react to the decisions of the firm in monopoly.