Question

Imagine an owner of a firm that is thinking about raising prices. Describe the consequences of doing so as a monopolist, oligopolist, monopolistic competitor, and perfect competitor. Include in your answer the definition and an example of each type of these market conditions.

Answer 1

1. Monopoly pricing is standard fare in microeconomic analysis, but that analysis takes output as the operative variable rather than price. The use of either price or output leads to the same result but using price as the operative variable gives more a more vivid depiction of what is involved and lends itself more readily to understanding the consequences of the subsidization of one part of the market. A monopoly raises price to the point where the negative effect on the quantity sold counterbalances the positive effect of the higher price per unit. Thus a monopoly does not stop raising price until it reaches the point where some or all of the consumers are restricting their consumption due to that price. A relevant case is the granting of monopolies for pharmaceuticals through the patent system. For this case the effect on the quantity demanded may be some consumers dropping out of the market rather than many consumers marginally reducing their purchases. If the government takes steps to keep price from affecting the purchases of one group of consumers through some subsidization program then the monopoly just moves the price up to the point where some other consumers diminish their consumption of the product due to the higher price.

A monopoly's potential to raise prices indefinitely is its most critical detriment to consumers. Because it has no industry competition, a monopoly's price is the market price and demand is market demand. Even at high prices, customers will not be able to substitute the good or service with a more affordable alternative.

As the sole supplier, a monopoly can also refuse to serve customers. If a monopoly refuses to sell an important good to a company, it has the potential to indirectly shut down that business. If the supplier sells to consumers, it can refuse to serve areas that have lower profit potential, which could further impoverish a region.

2. A pure monopoly maximizes profits by producing that quantity where marginal revenue = marginal cost. However, it is much more difficult for an oligopoly to determine at what output it can maximize its profit. There are 2 major reasons for this: the interdependence of the oligopolistic firms and their diversity, especially in terms of concentration ratios. Some oligopolies have a very high concentration ratio, allowing them to act more like a monopoly, while other industries have a much lower concentration ratio, thus, making it more difficult to determine the best pricing strategy, since the number of possible responses by competitors is increased.

If the dominant firms in an oligopoly can successfully collude to fix prices, then they can be certain of each other's output, which will allow to maximize their profits by producing that quantity of output where marginal revenue = marginal cost, just as it would be for a monopoly. However, if any of the firms cheat, then a price war may ensue, lowering the profits of all firms, and maybe even causing them to operate at a loss. In most modern economies, collusion is generally against the law, however there are certain countries that engage in collusion to maximize their profits from their natural resources.

One common obstacle is differences in demand and cost. Firms that serve different geographic markets will have varying levels of demand, and, in many cases, they will also have different efficiencies, resulting in different production costs. If economies of scale are steep for an industry, then smaller firms will aggressively compete on price to increase their market share, so that they can earn reasonable profits. In such cases, it will be difficult for the firms to agree on the price, because they will have different marginal cost curves. A good example is Saudi Arabia and Venezuela in the production of oil. Saudi Arabia is efficient in producing soil, whereas Venezuela, governed by an inept communist government, is highly inefficient, so it would be very difficult for Venezuela to accept a price that would be suitable for Saudi Arabia. Consequently, there is a great temptation for inefficient producers to cheat, and if they cheat, then price competition ensues.

3. Monopolistic competition characterizes an industry in which many firms offer products or services that are similar, but not perfect substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions of any one firm do not directly affect those of its competitors. Monopolistic competition is closely related to the business strategy of brand differentiation

Monopolistic competition is a middle ground between monopoly and perfect competition (a purely theoretical state), and combines elements of each. All firms in monopolistic competition have the same, relatively low degree of market power; they are all price makers. In the long run, demand is highly elastic, meaning that it is sensitive to price changes. In the short run, economic profit is positive, but it approaches zero in the long run. Firms in monopolistic competition tend to advertise heavily.

Monopolistic competition is a form of competition that characterizes a number of industries that are familiar to consumers in their day-to-day lives. Examples include restaurants, hair salons, clothing, and consumer electronics. To illustrate the characteristics of monopolistic competition, we'll use the example of household cleaning products.

As in a monopoly, firms in monopolistic competition are price setters or makers, rather than price takers. However, the firms nominal ability to set their prices is effectively offset by the fact that demand for their products is highly price elastic. In order to actually raise their prices, the firms must be able to differentiate their product from their competitors by increasing its quality, real or perceived.

4. A perfectly competitive firm is a price taker, which means that it must accept the equilibrium price at which it sells goods. If a perfectly competitive firm attempts to charge even a tiny amount more than the market price, it will be unable to make any sales.

• Perfect competition occurs when there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers.

• The market structure is the conditions in an industry, such as number of sellers, how easy or difficult it is for a new firm to enter, and the type of products that are sold.

A perfectly competitive firm is known as a price taker because the pressure of competing firms forces them to accept the prevailing equilibrium price in the market. If a firm in a perfectly competitive market raises the price of its product by so much as a penny, it will lose all of its sales to competitors. When a wheat grower wants to know what the going price of wheat is, they have to go to the computer or listen to the radio to check. The market price is determined solely by supply and demand in the entire market and not by the individual farmer. Also, a perfectly competitive firm must be a very small player in the overall market so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market.

A perfectly competitive market is a hypothetical extreme. Producers in a number of industries do, however, face many competitor firms selling highly similar goods, in which case they must often act as price takers. Agricultural markets are often used as an example.

The same crops grown by different farmers are largely interchangeable. According to the United States Department of Agriculture monthly reports, in 2015, US corn farmers received an average price of $6.00 per bushel and wheat farmers received an average price of $6.00 per bushel. A corn farmer who attempted to sell at $7.00 per bushel or a wheat grower who attempted to sell for $8.00 per bushel would not have found any buyers.

A perfectly competitive firm will not sell below the equilibrium price either.