Competing in a Free Market OpenStax Intro to Business

In a perfectly competitive market, if any firm is able to earn an economic profit, other firms will immediately enter the market, driving economic profit to zero. This is the Cournot-Nash solution for oligopoly, found by each firm assuming that the other firm holds its output level constant. The Cournot model can be easily extended to more than two firms, but the math does get increasingly complex as more firms are added. Economists utilize the Cournot model because is based on intuitive and realistic assumptions, and the Cournot solution is intermediary between the outcomes of the two extreme market structures of perfect competition and monopoly. Regulation is probably not a good solution to the inefficiencies of monopolistic competition, for two reasons.

This also promotes a sort of technological arms race in order to reduce the costs of production so that competitors can undercut one another and still earn a profit. Over time, however, as technology diffuses through to all producers, the effect is to lower consumer prices even further, as well as to erode profits for producers. A monopolistic market and a perfectly competitive market represent two market structures that have several key distinctions in terms of market share, price control, and barriers to entry. In a monopolistic market, there is only one firm that dictates the price and supply levels of goods and services, and that firm has total market control. A perfectly competitive market is composed of many firms, where no one firm has market control.

If other firms could enter the market, then they would do so, attracted by the profit opportunity. Therefore, a profitable monopoly could only exist if there were barriers to entry. For example, a patent can give the patent owner a legal monopoly on the production of the patented product. A Monopolistic Competition Market consists of the features of both Perfect Competition and a Monopoly Market. A market situation in which there is a large number of firms selling closely related products that can be differentiated is known as Monopolistic Competition.

Summary of Learning Outcomes

At least, that is, until new firms enter and imitate them, increasing supply and lowering prices and profits to normal levels. There are many companies in each MC product group and many companies on the side lines prepared to enter the market. For example, a company could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors. Larger economic forces and market disruptions like changes in consumer preferences or production costs would push both types of markets out of equilibrium. However, the market’s response and adjustment process to reach the new equilibrium again differ remarkably between perfect and monopolistic competition. In the long run, perfect competition results in both allocative and productive efficiency.

What Are Oligopoly and Monopolistic Competition?

It would prefer to lower its price only to the next customer, keeping its price high for existing customers. Oddly enough, this would enhance economic efficiency, by increasing output to the point where price is equal to marginal cost. Another key player in understanding imperfect competition is Joan Robinson, who published her book “The Economics of Imperfect Competition” the same year Chamberlain published his. It is assumed that in a perfectly competitive market all sellers are equally near or farther away from the market.

1. This is important because without it, a firm could possibly charge an uninformed consumer more, and this violates the price-taker condition.
2. Perfect competition, in its ideal form, assumes homogenous products with no variation in quality.
3. Consumers will change from one brand name to another for items like laundry detergent based solely on price increases.
4. Frequently, one or more member nations increases oil production above the agreement, putting downward pressure on oil prices.
5. Companies do not need to consider how their decisions influence competitors, and each firm can operate without fear of increasing competition.
6. A critical step in comparing the nature of perfect and monopolistic competition lies in their differences in long-run equilibrium.

Firms have total market share, which creates difficult entry and exit points. Since barriers to entry in a monopolistic market are high, firms that manage to enter the market are still often dominated by one bigger firm. Monopolistic and perfectly competitive markets affect supply, demand, and prices in different ways. In the real world, no market is purely monopolistic or perfectly competitive. Every real-world market combines elements of both of these market types. Collusion occurs when oligopoly firms make joint decisions, and act as if they were a single firm.

Real Life Perfect Competition Examples

Polaroid, for example, held major patents on instant photography for years. When Kodak tried to market its own instant camera, Polaroid sued, claiming patent violations. DeBeers Consolidated Mines Ltd., for example, controls most of the world’s supply of uncut diamonds. Profit can, however, occur in competitive and contestable markets in the short run, as firms jostle for market position. A monopolistic competition market is a market structure where many firms sell similar but not identical products, allowing them some degree of market power.

3 Oligopoly Models

The Nash Equilibrium calculated for the three oligopoly models (Cournot, Bertand, and Stackelberg) is a noncooperative equilibrium, as the firms are rivals and do not collude. In these models, firms maximize profits given the actions of their rivals. This is common, since collusion is illegal and price wars are costly. How do real-world oligopolists deal with prisoner’s dilemmas is the topic of the next section.

A game can be represented as a payoff matrix, which shows the payoffs for each possibility of the game, as will be shown below. A game has players who select strategies that lead to different outcomes, or payoffs. A Prisoner’s Dilemma is a famous game theory example where two prisoners must decide separately whether to confess or not confess to a crime. (2) The Stackelberg model may be most appropriate for an industry dominated by relatively large firms.

The number of major branded gas stations was reduced from ten to five with the mergers, but there are also a number of independent or non-name brand gas stations in most retail markets. Post-merger, most communities affected by the merger, those that had stations that represented each of the company brands that merged, still had more than one competing station. Mathematically, the problem must be solved this way to find a solution. Intuitively, each firm will hold the other firm’s output constant, similar to Cournot, but the leader must know the follower’s best strategy to move first. Thus, Firm One solves Firm Two’s profit maximization problem to know what output it will produce, or Firm Two’s reaction function. Once the reaction function of the follower (Firm Two) is known, then the leader (Firm One) maximizes profits by substitution of Firm Two’s reaction function into Firm One’s profit maximization equation.

These two companies are actively competing with one another, and seek to differentiate themselves through brand recognition, price, and by offering different food and drink packages. In monopolistic competition, one firm does not monopolize the market. Rather, multiple companies can enter the market and all can compete for market share. Companies do not need perfect competition and monopolistic competition. to consider how their decisions influence competitors, and each firm can operate without fear of increasing competition.

1. Contrast this to the automotive market, where the products are heterogeneous.
2. While firms can make economic profit or loss in the short run, the free entry and exit of firms eventually leads to an equilibrium where firms only earn normal profit (zero economic profits).
3. If it lowers its price in order to gain market share, perhaps its rivals will also lower their prices, foiling the attempt.
4. The market is at equilibrium in the long run only when there is no further exit or entry in the market or when all firms make zero profit in the long run.
5. On the other hand, the freedom to enter and exit the market allows for the fluid inclusion or extraction of firms in the economy, essentially facilitating competition.
6. Therefore, the gain from product diversity is likely to outweigh the costs of inefficiency.

This is important because without it, a firm could possibly charge an uninformed consumer more, and this violates the price-taker condition. The second is that there are negligible transaction costs, meaning it is easy for customers to switch sellers and vice versa. Monopoly is the other extreme of the market structure spectrum, with a single firm. Monopolies have monopoly power, or the ability to change the price of the good. Monopoly power is also called market power, and is measured by the Lerner Index. For instance, in the real world, complete information is rarely available.