In your responses, comment on at least two posts from your peers by providing examples from the news of oligopolistic markets. Compare and contrast with examples of monopolistic competitive markets.
Replying to 2 discussions post a couple of paragraphs each for a response.
An oligopolistic market is where a small number of firms produce the same or very closely related products. In an oligopolistic market any one firm can have a drastic impact on the revenue and profits of the entire market. Because the decisions of any one firm can have a significant effect on the decisions made by other firms in the market, game theory is used in the decision-making process. “The analysis of oligopoly offers an opportunity to introduce game theory, the study of how people behave in strategic situations.” (Mankiw, 2021) Game theory is basically the strategic initiatives a firm in an oligopolistic market utilizes to influence other firms to try to direct the market in their own favor. One of the main features in an oligopolistic market is a balance between the best interests of a firm and cooperation between the rest of the firms in the market. Ultimately, the best outcome for an oligopolistic market is for all of the firms to collaborate and act as a monopoly, in which the market produces a lower quantity of product while charging a price over the marginal cost.
Oligopolies have many ways to try to set pricing. They can collaborate or collude with other firms in the market to set pricing similar to a monopolistic market, where the overall price across all sellers would be higher than the marginal cost. This would categorize the group of firms as a cartel. “Once a cartel is formed, the market is in effect served by a monopoly” (Mankiw, 2021) Though this idea is the most profitable, it rarely works. Firms often disagree on the decisions made that affect the market and anti-trust laws have been created to specifically regulate the actions of firms within an oligopolistic market. To work towards an equilibrium in the market, the firms without working together, would set pricing and production that maximizes profit. In an oligopoly the outcome should be similar for each firm in the market because their products are the same or closely similar product. When firms in the market choose similar strategies to each other, the pricing ends up somewhere between monopoly and perfectly competitive market pricing. “A Nash equilibrium is a situation in which economic actors interacting with one another each choose their best strategy given the strategies that the others have chosen.” (Mankiw, 2021) However, oligopolies are driven by self-interest, which makes it difficult to maintain agreements that are mutually beneficial. This theory is known as the prisoner’s dilemma. In a two-firm oligopoly (duopoly), if all of the firms agree on a strategy they will maximize overall profits. If each firm turns on that decision and works against the other to try to take advantage of the situation, it will end up in a suboptimal outcome for all.
In an oligopolistic market, a small number of firms depend on each other when making decisions about production and pricing the market. These firms also manufacture products are exactly the same or very similar. A good example of an Oligopoly are companies within the Petroleum industry. BP, Exxon, Chevron (noting oil companies, all with a history of spill disasters) are selling/producing the same product. A decision to open a new refinery or drill in the Alaskan wilderness affects the entire industry and can influence the overall profits of the market. Generally, oligopolies have very little competition and a high barrier to entry, as in the oil industry, it would take millions upon millions for a new company to enter the oil producing market. This differs from a monopolistic competitive market, in that there are multiple competitors with freedom to enter or exit the market at any time with a relatively low barrier to entry. Coffee shops are good examples of firms within a monopolistic competitive market. Sellers range from street vendors to global behemoths like Starbucks. They all sell a similar, but not identical product. Starbucks prides itself on the quality and flavor of their coffee products and charges a premium for it. A street vendor may charge less money, for a lesser quality product, but in the city the convenience of buying a coffee right outside the front door of your building rather than walking down the street to Starbucks give the coffee vendor the advantage….maybe. It can depend on geographical location and saturation of the market. What I mean by that is in San Diego, the weather is nice most of the time, so a stroll down to the Starbucks on the corner might be worth the effort for a superior product. However, in Minneapolis, the corner street vendor outside the building may be the warmest option. Either way, the difference between the markets is clear. Oligopolies are a close-knit market with a small number of sellers producing the same product. A monopolistic competitive market has a large number of sellers of any size shape and form producing a product of a similar nature, but with variations that make the product unique to each seller.
Reference: Mankiw, N. G. (2021). Principles of microeconomics (#9 edition). Cengage.
From the text, “an oligopoly is a market structure in which there are only a few firms that produce similar or identical products. Oligopolies are price-setters and can collude to behave like a monopolist.” (Mankiw, Chapter 17 Introduction, 2021) In an oligopoly, firms will be affected by the decisions of other firms. For example, if one firm lowers their price, other firms in the oligopoly will also reduce their prices. In other words, the few firms that are part of oligopolies are interdependent on one another. Ideally, oligopolies would like to reach a monopoly outcome; however, oftentimes there is tension between cooperation and self-interest when making business decisions, such as how much output to produce and what price to set. With oligopolies, the barriers to entry are significant, but they are not as high as monopolies. A few barriers to entry in an oligopolistic market are economies of scale, complex technologies, patents, and even strategic attempts by existing firms in the market to shut new start-up firms out of the market. (Mankiw, 2021)
With oligopolies, as price approaches marginal cost, quantity approaches the socially efficient level of output. When cooperating, oligopolies lead to a quantity of output that is too low and a price that is too high. Therefore, lack of cooperation among firms in an oligopoly is the preferred outcome from the view of society. The oligopoly price is less than the price a monopoly would set but greater than the price in a competitive market structure. Oligopolists are better off cooperating, but oftentimes their own self-interest prevents them from doing this effectively. As each firm raises their production to gain a larger percentage of the market share, price falls. These firms are aware of this fact, though, and thus stop increasing production before producing up to the amount where price equals marginal cost. Therefore, the price of an oligopoly is less than the monopoly price and greater than the competitive price (equal to marginal cost). (Mankiw, 2021) When deciding on price and quantity of output, each oligopolist increases production until the output effect and the price effect balance, taking the other firms’ production as given. The output effect is when price is above marginal cost and selling one more unit of output will raise profit. The price effect is when raising production will increase the total amount sold and effectively lowers the prices and therefore the profit from all other units of output sold. If the output affect outweighs the price effect, the firm will increase production and if the price effect outweighs the output effect, the firm will either not raise, or they will decrease production. (Mankiw, 2021)
Monopolistically competitive markets have many firms. Oligopolistic markets have few firms. Monopolistically competitive markets have differentiated products. Oligopolistic markets have similar or identical products. Monopolistically competitive markets maximize profit by producing the quantity of output at which marginal revenue equals marginal cost. Because the demand curve slopes downward, the price firms in monopolistically competitive markets will charge will exceed their marginal costs. Oligopolistic markets maximize profits by adjusting their quantity of output based on the other firms in the market and that is generally above marginal cost. This is why the oligopoly price is less than the price a monopoly would set but more than the price in a competitive market. Monopolistically competitive markets have free entry and exit into or out of the market. Oligopoly markets have relatively high barriers to entry, although not as high as a straight monopolistic market. (Mankiw, 2021)
An example of a monopolistically competitive firm is novels. The publisher of a novel has the sole right to produce and sell that novel (effectively a monopoly), but because there are many publishers who publish many novels and there is free entry and exit in the market, it is said that novels are an example of a monopolistically competitive market structure. An example of an oligopolistic market is the market for crude oil. Most of the world’s oil is produced by just a few countries and is often described as a cartel – a group of firms acting in unison. Additionally, the product is identical between firms, as opposed to the product differentiation of a monopolistically competitive market. The barriers to entry in an oligopolistic market such as crude oil are plentiful due to economies of scale. (Mankiw, 2021)
Mankiw, N.G. (2020, January 1). Principles of Economics, 9th Edition, Chapter 17. Retrieved from https://ng.cengage.com/. For more information on Monopolistic Competitive Markets check out: https://www.encyclopedia.com/finance/encyclopedias-almanacs-transcripts-and-maps/monopolistic-competition
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