Comparing Market Structures

In perfect competition, the demand is perfectly elastic.  The producer is a price taker in that if he tries to sell for more he won't sell any product as all of his competitors are selling for the same price (P1) and if he lowers his price he'll just be losing money because the market is willing to pay the price P1.  The only variable is the quantity to be sold.  If the producer sells at output quantity Q1 then he will realize economic profit since the average revenue is above the average cost.

In monopolistic competition, the demand curve is downward sloping, but still fairly elastic.  The optimum quantity to produce is where marginal revenue and marginal cost meet.  The price is determined from the demand curve.  If the average cost curve is below the demand curve then economic profits are obtained (short-run profit).  If the average cost curve meets the demand curve, then normal profits are realized (long-run equilibrium).

In an oligopoly, the point of deflection in the demand curve is where other firms will match any decrease in price (ie. a price war).  The kink in the demand curve is the current market price and occurs where the marginal revenue and marginal cost curves cross.  When the average cost is below the demand curve, economic profits are realized.  Even if the marginal costs were to change (up or down) within the vertical portion of the marginal revenue curve, the price would still remain the same.

In a monopoly, the optimum profit is obtained at an output quantity where the marginal revenue and marginal cost meet.  This is a lower quantity and higher price than would occur in either an oligopoly or monopolistic competitive market.  The demand curve is steeper indicating a more inelastic demand.  Production output will always occur between the two breakeven points where the average cost curve crosses the demand (or average revenue) curve.  The socially optimum price is at the output quantity indicated where the marginal cost curve crosses the demand curve, representing a lower price and higher output than in an unregulated market and may result in losses or profits.  The fair return price is where the average cost curve meets the demand curve resulting in lower prices and higher output than in an unregulated market and always results in normal profits.

Defining Oligopoly and Game Theory

When I used to live in Winnipeg, Manitoba the company that provided your cable television service was determined by which side of the Red River you lived on.  On the west was Shaw and on the east was Videon.  I always thought this was very strange and wondered why I couldn't choose?  I now realize that there must have been collusion between the two oligopolistic companies where the divided the Winnipeg cable television market in half in order to minimize competition, which would have resulted in lower fees being charged and minimal advertising expenditures.  This would allow both companies to maximize profit, by being able to charge customers more and reduce their expenditures on maintaining market share.  Eventually, Shaw bought out Videon, but it is now competing against satellite cable providers and digital television through the phone company, resulting in lower rates for consumers and more aggressive advertising, which would all result in lower profits for everyone.

In this case, the two companies (Shaw and Videon) followed through with their agreement to the end. From the point of view of Game Theory, this is an unexpected result.  Assuming there were no physical or technological barriers that would prevent the two companies from cheating, they should have attempted to "steal" customers from the other side of the river in order to maximize their gains, assuming the other company would do the same.

		Videon’s Service Area in Winnipeg
		Limit Service		Expand Service
Shaw’s Service Area in Winnipeg	Limit Service	Videon Profit $500k	Shaw Profit $500k	Videon Profit $650k	Shaw Profit $250k
	Expand Service	Videon Profit $250k	Shaw Profit $650k	Videon Profit $300k	Shaw Profit $300k

With the increase in competition the two companies would need to reduce their rates and spend more on advertising to attract the new customers resulting in lower total overall revenues for the two companies combined.    If Videon broke the agreement and started hooking up additional customers from Shaw's service area, then Shaw's profit would decline and Videon profit would increase.  Therefore, Shaw should consider cheating as well to prevent Videon from having an advantage.  The final result should be that both companies cheat and sign up customers from both sides of the river, removing any advantage of the collusion and resulting in both companies having lower profits.

I think that from a business perspective an oligopoly can be the best and worst situation.  It provides a business with the ability to set prices to a certain degree, but it prevents it from realizing allocative and productive efficiency.  However, the competition between these companies and the profit generated create a technology race that will ultimately decrease the cost to consumers as the technology is improved and becomes less expensive to produce.  The surge in cellular phone technology is a great example.  There are several major players (HTC, Motorola, Nokia, Samsung, Google, Blackberry), but by having each one continually trying to push up the performance or feature bar the technology is becoming less expensive and more powerful.  This may not occur in a monopoly where there is no incentive to make things better or cheaper.  As well, the barrier to entry into some of these high-tech industries prevents monopolistic competition or pure competition from being a realistic model.  The larger companies get larger by acquiring smaller firms that specialize in a specific facet of technology, but there are very few cell phone manufacturers that just "start up".  Even Google got into the cell phone market by buying Motorola.  Why reinvent the wheel?

For consumers, an oligopoly gives the perception of choice due to the competing advertising campaigns, but in reality the choices are much slimmer than they appear and the low prices usually come with strings attached.  Remember there is no such thing as a free lunch!

Monopolistic Competition

Monopolistic Competitive Companies

	Size:
Features:	Small Company (i.e. Clif Bar & Company	Medium Company (i.e. Lego)	Large Company (i.e. Sears)
Differentiated products	YES	YES	YES
Control over price	Some	Some	Some
Mass advertising	NO	YES	YES
Brand name goods	YES	YES	YES
Extensive Knowledge	Fairly Complete	Fairly Complete	Fairly Complete
Free Entry and Exit	YES	YES	YES

Economic Definition:  A monopolistic competitive company will achieve maximum profit where the difference between total revenue and total cost is the greatest.  This is also where marginal revenue equals marginal cost (MR = MC), providing the maximum profit output (Q1).  The price at this output level will be higher than MC (P > MC), preventing productive and allocative efficiency from being attained.

Practical Definition: A monopolistic competitive company will be one of many smaller companies that offer differentiated products (physically or perceptually) with minimal control over the price obtained.  There are minimum barriers to entry (i.e. government or regulatory controls) into the market and they will have fairly complete knowledge of the costs and prices for competing products.  Smaller companies may have minimal mass advertising, whereas larger companies may be able to afford mass advertising.