Economics-Market Power, Oligopoly, Monopoly - Essay Example

Economics: Market Power, Oligopoly, Monopoly Question Discuss whether or not it is reasonable to argue that competition is socially harmful rather than market power. Explain the significance of the following for our understanding of the effects of market power: economies of scale and product durability. Competition and Market Power Depending on the premise and circumstances of the discussion it can be reasonable to argue that competition is socially harmful as compared to market power. However, the argument against competition is very weak since empirical evidence and data shows the competition has more economic benefits and support for the development of the market than a single firm holding and dominating market power over an industry. This is because there are several benefits which can be gained from having some competition in a market. For instance, competition may force prices to go down for the consumer if a lower cost producer competes in the market. Additionally, a better product might be entered into the market with actually superior or perceived superior quality. The combination of these two factors can create products which are innovative, desirable and can cause the emergence of brands within an industry. At the same time, competition may be unnecessary or wasteful if the product differentiation is very low. For instance, the battle between Coke and Pepsi for market share seems to be wasteful since the products they are marketing are very similar to begin with. However, advertising can be socially effective when the products are dissimilar and offer different benefits as in the case of computer operating systems like the ones created by Apple, Microsoft and Linux. Since this is a social issue as well as an economic issue, governments regulate and control competition in the market with their policies. Upon an examination of government policies, we realise that the aim of the government is not so much as to protect the consumer but rather the government aims to protect the competition since that is believed to be better for all concerned parties. With competition, the only company which can continually survive is the one which gets competitive advantages rather than the one which has monopoly control. Overall, it certainly depends on several factors like the product being sold, the nature of the market, the economies of scale, economic waste of competition and social responsibility which define whether competition is socially harmful or not. Economies of Scale and Product Durability Economies of Scale refer to the advantages a company can have in terms of lowered operation costs if the production and service facilities of the company are gigantic compared to the other players in the market. An example of a firm which achieves economies of scale by having a large scale of operations is a car assembly operation like FIAT or supermarket operators like Wal-Mart. Additionally, economies of scale act as market barriers since small competitors can not enter the firm due to the tremendous initial investment involved in getting a production facility up and running. On the same level, product durability also has an effect on monopoly power since the greater the durability, the less strength the monopoly would have on maintaining control of the price. Single use products like pharmaceuticals can have a higher monopoly control since they are not durable. Once a medicine has been used, it can not be transferred by the buyer to anyone else. A house building monopoly might be weaker in comparison since houses can be sold to other parties as second hand products which add supply to the market. A further explanation of durability could point towards the fact that it would be in the interest of the monopoly to not make products that a durable and lasting since that would create a secondary market and weaken their monopoly power. This can also be used as an argument against the creation and continuation of monopolies which produce goods rather than provide services to the people. Additionally, this idea can be used to support the creation of monopolies which provide services since the durability of services is seldom in question. Question 2) "Oligopoly theory gives us a rather confused picture of the relationship between economic profits and market structure" Discuss. Has empirical investigation of this relationship helped us to clarify the picture? Oligopoly It appears that economists can simplify the issues when it comes to extremes as defined by monopolies or perfect competition but have problems explaining the complex relationships which are created when there are just a few players in the market. Market competition amongst the few or a small group of sellers is called an oligopoly and the fundamental distinction between various types of monopolies depends on two factors. The first is the nature of the goods they are selling i.e. homogeneous or heterogeneous. The second distinction depends on the level of cooperation or competition between the firms. The first element of an oligopoly which concerns the differentiation of products sold by the producers confuses the picture since the products being sold are similar to some extent, yet they have differences that allow different prices to be charged in the market. An example of such a situation would be car manufacturers who differentiate their products based on factors like appeal, utility, speed, comfort, and image. The basic purpose of all cars is to provide transportation, yet a few players in the market have to differentiate their products since a single car can not fulfil the demands of the market. That picture is further complicated with the idea that certain market segments hold more value and certain buyers can only afford to pay set amounts for a car. Therefore a sports car for the 40-60 year old market will have different amenities and attributes than a sports car for the 20-30 market segments. In the same segment, car manufacturers can cooperate with each other in terms of technology, information sharing or even agreements on the level of development which will be taken with a particular product. The heterogeneous market will require ongoing development and enhancements in quality or features to get to a point where all products perform to an acceptable level but are imperfect substitutes for each other. This is because the industry itself is bridled by strategic interdependence which means that the decisions, prices and products offered by one competitor will affect the other. In an oligopoly, no firm can take independent decisions and completely ignore the competition without a threat of reprisal. The companies have to realize that they are related to each other and the only way they can maximize their profits is by cooperation and collusion. However, this is an unstable market situation since the incentive to cheat and gain market share is always there. The third method of operation for a firm in an oligopoly is to work in solitude but keep a close watch on what the competition is doing but this does not take into account unpredictable behaviour from the competition. Empirical Analysis The empirical analysis for oligopoly type market structures does show us what happened in the past where oligopolies were created and the eventual outcomes that could be seen once the dust settled after the initial phases of market creation. Two models have been defined for cooperative and non-cooperative oligopolies i.e. Bertnard’s and Cournot’s. A small number of non-colluding companies appear to act in line with the guidelines presented in the Cournot model of oligopoly. On the other hand, the colluding firms create a model which is similar to that presented by Bertrand. The Cournot model gives the idea that each firm creates its own output level on the assumption that other firms will maintain and keep a stable level of output. The Bertrand model of oligopoly assumes the reverse will follow since the firms are not cooperating with each other. The Cournot model is better for the parties involved in the oligopoly since it leads to an eventual equilibrium with above normal profits for all members. The Bertrand model also leads to an equilibrium state but with normal profits. When empirical evidence is sought for the dealings and production setting techniques of oligopolies, no particular model can be applied in all cases. The basic models of non-co-operative oligopoly are internally inconsistent and do not match up with the real world data in which both cooperation and competition are visible. The models which accept the mutual interdependence and complete cooperation between firms are not found in reality since the incentive to cheat means that the cooperation is more or less temporary and will be broken by one or more of the members in the oligopoly. Question 3) Why might it be argued that it takes only a few rivals competing in the same market to achieve an outcome very close to that of large numbers perfect competition? Does it make much difference if the rivals can cooperate with one another? Oligopolies and Perfect Competition The two reasons why it can be suggested that an oligopoly is close to perfect competition are the characteristics of an oligopoly and the resultant market situation which is created with oligopolies. While the characteristics of the market are less important, they are the foundations over which the market structure is created similar to the one which develops with perfect competition. There are a few elements of the structure and the market situation which must be analysed to present a complete answer. The key common element of oligopolies and perfect competition markets is more than one producer or provider and the secondary common element in terms of structure is that the products are identical or differentiated to some extent. If the products are identical then the oligopoly model is closer to perfect competition. If the number of sellers is large that will also serve to bring the model closer to the perfect competition setting. In both perfect competition and oligopolies, a single firm can not have an overriding effect on the market since in the oligopoly a firm behaving out of line would be corrected by the actions of the other firms while a renegade firm in perfect competition would be corrected by the market. While the products sold in perfect competition are perfect substitutes for each other, they are limited substitutes in an oligopoly. This also brings the oligopoly model closer to perfect competition since a monopoly is created only when there are no substitutes. More interesting than the structure of the market is the behaviour of firms that can be observed in empirical studies. The models of competition between the firms in an oligopoly show that firms are interdependent on each other which means they have to keep a close watch on all players in the market since without this awareness their decisions could be harmful for themselves. This helps to keep prices stable over long periods since the firms in the market can only make price and quantity production decisions on supply and demand. In effect, the price is rigid and determined by the factors which influence the overall market as it is set in perfect competition. Since a price increase by one player in an oligopoly is not likely to be followed by a similar increase by other players, the one who raises the price is likely to sell less. On the other hand, if a company reduces its prices, the competition will also have to come close to the same price point to remain competitive. With rigidity in overall prices, the only means a firm has to compete in the market is through product differentiation that leads to innovation and other non-price related competition as in the perfect competition scenarios. The single most effective way for firms to gain market share and to increase their size is mergers and acquisitions whereby they can gain competitive scale advantages in oligopolies. At the same time, firms can resist being taken over or mergers can be stopped by the government if monopolistic firms start to emerge in the market. So if the firms are in collusion in an oligopoly they can attain above normal profits for themselves. Firms in Collusion It makes all the difference in the world if firms can cooperate with each other and convert the market from an oligopoly to one which is closer to a monopoly. With cooperation, they can set the price, the level of innovation and the supply given out to the market. They can attain all the advantages which a monopoly has simply by ensuring that all members of the oligopoly agree to certain basic rules for production and price. However, this situation almost never takes place since the incentive to cheat for a firm is simply too great. Players in the market often assume that they can become the monopoly power by outplaying the competition and by creating advantages for themselves. Additionally, government regulation is often created for precisely the purpose of not permitting collusion between firms and ensuring the survival of the competition which maintains the oligopoly. Finally the cost of maintaining cooperation and ensuring that firms cooperate with each other might be too great if there are negotiations, contracts, monitoring and no way to enforce the contracts. Question 4) Explain why it is believed monopoly power harms economic efficiency. How is the view that monopoly is harmful affected by the following: price discrimination, countervailing power, durability of the product and economies of scale? Monopolies and Economic Efficiency A monopoly is believed to be harmful and economically inefficient primarily because there is no competition for the monopoly. This is in fact also the central reason for the existence of the monopoly therefore it can also be said that monopolies, by their very nature, are inefficient and harmful. Not having any competition means that the monopoly can be placed in certain situational traps and positions where inefficiency is likely to be created. For instance, a monopoly has control over the price it sets or the supply of the product in the market. This means that instead of the market setting the price of the goods, the monopoly power sets the price because there is no one to challenge the price or to offer the same product at a lower cost to the consumer. This is economically inefficient since market forces are marginalised and the strength of the monopoly determines the market condition. There is a large amount of empirical evidence to support this position since government owned monopolies on several goods and services have often been seen as inefficient as compared to monopolies in private hands or industry wide competition for the same goods and services. Since a monopoly power precludes the existence of availability of substitutes, the economy has nothing to fall back on if the monopoly power fails to deliver. Finally, a monopoly is inefficient since the main source of the monopoly power is its singular status in the market. Therefore it can devote a large number of its own resources to ensure that there are sufficient barriers to entry for other companies. The monopoly may create artificial prices to prevent the entry of another seller or control suppliers to the extent of exclusivity. While lowering prices may be good for social reasons, the only motive behind such a move would be to maintain the position of the monopoly and not to seek the benefit of the public at large. Adjustment of the View The social and economic negative influence of a monopoly is reduced significantly if a monopoly organisation can achieve price discrimination. This is because one of the central objectives of competitive practices is to ensure the presence of price discrimination and if such a condition is achieved by a monopoly, the negative effects of competition are outweighed by the price discrimination benefits of the monopoly. However, this state of price discrimination is not easy to achieve in reality since all monopolies would like to use this tool but it can cost a lot to create price discrimination. The customer may not be willing to pay a discriminated price for heterogeneous products produced by the same firm and arbitrage problems can also arise for the monopoly seeking to discriminate the price of the product. Where there is countervailing power, the monopoly can actually be placed at a significant disadvantage. Standard monopoly arrangements assume that there is no countervailing power and the buyers do not have a consumer’s union or negotiation power. The case can be taken to the extreme by looking at a monopsony where there is only a single buyer in the market and in situations where large companies deal with other large companies, monopoly power often has little to do with the negotiations. For example, a buyer like McDonald’s can dictate her terms to suppliers of meat, potatoes or even companies like Coca-Cola simply because they have the countervailing power to do so. Product durability also affects the power of the monopoly since a more durable product will mean less monopoly control over price with the passage of time. With a multi-period setting the first time the product is sold it is only bought by those who have the highest desire to buy the item. The case of early adaptors in electronics or high end computer equipment certainly can be used as an example here since they might pay a lot more for the product than they would if they could have waited a few months. However, after the product has been sold at a high price, the monopoly power will have to lower the price for the second round of sales in effect creating price differentiation based on time. Finally, economies of scale is one item that encourages monopolies since by using the economies of scale a monopoly can get to a performance level which is better than the one provided by a market where there is open competition between firms. Economies of scale benefit those operations which are large and have access to several different resources to perform their economic functions, e.g. automobile plants, nuclear energy producers and supermarkets etc. all function more economically if they are run at a large scale. If the monopoly has a large enough scale and they are benign, it is plausible that they perform better in economic terms than the competition environment. Therefore, instead of being harmful for the economy, the end result of a monopoly operating with extensive economies of scale could be an improvement in the overall efficiency of the market. Depending on this factor and the others mentioned above, it is not always necessary that a monopoly would be inefficient and wasteful but it is likely that a monopoly would be less useful than open competition between firms. Word Count: 3,116 Read More