Contrast the top features of perfect competition with those of oligopoly. (10)
The comparison between perfect competition and oligopoly will be based on the following: range of buyers and sellers, nature of product, and barriers to entry of firms.
Number of buyers and sellers
Perfect competition is a market structure that is characterised by many buyers and sellers with each firm's output representing an insignificant proportion of the full total output. Hence, sellers cannot influence prices by changing its level of output. Thus, they accept the marketplace price as given i. e these are price takers. Each firm then faces a properly elastic demand curve as shown in fig 1a.
An exemplory case of a market that comes close to the correctly competitive model is that of agricultural farming. How much the farmer sells his wheat for will depend on the prevailing price of wheat on the market.
On the other hand, an oligopolistic firm produces a significant amount of the total market output. The seller can either influence the price or output. It could sell more by lowering price or increase price but sell less. This means that that the firm's demand curve is downward sloping.
In addition, because of the small number of firms prevalent in the market, each firm now makes its decisions based on the result of other businesses in the same industry. No firm can afford to disregard the actions and reactions of other businesses on the market. For instance, there are only a few car manufacturers in the US such as Chrysler, GM and Ford Motors. If Ford Motors wants to increase sales, it can lower the price tag on its cars so that some buyers will switch from either Chrysler or General Motors but the increase in quantity demanded will be insignificant given that Chrysler and General Motors will observe the cut in cost. This behaviour can be summarized by the kinked demand curve.
Nature of product
In perfect competition, each seller produces an identical product, thus they are simply perfect substitutes for each other. Since consumers think that the products are the same, they'll not show any preference towards the goods of 1 firm over another. This means that sellers are not able to arbitrarily raise their prices for fear that consumers switch to other firms. Firms in perfect competition are price takers, and the demand for his or her goods are correctly price elastic, hence the horizontal demand curve. In oligopoly, organizations may either be creating a homogenous product or a differentiated product. When the product is differentiated, the oligopolist can boost the price and the output wouldn't normally fall significantly. Therefore substantial market power for the organizations within an oligopoly. Even though the nice is homogenous like steel or aluminium, the firm is likely to differentiate in conditions of the assistance and terms of conditions, hence the downward sloping demand curve.
Barriers to entry
There are no barriers to entry or exit in a PC industry so the markets will contain a large amount of small sellers. The implication of the is that the firms in perfectly competitive industry will earn normal profits over time as supernormal profit earned by the companies in the short run will be depleted by the entry of the new businesses into the industry. It is not too difficult to lease a parcel to grow wheat and in the event that the farmer chose to give up wheat farming, he could easily terminate his lease with the landlord. The beginning up cost is low as all he needs are some simple tools and seedlings. In oligopoly, there are significant entry and exit barriers. For instance, in car production, there are very high initial fixed costs like the establishing of the assembly line and only when the firm produces an extremely large output level will the common cost fall significantly. The lower cost associated with a large output serves as an entry barrier for new firms as their initial demand is usually low. Exit is also difficult, as it is not easy to dispose of the firm's fixed assets. Other types of barriers could be patent rights, exclusive ownership of certain recycleables and legal barriers. Therefore the oligopolist can earn supernormal profits even over time.
2b. Discuss why oligopoly is a far more common kind of market structure in comparison to perfect competition. (15)
Perfect competition is an ideal model therefore it is difficult to find markets which have all these characteristics. There are some markets in real life that approximates perfect competition. Types of such markets are farming, the stock market market and the forex market. These markets possess a few of the characteristics of PC as explained in part (a). However, even in such markets, a few of the characteristics are hard to fulfil. For instance, buyers and sellers may well not be price takers. Within the stock market market, there are a few individuals or institutions that can influence the price of shares through their large holdings of a particular company's shares. The product is also not homogenous if stock of different companies are considered. , Thus, if they were to sell their shares, price will fall. Knowledge is not perfect either. Although buyers and sellers do have easy access to information through their brokers and the web, there are a few who do have insider information and use that to their advantage. Moreover, managers have a tendency to reveal more info about their companies to financial specialists rather than to small investors.
In real life, most industries don't have that many firms. In fact, in industries such as automobiles, air-craft manufacturing industry, oil industry, steel industry, supermarket chains and pharmaceutical industry, the industry is dominated with a few large firms. Most businesses would prefer to face less competition so that their market power can be consolidated and secured. Oligopoly is thus a far more desired form of market structure as far as sellers are worried.
Oligopoly is a more common market structure. It could be attributed mainly to the high entry barriers. Barriers to entry refer to any impediments that prevent new organizations from competing on an equal basis with existing businesses within an industry. A highly effective barrier for new firms to enter the industry is substantial economies of scale. The production of some goods involves very high initial fixed costs. Good examples are the petroleum industry and the manufacturing of aircrafts. For example, Airbus and Boeing must construct huge expensive structures to make the A380. Thus, for the production of such goods, the larger the output the higher is the economies of scale enjoyed by the firm. Such industries have large Minimum Efficient Scale, and therefore, just a few organizations exist in such industries.
Economies of scale are not the only way to obtain barrier to entry. Other barriers to entry could possibly be the possession of superior technical knowledge or sterling reputation for quality or efficiency. Take for example, top quality sports cars like the Ferrari is such well known brandnames that it is quite impossible for any new auto firms to reproduce them. For a long time, they are the symbol of quality and luxury, a graphic that the carmakers have painstakingly cultivated. Production of such cars also requires superior technical knowledge, which is jealously guarded by the manufacturers. Thus it is not possible for new firms to enter such industries. In addition, existing firms may have spent millions on advertising to create and maintain brand loyalty. It will require a substantial amount of high advertising costs and low revenues for new entrants if they want to establish themselves. Also, they can spend large amounts on advertising to make it difficult for a new entrant to differentiate its product.
With the high entry barriers, firms have the ability to earn supernormal profits over time and have the financial strength to block the entry of new firms. Such companies can also adopt predatory pricing to further keep out competitors. Their huge profits allow them to cut prices drastically to drive out competitors. They can maintain excess production capacity as a sign to a potential entrant that with little notice, they could easily saturate the market and leave the new entrant with little or no revenue.
Besides, huge profits allow organizations to invest generously on R&D. The discovery of new and better products allows those to compete better on the market and also keep out other firms. For instance, in the pharmaceutical industry, millions of dollars must discover a new vaccine or a new drug. Hence the presence of high entry barriers ends up with many oligopolies.
Globalisation and liberalization
With increased globalisation, many domestic organizations are threatened by the entry of big foreign organizations or MNCs. Bigger organizations have a competitive advantage in terms of pricing. Domestic businesses can survive so long as there is certainly government legislation to prevent the entry of foreign firms. But most governments are liberalizing their domestic industries. In order to compete with foreign firms, domestic businesses have to merge. A merger would safeguard their survival as well as to allow them to compete more effectively. For example, the merger of DBS bank with POSB and UOB with OUB, are all designed to expand how big is each bank to be able to better compete with other international banks such as Citibank and Standard Chartered etc when MAS liberalize the financial sector to encourage competition. Hence globalisation has increased the tendency for mergers and the forming of oligopolies.
There are not many industries in the real world that satisfy the characteristics of the flawlessly competitive model given it is a perfect model. Alternatively, the characteristics of an oligopoly are easier met. The nature of production is more favourable for an oligopolistic kind of market. There are various benefits to being big. Some organizations are big due to high entry barriers - natural or man-made, while some expand internally or externally through mergers and acquisition in response to a changing external environment. The main reason for oligopoly being truly a common market structure can be attributed to benefits associated with economies of scale gives companies the incentive to merge and become large. It will lower their costs and present them higher returns to meet potential competition and as a result, they may have huge incentives to erect barriers to deter entry by new firms, and to consolidate their position.
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