MARKET STRUCTURE

In economics the definition of a market has a very wide scope. So understandably not all markets
are the same or similar. We can characterize market structures based on the competition levels and the
same nature of these. Let us study the four basic types of market structures markets.
A variety of market structures will characterize an economy. Such market structures essentially
refer to the degree of competition in a market.
There are other determinants of market structures such as the nature of the goods and products,
the nature of the product or service, economies of scale, ect.
One thing to remember is that not all these types of market structures actually exist. Some of
them are just theoretical concepts. But they help us understand the principles behind the classification of
market structures.

As firms maximize profits at the output level where marginal revenue is equal to marginal cost
(MT=MC), the environment where firms operate can have an influence to the behavior of firms. The
environment can have different market conditions which can affect firms in different ways. Thorough the
years, economists have identified characteristics of a firms and categorized them into mainly for
structures: perfect competition, monopolistic competition, oligopoly and monopoly.
PERFECT COMPETITION
Many firms sell the same goods or services. See that this free competition forces the firm to produce at
peak efficiency. Perfect competition, as economist wistfully point out, an ideal state of affairs, which
unfortunately, does not exist in any industry. It is a market structure with many well-informed sellers and
buyers of an identical product and no barriers to entering or leaving the market. But why bother about it?
Perfect competition attains the ideal of always being right. It is held up as we should strive to approach,
even if we can never hope to attain its state of grace. For three purposes, perfect competition will be
considered as an unattainable standard by which the other forms of competition:
Monopoly, monopolistic competition and oligopoly will be judged. Thus, even though it does not exist,
perfect competition has its uses. Let us examine these characteristics one at a time.
 LARGE number of Small Firms
One of the characteristics of perfectly competitive market is composed of many firms and buyers,
that is, a large number of independently-acting firms and buyers with each firm and buyer
sufficiently small to be unable to influence the price of product transacted in the market. How
many sellers make up a large number> And, how small is a small firm? Certainly, one, two, ten,
fifteen or even one hundred firms in a market would not be a large number. In fact, under perfect
competition, the exact number cannot be determined.

The condition mentioned earlier id fulfilled only when each firm in a market has no significant
share of total output and therefore, no ability to affect the product’s price. Each firm or producer
acts independently rather than coordinating decisions collectively. For instance, there are
thousand vegetable farmers throughout the Philippines. If any single farmer raises (lowers) the
price of vegetables, the going market price for vegetable in the market will be an affected.

 Homogeneous or Identical Product

In perfectly competitive market, the products offered by the competing firms are identical not
only in physical attributes but also regard as identical by buyers who have no preference between
the products of various producers. In other words, all firms produce a standardized or
homogenous product. Thus, for perfect competition to take place, all the firms in the industry
must sell an identical or standardized product. In simpler terms, those who buy the product can
not distinguish what one seller offers from what another seller offers which, in the buyer’s mind,
the products are identical hence, the buyer has no reason to prefer one seller to another.

If is the case, therefore the rice produced by farmers in Nueva Ecija is similar to the rice produced
by farmers in Bohol. More specifically, Pedro’s rice is identical with Juan’s rice. The assumption
rules out rivalry among firms in advertising and quality difference.

 Very Easy Entry, and Exit

There are no barriers to entry of new sellers or impediments to the exit of existing seller that is,
new firms face no barriers to entry while existing firms can readily leave the market without
difficulty. Barriers can be in the form of financial, technical, long term contracts, or government-
imposed barriers such as licenses, patents, permits, copyrights, franchises, ect. For example,
anyone who wishes to plant tomatoes or sweet potato need only a plot of land.
 Under the condition, firms are free to move wherever there is an opportunity for profits—land,
labor, and capital will move where they can secure the highest possible return. An entrepreneur
will give up his or her business and work for someone else if the wage offered is higher than the
firm’s profit.

However, no market fits exactly the three assumptions of perfect competition. The perfectly
competitive market structure is only a theoretical or ideal model, but some actual markets do
approximate the model fairly closely. Typical example of this type of market structure is the
agriculture sector or farm products market.

The Perfect Competitors Demand Curve

The perfect competitor faces a horizontal, or perfectly elastic, demand curve (see Figure 1). A
firm with a perfectly elastic demand curve has an identical MR curve. This the significant because the
firm can sell as much as it wants to sell at the market price. It is not necessary to lower price to sell more.

Now, what determines the market price in a competitive market structure? It is the interaction
between supply and demand in the market. Figure 1 has a supply curve and a demand curve crossing each
other. The market price is the point of which supply and demand curves cross.
In our graph, the price is set at P5.00. The firm can sell all it wants to sell at that price. What will
happened if it raises its price to P5.01? It will lose all its sales so many competitors who will still be
charging P 5.00, so the firm will never raise the price above market price.
 Would a firm ever lower its price below market price, say to P4.99? why should it be done? To
get sale away from its competitors. There is no need to do this because the perfect competitor can sell as
much as he or she desires at the marketplace. In other word, there is no point charging less under a
perfectly competitive market structure.

Perfect Competitor: A Price Taker, Not a Price Maker

If a group of entrepreneurs owns a store, they get to decide how much to charge your customers.
But if they happen to be a perfect competitor, they do not have that privilege; they are price takers, not
price makers. What price do they take? They take the market price, just like what was illustrated in Figure
2.
As one might have already observed, the industry wide supply and demand determine the market-
place. If it feels that price is too low, the only thing that can be done is to close the shop and leave the
industry. Otherwise there is no choice but to charge what everyone else is charging.

Farmers particularly rice farmers, are about as close to perfect competition. And more likely than
not, they complain about crop prices particularly during bumper harvest. If the price of palay is P3.00 per
kilo, the farmer as the price taker, he has no choice but to sell his entire output at the price. The farmer in
this case is the classic price taker.
Efficiency, Price, and Profit
Efficiency is defined as something cheap. When a firm is an efficient producer, it produces its
product at a relatively low cost. A firm operates at peak efficiency when it produces its product at the
lowest possible cost. That would be at the minimum point of its ATC curve, the break-even point.
For the perfect competitor in the long run, the most profitable output is at the minimum point of
its ATC curve. At any other output, the firm would lose money; just to stay in business; it must operate at
peak efficiency. The other forms of competition do not force peak efficiency.
Perfect Competition is very good for consumers; they can buy at cost, wherein price is equal to
ATC. Remember, there is no economic profit. And consumers have the firm’s competitors to thank for
such a low price. Competition will keep business owners honest, that is, if there is enough competition.
Pareto Optimality and Efficiency
When the economy is perfect competitive, the act of competing means that not everyone can have
everything he desires, as one loses out to the competition. This in effect makers one better off, when
desires are met, and somebody else has been made worse off, as one loses to the other who has gained in
the competition. This has brought some issues about efficient allocation.
The concept of Pareto optimality comes to play to settle the inefficiency. Named after Vilfredo
Pareto, an Italian economist who specialized in resource and income allocation. Pareto Optimality that
states An Economy is Pareto optimal or efficient when no one further changes in the economy can made
one individual better off without making someone else worse off. Pareto optimality is an allocative
efficiency which occurs when the value that consumers place on goods or services equals the cost of the
factor resourced utilized in the production. Points lying on the production possibility curve provides for
efficient allocation as shown in Figure 4.
 Different sets of resource allocation exist so when a change in the initial allocation that makes an
individual better off while not making another worse off, the movement is called Pareto improvement.
Looking at the give graph, moving from point A to point D indicates a Pareto improvement. However, a
movement from point A to point B and C would not be considered a Pareto improvement since at point B,
the allocation increases the production of bags, thus shoe- production worse off. Conversely at point C,
production of shoe is greater than the bags. The more from point B and C are not Pareto improvement
since it makes one side better off by making another worse off.

MONOPOLISTIC COMPETITION
Why do people shop at one drugstore rather than another? Why do people frequent particular
restaurants, beauty parlors, spas, coffee shops, and internet cafes. Do people always buy at stores than
charge the lowest prices?
Most real- world markets lie between the extremes of perfect competition and monopoly. Most
firm possess some power to set their prices as monopolies do, and they face competition from the entry of
new firms as the firms in perfect competition do. This market in which such firms operate in under
monopolistic competition.
Monopolistic competition is a type of market structure characterized by (1) many small firms, (2)
differentiated products, and (3) easy market entry and exit. While monopolistic competition is formed by
high number of firms producing similar goods that can be seen as unique due to differentiation, this
market structure allows prices to go higher than marginal costs. This means that each producer will be
considered as a monopoly but the whole market is considered competitive because the degree of
differentiation still considered the possibility of having substitution effect. Examine each of the
characteristics that was mentioned.
Monopolistically competitive market is comprised of a large number of independently-acting
firms and buyers. However, under the monopolistic competition, just like perfect competition, the exact
number of firms cannot be determined. So, how many is many? So many that no firm has any significant
influences on the price. Nevertheless, monopolistic competitors do have any significant influence over
price because their products are differentiated. But still, it is a “small” influence.

Therefore, ‘many-sellers’ condition is met when each firm is so small relative to the total market
that its pricing decisions have a negligible effect on the marketplace. For instance, Don Pedro owns a
seafood restaurant at the Manila Bay are. He assumes that he can set prices slightly higher or improve
services independently without fear that his competitors will react by also charging their prices or giving
better service. In such case, if any single seafood restaurant raises its prices, the going market price for
seafood dinners increases by a negligible amount.
The products offered by competing firms under a monopolistically competitive market are
differentiated from each other in one or more aspects. In fact, this is the key feature of monopolistic
competition. Product differentiation is the process of creating real or apparently differences between
goods and services sold in the market. A differentiated product has close, but not perfect, substitutes.
Although the product of its firm is highly similar, the consumer views them as somewhat different or
distinct. Some people will pay more for any variety of the product, so when its price rises, the quantity
demand decreases. Thus, although there are several seafood restaurants along the Manila Bay area, they
are not at all the same. They differ in location, atmosphere, quality of food, type of menu offered, quality
of service, ect.
Product differentiation can be real or imagined. It does not matter which is true as long as
consumers believe such differences exist. In our previous example, many customers may think that Don
Pedro’s seafood restaurant is the best along thew Manila Bay area although there are other restaurants that
offer a similar product. The importance of these viewpoint, therefore, is that consumers is willing to pay a
slightly high price for Don Pedro’s seafood.
The example makes clear that under monopolistic competition rivalry centers on nonprice factors
in addition to price competition. With nonprice competition, a firm under this type of market structure
competes using marketing strategies like advertising, packaging, product development and innovation,
better quality, and better service rather than simply lower price. Nonprice is an important characteristic of
monopolistic competition that distinguishes it from perfect competition and monopoly.
Summing it up, the product of one firm can be differentiated from that of another, in a
monopolistically competitive market. An efficient producer will use nonprice competitive methods to
convince his or her consumers to pay a higher price for the product. The most common form of nonprice
competition is advertising.
Remember that when an entrepreneur’s business is under a monopolistically competitive market
structure, competitor’s product is a close substitute. As such, one most maintain relatively high levels of
nonprice competition strategies to keep the customers and thus make the business vibrant.
 In a monopolistically competitive market, there are no barriers to entry preventing new firm
entering the market or obstacles in the way of existing firms leaving the market. Thus, unlike a monopoly,
firms in a monopolistically competitive market face low barriers to entry. However, entry into
monopolistically competitive market is not quite as easy as entry into a perfect competitive market.
Because monopolistically competitive firm sell differentiated products, it is somewhat difficult for new
firms to become established. Fore instance, an individual can establish his own seafood restaurant along
Manila Bay since he can easily get a business permit, secure loan, lease a property, and start serving
seafood without to much trouble. However, his restaurant may have trouble attracting customers because
Don Pedro’s seafood restaurant has established a reputation of being the best seafood restaurant in the
area.

In such it can be said that in a monopolistically competitive market there are barriers to entry, but
these barriers are relatively small. The number of firms operating in such a market is large; each firm Has
a small market share and firms have only limited ability to influence prices.
What is the most important however is that a firm in a monopolistically competitive market
cannot make an economic profit in the long run. This is because when firms make economic profits, new
firms enter the industry. Consequently, this entry lowers prices and eventually eliminates economic profit.
On the other hand, when economi9c losses are incurred, some firms may leave the industry. The exit of
these firms increases prices and profits and eventually eliminates the economic losses. In the long run,
equilibrium firms neither enter nor leave the industry and the firms in the industry make zero economic
profit.

Market for Haircut

Illustrating the concept discussed previously about monopolistic market structure, Figure 5 shows
the demand and supply curve for haircut.
Hairdressers operate in a monopolistically competitive market. In Figure 5 effect can be seen
when one salon increases the price for a standard haircut from P120.00 to P150.00. Because of the
increase in price, sales have fallen from 150 Haircuts per week ton 100 per week, that is, from point E to
point E1. So, what can a hairdresser do to increase sales back to the old level? Marketing and promotion
is one key to get sales back.
 Many service providers advertise that their ‘customer service’ is much better than their
competitors. Some will capitalize on customer friendly relations where customers’ names and preferences
are considered and given priority. Some salons offer loyalty programs for customers to enjoy discount
perks.
Monopolistically competitive markets can be found in a wide range of industries. One major area
is in garments retailing, and other small businesses. Many service markets are monopolistically
competitive consider electricians, plumbers, hairdressers, and dress shops.

Product Differentiation and Demand Elasticity

The demand curve of a firm in a monopolistic competition market structure is downward sloping
because of the preference of customers for the features of the differentiated products. However, because
there are many close (if not perfect) substitutes readily available, the de4mand is highly elastic.
Graphically, this means that the demand in monopolistic competition is flatter than in monopoly (refer to
Figure 6). For example, the demand of a restaurant is likely to be very elastic because there are many
other food outlets available customers. But the demand is not perfectly elastic (i.e. horizontal) as in the
case of perfect competition because, each restaurant has something to offer which other restaurants do
not: for instance, convenience, location, elaborate menu, or ambience.
 Perfectly competitive firm face a perfectly elastic demand curve for their product because all
firms in their industry produce identical products. In contrasts, a monopolistic competitor faces a
downward – sloping firm demand curve. This type of curve is based on the notion that the firm can
change its price without losing all its business because buyers do not see any perfect substitute. Thus, the
fewer the substitutes (i.e. the more product differentiation), the less elastic the demand curve will be.
A monopolistic competitor, in the short run, is like a monopolistic because it is the only producer
of its unique product. But unlike a monopoly, the monopolistically competitive firm faces competition
from other firms producing good substitute for its product.

MONOPOLY
Monopoly refers to a market situation where there is only one seller or producer supplying unique
goods or services. (Pindyck & Daniel 2001). It is a single seller that has a complete control over a specific
industry. Thus, there is nobody else selling anything like what the monopolist is producing. Thus, there
are no close substitutes. Monopoly comes from the Greek word ‘mono’ which means one and ‘polist’
which means seller (Samuelson & Nordhaus, 2005)
Monopoly is the opposite extreme of perfect competition. Under monopoly the consumer has
only two choices-- either buy the monopolist’s product or none at all. Monopoly is a market structure
characterized by (1) a single seller or producer, (2) a unique product or service, and (3) impossible entry
into the market. Unlike perfect competition, there are no close substitutes for the monopolist’s product.
Single Seller of Producer
A monopoly market is comprised of a single supplier selling to a multitude of small
independently acting buyers. In other words, a monopoly means a single firm in the industry. That is, one
firm provides the total supply of a product in a given market. Local monopolies are more common in real-
world approximations of the model that national or world market monopolies. For example, MERALCO
is a local electric power provider in Metro Manila and nearby provinces. Manila Water is the distributor
of water to the residents of the eastern zone of Metro Manila. Nationally, the armed forces provide
military service to the entire country.
Unique Product
A unique product means that there are no close substitutes for the monopolist’s product. As such,
the monopolist faces little or no competition. In reality, however, there are few, if any, products that have
no close substitutes. For example, buying a generator or using a gas lamp is a substitute for MERALCO.
Similarly, putting a deep well in your backyard or community can be a substitute for Manila Water.
Nevertheless, these may not be good substitutes to the product mentioned previously since putting them
up yourself will be costly and inefficient.

Impossible Entry
Barriers to entry are so severe in a monopoly that it is impossible for new firms to enter the
market. In other words, extremely high barriers make it very difficult or impossible for new firms to enter
an industry. Barriers to entry include (1) sole ownership of a vital resource, (2) legal barriers like
government franchises and license, and (3) economies of scale.

Other Characteristics of Monopoly Market:

The monopolist definitely makes the price for the products or services. In other words, it is the
monopolist who dictates the price of commodities because the products or services offered are unique and
have no close substitute in the market. As a result, consumers are left with no choice but to follow
changes made by the monopolist regarding the prices of its commodities.
In addition, there is no need for an extensive advertising or sales promotion depending on the
goods or services of the monopolists. There is no need for the monopolist to promote the product, since it
is the only one selling it and offering it to the public. If there are advertisement and promotion of the
monopolist in the market these are just for announcement in regard to the changes in price, warning, do’s
and don’ts, safety tips, ect. (Fajardo 1977)
In the television advertisements of MERALCO or Manila Water, what can be observed? These
were all focused on providing consumer tips, warnings, and measures towards the protection of the
environment.

The Graph of the Monopolist

Monopoly is the first of a tree types of imperfect competition. The distinguishing characteristic of
imperfect competition is that the firm’s demand curve is no longer a perfectly elastic horizontal line; nor
it curve downward to the right. This means that the imperfect competitor will have to lower price to sell
more.
Table 1: Illustrates a hypothetical demand and cost schedule of a monopolist. As reflected from the table,
the demand (depicted by price) and marginal revenue do no anymore coincide with other. This means that
demand (shown in column 3 is now higher than marginal revenue (shown in column 4).

Using the Table 5.1 four standard curves: demand, marginal revenue, marginal cost and average
total cost can be drawn (refer to Figure 5.7). Now examine the graph carefully. What can we observe? It
is depicting that ATC and MC curves are the same as they were for the perfect competitor. In addition,
the MC curve intersects with ATC curve at its minimum.

Table 1: Hypothetical Demand and Cost Schedule for Monopoly

Output Price (P) TR (P) MR (P) TC (P) ATC (P) MC (P)

1 16 16 16 20 20.00 -
2 15 30 14 30 15.00 10
3 14 42 12 36 12.00 6
4 13 52 10 42 10.50 6
5 12 60 8 50 10.00 8
6 11 66 6 63 10.60 13
7 10 70 4 84 12.00 21
The table depicts the cost and revenue schedule of the monopolist. Under a monopoly the demand (price)
and marginal revenue (MR) schedules are no longer equal.

Observe the demand and managerial revenue slope downward to the right. Note that at one unit of
output, the demand and marginal revenue curves share the same point, P 16.00, but the marginal revenue
curve slopes down faster than the demand curve. In fact, when the demand curve is a straight line, the
marginal revenue curve is also straight line that falls twice a quickly. As much, demand curve is above
the marginal revenue curve.
You might be wondering why the marginal curve declines faster than the demand curve and why
they slope downwards. To answer your query, let us go back to out data on Table 1. You noted that when
the output is one, price is P16000; but to sell two units out output, the seller must lower his price to
P15.00. Two units at P15.00 equals P30.00 in total revenue. Notice that the seller cannot charge P16.00
for the first unit and P15.00 for the second. That is because the seller has no post one price.
When price is lowered to P15.00 the total revenue is P30.00 while marginal revenue is at P14.00.
At two units of output, price was lowered to P15.00, then the point on the demand curve at P14.00 on the
marginal revenue curve. Definitely, as price is lowered, demand falls but not as faster than the marginal
revenue.
Given the example, it can be said that the monopolist lowers his price to sell more output, he
lowers the price of his product on all units of output, not just on the last one. This drives down marginal
revenue faster than price. Notice also that the marginal revenue curve falls twice as quickly as the demand
curve (refer to Figure 1)
Calculating the Monopolist’s Profit
As we level of output does the monopolist produce? Using the marginal analysis, can be
determine the most profitable output. How can it be done? First take a look again of Figure 5.7 and find
the point at which marginal cost curve intersects marginal revenue. That is our output.
According to Figure 5.7., marginal cost equals marginal revenue at five units of output. Using the
formula for total profit, it can be computed as below:

Total Profit = (Price – ATC) x Output

= (P123 – P10) x 5
= P2 x5
= P10
But one conflict that does not exist under perfect competition is the perfect competitor produced
at the most profitable output, which in the long run always happened to be the most efficient output.
However, the monopolist does not produce where output is at its most efficient level (12the minimum
point of the ATC curve). Remember, every firm will produce at its most profitable output, where
marginal cost equals marginal revenue. If that does not happen to be the most efficient output, then that is
the way the firm will lose. Nevertheless, finding the monopolist’s price and output is a little harder than
finding the price and output for the perfect competitor. So how can this be done? Go back again to Figure
5.7 this is output 5 (Labeled point o as indicated by the dotted line). Moving up further the dotted line
from where marginal cost equals marginal revenue to the demand curves and moving horizontally along
the dotted line going to the price axis, one can find that the price is P12.00 (labeled p). In this case,
therefore, the monopolist will sell five units of output at P12.00.

Natural Monopoly and Economies of Scale

A natural monopoly exists when there is great scope for economies of scale to be exploited over a
very large range of output. Indeed, the scale of production that achieves productive efficiency may be a
high percentage of the total market demand for the production in the industry. A natural monopoly
therefore is a situation where economies of scale are so significant that costs are only minimized when the
entire output of an industry is supplied by a single producer, so that supply costs are lower under
monopoly than under conditions of perfect competition and oligopoly.
Natural monopolies tend to be associated with industries where there is a high ration of fixed to
variable costs. For example, the fixed costs of establishing a national distribution network for a product
might be enormous, but the marginal (variable) cost of supplying extra units of output may be very small.
In this case, the average to9tal cost will continue to decline as the scale of production increase, because
fixed ( or overhead) costs are spread over higher levels of output.
The telecommunication industry has in the past been considered to be a natural monopoly
(especially during the time when the industry has not yet been deregulated by the Philippine government).
Like railways and water provision, the existence of several companies supplying the same area would
result in an inefficient multiplication of cables, transformers, pipelines, ect. However, the perception of
what constitutes a natural monopoly is now changing because of thew impact of new technology in
reducing traditional barriers to entry the market.
Monopoly Seen as Inefficient
Monopolist’s are price makers, yet they are still subject to the law of demand. Thus, the highest
the price they set on their product, the lower the amount that is bought by consumers.
Economists say that firms will reach a level of production when marginal costs start to rise. As
long as marginal revenue (the extra income generated from extra units of output) is greater than marginal
costs, a firm in a competitive market will continue producing. Society will have more to consume. In
addition, if marginal revenue equates with marginal cost, it determines the profit maximizing output of
monopolist, wherein this is the usual practice or general rule of every firm to maximize profit. On the
other hand, if the marginal revenue is below the marginal cost increases monopolist should reduce its
production; in return, decreasing marginal cost increases its marginal revenue. In summary, if MR>MC,
the monopolist gains profit by increasing output and vice versa if MR<MC (Colander 2010).
In comparative market, production rises to level where marginal costs equal marginal revenue. In
a monopoly, production rises to a level where profit per unit is maximized. After this point, the
monopolist will make less and less profit per unit. Why work harder, for less?
In a monopoly, the quantity produced of goods is often less than the socially desirable level of
production. There was been a misallocation of resources: not enough resources are being used where they
should be, and other resources are being underutilized. It is for this reason that monopolies are seen as
inefficient.
OLIGOPOLY
In terms of competitiveness, the spectrum of market structures reaches from pure competition, to
monopolistic competition, to oligopoly, to monopoly.
Oligopoly, a market dominated by few large producers, or sellers of a homogeneous or
differentiated product. Because of their ‘fewness’, oligopolists have considerable control; over their
prices, but each must consider the possible reaction of rivals to its own pricing, output, and advertising
decisions.
Basically, an oligopoly is characterized by (1) few sellers, (2) either a homogeneous or a
differentiated product, and (3) difficult market entry. Oligopoly, just like monopolistic competition is
found in real world industries. In fact, oligopoly is the prevalent type of industrial competition in most
developed countries like the Unites States, Japan, and most of Southeast Asian countries.
Under oligopoly, the bulk of market supply is in the hands of a relatively few large firms who sell
their products to many small buyers. Therefore, it can be said that oligopoly is competition ‘among the
few’. For example, the “Big Three“ oil companies (i.e. Petron, Shell and Chevron) under oligopoly means
that these three firms dominate the oil industry. But what does ‘few firms’ really mean? As with the other
market structures, there is no specific number of firms which must dominate an industry before it is called
an oligopoly.
Basically, an oligopoly is a consequence of mutual interdependence. It is a condition in which an
action of one firm may cause a reaction from other competing firms in the industry. In other words, a
market structure which a few powerful firms make it easier for oligopolist to collude. The large number
of firms under perfect competition or monopolistic competition and the absence of other firm in
monopoly rule out mutual interdependence and collusion in these market structures. Hence, ‘few-sellers’
condition is met when these firms are relatively large to the total market that they can affect the market
price.

Homogeneous or Differentiated Products

In an oligopolistic market, the products offered by suppliers may be identical, or more commonly,
differentiated from each other in one or more respects. These differences may be of a physical nature,
involving functional features, or may be purely ‘imaginary’ in the sense that artificial differences are
created through advertising and sales promotion. For instance, the unleaded gasoline of Pilipinas Shell is
identical with unleaded gasoline of Petron and Chevron. However, cars produced by the major
automakers, like Toyota, Honda, and Ford, are differentiated products. If such is the case, buyers in an
oligopoly market may or may not be indifferent as to which seller’s product they buy. In other words, the
unleaded gasoline that a person buys at Shell station is no different from that a Petron or Chevron station.
In other words, that person in different whether he buys gas from the former or the latter.

Difficult Entry
Similar to monopoly, there are formidable barriers that make it very difficult for new firms to
enter and compete in the market. As a matter of fact, the same barriers to entry that create pure monopoly
also contribute to the creation of oligopoly. High barriers to entry in an oligopoly protect firms from new
entrants. These barriers include exclusive financial requirements, control over essential resource, patent
rights, and other legal barriers. But the most significant barriers to enter in an oligopoly market is
economies of scale. Economies of scale are important entry barriers in a number of oligopolistic
industries, such as oil, telecommunication, and airline industries. For example, large oil firms achieve
lower average total costs than those incurred by small oil firms. Thus, it can be seen that even with the
deregulation policy of the government still dominant players in the oil industry are the ‘Big Three’ firms.
Because of these barriers, competition in an oligopolistic market is intense. Both price and
nonprice methods of competition are used. People have probably seen, read or heard advertisements along
these lines. “We will not be beaten on price. If our competitors are selling item X for less, we will match
their price, whether the item’s price has been reduced for a special sale or not”
Moreover, firms in oligopolies compete by offering warranties, “We will replace the item
without cost if it if found to be defective in any way”, and through customer (friendly, helpful staff, and
free home delivery).
Because of stiff competition, firms in oligopolies are said to me mutually interdependence. If one
firm changes in prices, this well have an effect on the sales of all other firm in the market.

Illustration of Oligopoly
In the graph presented in Figure 5.10, Mr. Tan and Mr. Kim are initially selling gasoline at P
60.00 per liter (represented by point E). Mr. Tan decides to lower its price to P50.00 per liter. Sales
increase from 20,000.00 liters per week to 30,000.00 liters per week from point E to E1. Mr. Kim is
unhappy losing so many sales to Mr. Tan, and matches Mr. Tan’s price of P50.00 per liter.
 Mr. Kim then decides to decrease the price of his gasoline to P30.00 per liter to make more
profits similar to what Mr. Tan did when he lowered the price of his gasoline further from P 50.00 to
P30.00. The move of Mr. Kim is shown as the movement from point E1 to E2. However, sales volume
only increased from 30,000 liter per week to 35,000 liter per week.
Many oligopolist face Kinked demand curves. Kinked demand curve is a curve that explain why
prices charged by competing oligopolists, once established, tends to be stable. Basically, the demand
curve for the product of oligopolists has two segments: one elastic, and the other inelastic. Refer to Figure
5.10 again and observe the shape of a kinked demand curve.

People consume gasoline, but as price falls, they will not buy greater amounts of them.
Consumers will switch their buying patterns from one free to another. The two firms are close substitutes.
Changes in price between firms will result a mark reduction in sales volume, from one firm to the other.
However, from the perspective of the total market demand for gasoline (the total amount of gasoline
bought from all firms), demand for gasoline is inelastic when its price is already low. This depicts price
wars that do not benefit firms but benefit consumers instead.
It is observed however that the major retailers concentrate their competitive efforts in nonprice
areas such as advertising and other after-sales service. Critics of firms operating in oligopolistic markets
say that these firms are not interested in real competition that results in lower prices for consumers.
An oligopoly therefore usually exhibits the following features:

1. Product Branding. Each firm in the market is selling a branded (differentiated) Product.

2. Entry Barriers: significant entry barriers into the market prevent the dilution of competition in n
which maintains supernormal profits for the dominant firms. It is perfectly possible for many
smaller firms to operate on the periphery of an oligopolistic market, but none of them is large
enough to have any significant effect on market price and output.

3. Interdependent Decision- making: Interdependence means that firms must take into account likely
reactions of their rivals to any change in price, output, or forms of nonprice competition. In
perfect competition and monopoly, the producers did not have to consider a rival’s response when
choosing output and price.

4. Nonprice Competition. Nonprice competition is a consistent feature of the competitive strategies

of oligopolistic firms. Example of nonprice competition include: (a) free deliveries and
installation; (b) extended warranties for consumers and credit facilities; (c) longer opening hours
(e.g. supermarkets and petrol stations); (d) branding a products and heavy spending in advertising
and marketing; € extensive after-scale service; and (f) expanding new markets plus
diversification of the product range.

The Importance of NonPrice Competition under Oligopoly

Nonprice competition assumes increased importance in oligopolistic markets. Nonprice competition
involves advertising and marketing strategies not increased demand and develop brand loyalty among
consumers. Businesses will use other policies to increased market share with the following strategies in
mind:

1. Better quality of service including guaranteed delivery times for consumers and low-cost
servicing agreements.

2. Longer opening hours for retailers, 24-hours telephone and online customer support;
Extended warranties on new products;
3. Discounts on product upgrades when they become available in the market; and

4. Contractual relationships with suppliers for example the system of tied hours for pubs and
contractual agreements with franchises (exclusive distribution agreements)

Advertising spending runs a million of dollars or pesos for many firms, as people see them on their
television sets, or billboards along the highways. Some simply apply a profit maximizing rule to the
marketing strategies. Nonetheless, a promotional campaign is profitable in the marginal benefit (or
revenue) from any extra sales exceeds the cost of the advertising campaign and marginal costs of
producing an extra unit of output. However, it is not always easy to measure accurately the incremental
sales arising from a specific advertising campaign. Other businesses see advertising simply as a way to
increasing sales revenue. If persuasive advertising leads to an outward shift in demand curve of the
product being advertised, this implies that consumers are willing to pay more for each unit consumed.
This increase the potential consumer surplus that a business might extract.
 Relatively, high spending on marketing is important for new business start-ups such as the huge and
often extravagant sum spent on marketing by the emerging dot-coms during the internet mania of the late
1990s and into 2000 and also by firms trying to break into an existing market where there is consumer or
brand loyalty to the existing products in the market. Take note for instance how Sun Cellular undertook
massive promotional activities and advertising campaigns when it started its business in late 1990s so as
to penetrate the market and thus compete with the two giant telecommunication companies, Smart and
Globe.

Price Leadership- Tacit Collusion

As discussed, oligopoly is a market structure with only a few firms dominating the industry.
Since the market is shared by few firms, market becomes highly concentrated.

Another type of oligopolistic behavior is price leadership. This is when one firm has a clear
dominant position in the market and the firms with lower market shares follow the pricing changed
prompted by the dominant firm. Examples of this are the major telecommunication and airline firms
where smaller firms follow the pricing strategies of leading firms. If most of the leading firms in a market
are moving prices in the same direction, it can take some time for relative price differences to emerge
which cause consumers to switch the demand.

Firms who market to consumers that they are” evert knowingly understood” or what claim to be
monitoring and matching the cheapest price in a given geographical area are essentially engaged in tacit
collusion. Does the consumer really benefit from this?

Tacit Collusion occurs when firm’s undertaker action that are likely to minimize a competitive response,
e.g. avoiding price cutting or not attacking each other’s market.

Price Fixing

Collusion is often explained by desire to achieve joint-profit maximization within a market or prevent
price and revenue instability in an industry. Price fixing represents an attempt by suppliers to control
supply and fix price at a level close to the level we would expect from a monopoly. When price fixing
happens, producers or suppliers tend to control supply and fix price at a level somewhat close to the price
in the monopoly market. To collude on price, producers must exert control over market supply.

To fix prices, the producers in the market must be able to exert control over market supply. In Figure
5.11, a producer is Assumed to fix the cartel price at output Qm and price Pm. The distribution of the
cartel output may be allocated based on an output quota system or another process of negotiation.

Although the cartel is maximizing profits, the individual firm’s output quota is unlikely to be at their
profit maximizing point. For any one firm within the cartel, expanding output and selling at a price that
slightly undercuts the cartel price can achieve extra profits. Unfortunately, if one firm does this, it is in
each firm’s interests to do exactly the same. If all firms break the terms of their cartel agreement, the
result will be an excess supply in the market and a sharp fall in the price. Under these circumstances, a
cartel agreement might break down.
Forms of Collusive Agreement
Having exclusive dealings and trying contracts are illegal to the extent that perfect competition is
being restricted. Exclusive dealing is a contractual agreement between two firms that limits outside firms
to participate or engage in.

Figure 11: Output and Price of a Cartel

Collusion in a market or industry is easier to achieve when (1) there are only a small number of
firms in the industry and barriers to entry protect the monopoly power of existing firms in the long run;
(2) market demand is not too variable; (3) demand is fairly inelastic with respect to price so that a higher
cartel price increases the total revenue to suppliers in the market; and ((4) each firm’s output can be easily
monitored- this enables the cartel more easily to control total supply and identify firms who are cheating
on output quotas.

Possible Breakdown of Cartels

Most cartel arrangements experience difficulties and tensions, and some producer of cartels collapse
completely. Several factors can create problems within a collusive agreement between suppliers. These
includes:
 1. Enforcement problems: The cartel aims to restrict total production to maximize total profits of
members. But each individual member of the cartel finds it profitable to raise its own production.
It may become difficult for the cartel to enforce its output quotas. There may be disputes about
how to share out the profits. Other firms, not members of the cartel, may opt to take a free ride by
producing close to but just under the cartel price.
2. Falling market demand during slowdown or recession excess capacity in the industry and puts
pressure on individual firms to cut prices to maintain their revenue. These are good recent
examples of this in international commodity markets including the collapse of the coffee export
cartel and some of the problems that have confronted OPEC in recent years.
3. The successful entry of non-cartel firms into the industry undermines a cartel’s control of the
market, e.g. the emergency of online retailers in the book industry in the mid1990s.

Size of an Oligopoly and the Market Outcome

Generally, the more companies in the industry, the harder it is to form a cartel and to enforce it.
As the number of the companies increases, the more the industry resembles a competitive outcome, since
each company has a smaller effect on the outcome. The mentality where ach company tends to think only
of its own profit and strategic behavior is reduced. Each company will increaser production as long as
price is greater than marginal cost. As the number of companies increases, the market or the industry
tends to move towards a perfectly competitive outcome.

Duopoly
Duopoly is another form of oligopoly wherein two corporations produce similar goods or services
which are almost identical. In a duopoly, only two companies have the entire control of the market and
the firm’s interactions with one another shape of the market. Examples of duopolistic market are Airbus
and Boeing, Bloembergen and Reuters.
In a duopoly, the set -up forces each producer to consider the rival firm’s actions to certain
business decisions. When there’s a duopoly in the market, the consumers may tend to benefit from the
action of the two firms when they compete on price since firms will drive the price down in order to keep
up in the competition with each other. However, since there are only two firms sharing in the market, this
condition givers the duopolists an opportunity to agree and change a monopolistic price in order to gain
profit.
There are two types of duopoly. The Cournot duopoly and the Bertrand Duopoly name after
French mathematician Antonine Augustin Cournot and French economist Joseph Bertrand.

The Cournot Duopoly

The competition between two companies is based on the quantity of products supplied, saying
that it is the quantity which shapes the competition between two firms. The Cournot model believes that
each company receives price values on the availability of goods and services. So, the price each company
receives for the product based on thew numerical counts or quantity of the produced goods. Equilibrium
is achieved when the two companies react to the changes in production of each other.
The Bertrand Duopoly
While the Cournot duopoly focused more on quantity, the Bertrand duopoly focused on the price
since this is what drives competition in the market between two companies. When given a choice between
two goods or services which tend to be equal or similar, consumers will go for the firm that will offer the
best price.

Monopsony
Monopsony is similar to the concept of monopoly that has one seller and many buyers. For
monopsony, there is only one buyer buy many sellers. The buyers is called the monpsonist.
Monopsony occurs when there is a market power exercised by a firm when employing factors of
production, giving the monopsonist the control when negotiating prices.
One example of monopsony is the case of one employer and many workers seeking employment.
Since there is only one employer, the market power in setting wages and the number of how many will be
given employment, rest mainly on the command of this one major employer.
One example of monopsony is the market industry which source their food and agricultural
supplies from the farmers. If there are no products to sell to supermarkets, it would be hard to look for
alternatives farm products. Another example is the industry of coal mining in one province wherein
employment in the industry become the primary or the only source of employment in that specific town.

Market Structure and Innovation

For many years, the question which market conditions are optimal for effective and sustained innovation
to occur has always been an interesting concept for economists and business academics. High levels of
research and development spending are frequently observed in oligopolistic markets, although this does
not always translate itself into a fast face of innovation.
The work of William Baumol (2002) provides support for oligopoly as market structure best suited for
innovative behavior. Innovation is perceived as being “mandatory” for businesses that need to establish a
cost-advantage or a significant leadership in product quality over their rivals.
“As soon as quality competition and sales effort are admitted into the sacred precincts of theory, the price
variable is ousted from its dominant position… But in capitalist reality as distinguished from its textbook
picture, it is not that kind of competition which counts but the competition which commands a decisive
cost or quality advantage and which strikes not at the margins of profit and the outputs of the existing
firms but at their foundations and their very lives. This kind of competition is as much more effective
than the other as bombardment is in comparison which forcing a door” (Baumol 2002).
Supernormal profits persist in the long run in an oligopoly and these can be used to finance R&D.
Important Developments in Market Structures
The fast-changing business environment during the past decades has brought about important
developments in market structures. We can cite some of these important development as follows:
1. Increasingly most innovation is done by smaller firms. Indeed, multinational corporations are
now outsourcing their research and development spending to small businesses at home and
overseas, much is being shifted to cheaper locations “offshore” – in India and Russia and recently
China.

2. Innovation is now a continuous process, in part because the length of the product cycle is getting
shorter as innovations are rapidly copied by competitors, pushing down profit margins and
(according to recent article in The Economists) “Transforming today’s consumer sensation into
tomorrow’s commonplace commodity”. A good example of this is the introduction of two major
competitors to the anti-impotence drug Viagra. However, this is more evident in the IT industry
as well as the tech gadgets market.

3. Innovation is not something left to chance. The most successful firms are those that pursue
innovations in a systematic fashion. One very good example is the continuous innovations of
Microsoft Corporation which make the company the leader in the software business.

4. Demand innovation is becoming more important. In many markets demand is either stable or in
long-run decline. The response is to go for “demand innovation”- discovering new forms of
demand from consumers and adapting an existing product to meet them. Toy industry is a classic
example of this.
5. Globalization is driving innovation and not just in manufactured goods has across a vast range of
households and business services and in particular in high knowledge industries.
Classic example of innovation first achieved by smaller firms:

 Air-conditioning
 Hydraulic brakes
 Digital X-Rays
 Digital cameras
 S0ft contact lenses
 Quick frozen food
 Zap fastener