Tutor's Note: This is an Economics question modified and simplified from an actual “A” levels Economics examination.
What is Oligopoly?
What is oligopoly? Oligopoly refers to a market where the barriers to entry are high, such that there exist only a few large firms in that particular industry, each with a significant market share, selling either homogeneous or differentiated products. Homogenous products are products that are perfectly substitutable for each other and have little or no product differentiation, unlike differentiated products.
What is Monopolistic Competition?
What is monopolistic competition? Monopolistic competition, on the other hand, refers to a market where the barriers to entry are low, such that there exist many firms, each with insignificant market share, selling somewhat differentiated products. This paper deals with the characteristics first and then the nature of the products sold, and then finally the performance of the two market structures.
Barriers to Entry for Oligopoly and MC Firms
Homogeneous vs Differentiated Products
Monopolistic competitive firms sell differentiated products, and hence as such derive their pricing power from their product differentiation, whether it is merely psychologically perceived or actually substantially differentiated.
Oligopolies, on the other hand, can sell either differentiated or homogenous products, and their source of market power comes instead from their large market share arising from the few players that exist within that industry, and their huge economies of scale.
First, an oligopoly may be X-inefficient – meaning that it does not work energetically to cut costs – but monopolistic competition is X-efficient as well.
Both market structures are allocatively inefficient, where allocative efficiency refers here to P = MC, but the extent is likely much greater for oligopoly, because the price will be much higher than marginal cost for an oligopoly compared to monopolistic competition, which also has P > MC, but not by that much.
In terms of dynamic efficiency, oligopoly generates more research and development (R&D) than monopolistic competition, and as such is more dynamic efficient because it has the willingness and ability to innovate.