Explain with relevant examples the main differences between oligopolistic and monopolistic competition. [10]

Explain with relevant examples the main differences between oligopolistic and monopolistic competition. [10] 

Tutor's Note: This is an Economics question modified and simplified from an actual “A” levels Economics examination.

This paper explains with relevant examples the main differences between oligopolistic and monopolistic competition. 

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

Let us examine the characteristics of the two market structures of oligopoly and monopolistic competition. First let us deal with the barriers to entry. There are high barriers for oligopoly, for instance large economies of scale (internal EOS) in the provision of telecommunications services, whereas there are low barriers for monopolistic competition, for instance low economies of scale (internal EOS) in the clothes retails.   

Homogeneous vs Differentiated Products

Next, let us deal with the nature of the product. A product is homogenous when, for instance, every seller sells exactly the same item, for instance, petrol for cars of a certain particular grade such as 95 or 98 octane, whereas on the other hand a product is differentiated when the product sold by a firm is similar, but not exactly identical to that of its competitor’s product, be it "psychologically" or physically different, for instance, branded cars or cars of different makes and styles. 

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.

Profits

Let us now examine the performance of the market structures. What kind of profits would these firms earn? In the long run, only normal profits exist in monopolistic competition, while supernormal profits exist for oligopolies, so monopolistic competition is likely to be more equitable compared to oligopoly, which seems more inequitable.

Efficiencies

In terms of efficiency, there are many arguments to make to show the differences. 

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.   

JC Economics Essays: Tutor's Comments - This Economics paper is short, sharp, sweet, and to the point, and was contributed by a hardworking, dedicated student who composed it under model examination conditions. This Economics essay is also quite well organised and structured, and structured essays are very well received by Economics examiners and teachers. Certainly, we can all learn from it, not just content knowledge but also how to craft to-the-point essays. However, there are a few possible criticisms/ issues: one, the student has not consistently used examples throughout the Economics paper (in particular, "relevant examples") to illustrate his points; two, the student could be more accurate and specific in his introduction by telling the reader, examiner, or Economics tutor reading his paper EXACTLY what he is going to do and say in the paper; three, there is no conclusion, probably because he ran out of time writing; four, he could have defined his terms better and clearer, and more consistently too. Maybe the paragraphing could be slightly better as well, and arguments could be grouped together. Having said that, this Economics essay is still good and in fact the criticisms made would not hurt it very much, because overall it is well written and in examination conditions this precision and clear economic analysis is recognised, valued, and appreciated - although it could have been further improved. Thanks for reading and cheers. 

Discuss, with relevant examples, whether oligopoly is the most appropriate market structure that can explain the behaviour of firms in Singapore. [25]

Discuss, with relevant contextual examples, whether oligopoly is the most appropriate market structure that can explain the behaviour of firms in Singapore. [25]

Introduction - market structure, oligopolies and monopolistic competitive firms

Firms’ behaviours can be explained by the market structures they exist in, where the conditions and situations are the number of buyers and sellers in the market, the type of goods they produce be they homogeneous or differentiated, the barriers to entry that make it easy or difficult for individual firms to enter or exit the industry, and the strategic interactions between different rival firms. These conditions and situations would determine the behaviour of various types of firms in different industries in Singapore. 

In Singapore, it can be argued that the huge, large firms that dominate the economy are largely big manufacturing and service industries, and global Multi-National Corporations/ Multi National Companies (MNCs) that export products overseas. The small size of Singapore’s markets allows just a few firms to dominate and hence it would seem that prima facie oligopoly is the most appropriate structure that can explain the behaviour of firms in Singapore. 

This Economics paper therefore argues that many firms in Singapore are large companies, often exhibiting high barriers to entry and often large economies of scale, and are strategically interdependent on their rivals’ actions, and thus the oligopoly market structure is arguably the most appropriate model for explaining their behaviour. 

However, on the other hand, it can also be argued that monopolistic competition can also describe and explain the behaviour of smaller firms in Singapore, given that there are many smaller firms in Singapore.

Oligopoly can be applied to Singapore’s context

First, there are significant barriers to entry for most large firms in Singapore, which are possibly driven by economies of scale (EOS). As the pure forms of market structures, such as perfect competition and monopoly, do not adequately explain the behaviour of firms in real life, let alone Singapore firms, it has to be argued instead that oligopoly’s features go a long way to describe the behaviour of firms. For example, in the telecommunications industry, starting up requires a lot of capital, and thus this creates a major barrier to entry for most entrants because of the huge fixed, and often sunk, costs required, and thus it is no surprise that Singtel, M1, and Starhub are oligopolistic in nature. 

[Economics tutor's note: For advanced A level students or H3 students or undergraduate students who want to learn more Economics, see Oliver Williamson for more Economics materials on asset specificity. On a related note, for transaction costs: Ronald Coase might be interesting to read about too, on this topic.] 

Other barriers to entry may not be based on EOS, which is a natural kind of barrier; other barriers may be man-made artificial barriers such as laws and regulations, such as those regulating SMRT and SBS – hence, the high barriers to entry that are characteristic of oligopolies are present in many large Singapore firms.

Secondly, oligopolistic markets are also characterised by non-price competition, using aggressive branding to differentiate their goods, with firms being mutually interdependent, which results in their need to monitor their rivals’ actions and devise counter-responses. Strategic interaction, which means responding to rivals’ actions by devising counter-responses, is a particular characteristic of oligopoly not found in other market structures. 

There are many good examples to illustrate this feature. Take the example of the market for Singapore breakfast toast and coffee; the market in Singapore has major firms selling toast, coffee, and tea, alongside a variety of Singaporean foods. These products are differentiated because the meals are tweaked to match unique styles and there are a few other cafes selling similar yet differentiated goods. The market is largely a mix of firms competing with barriers to entry in terms of the cost of branding. There is price leadership in this particular market, with prices of drinks set similarly, and with smaller cafes usually taking their cues for pricing from the bigger chain cafes mentioned.

In major markets such as banking, supermarkets, and telecommunications, non-price competition is easy to spot from differentiated services offered; often a new service or promotion becomes widespread after it is first started by a dominant player in the market, demonstrating once again that the firms are strategically interdependent. Oligopolies have strategic, game-theoretic interactions because they face rivals and not competitors. Because of Singapore’s small market size, most of these markets are dominated by just a few major players, and as such they have to take into account their rivals’ actions. 

In banking, for example, there are the giant firms DBS and UOB, while the Singapore telecommunications industry also features a few giants, Singtel, Starhub, and M1. Whenever DBS comes up with a new form of priviledged banking, UOB must come up with some similar programme too. Singtel, Starhub, and M1 often have advertising campaigns and fund major events such as Formula One (F1), and offer exciting promotions to attract customers to their cable channels.

Monopolistic competition can be applied to Singapore’s context

On the other hand, monopolistic competition can also explain many of the other types of firms in the Singapore economy. Many small firms in Singapore operate in a monopolistic competitive market, characterised by many buyers and sellers, rather differentiated products, and generally low barriers to entry. For instance, hawker fare in hawker centers, restaurants offering Chinese food, and neighbourhood convenience stores (the famous "mama shops") are good examples; namely the point is that firms that are small, with limited market power, and which provide slightly differentiated goods and services are monopolistic competitive. Each has limited pricing power because there are many of them sharing the same market, and barriers to entry are low, thus ensuring these firms earn normal economic profit in the long run, because the presence of supernormal profit would entice others into the market and compete away the profits due to the low barriers to entry. Hence, the monopolistic competition model thus goes a long way in explaining the many different small shops in Singapore’s economy.

Conclusions

While there are many market structures, such as perfect competition, monopolistic competition, oligopoly, and monopoly, primarily monopolistic competition and oligopoly are relevant, given Singapore’s context. Perfect competition and monopoly in their pure forms often cannot be seen in the real world due to their ideal nature. In conclusion, the oligopoly model is one of the most appropriate models that could explain the behaviour of large firms in Singapore, as huge firms dominate major sectors in Singapore's small and open economy. Yet, clearly the smaller firms in Singapore can be explained using the monopolistic competitive market structure. Perhaps it takes more than one market structure to adequately characterise firms’ behaviour in any economy, and not just Singapore’s. However, given that Singapore is a small economy, and most major firms located in Singapore are large, so as to reap massive EOS, even with the presence of many firms engaged in monopolistic competition, oligopoly still seems to be the model most appropriate in describing the behaviours of firms in Singapore. 

JC Economics Essays: Tutor's Comments - This Economics essay on market structure, about oligopoly and monopolistic competition, is rather well argued, interesting, and relevant. The Economics materials presented are based on real life examples from the relevant context, and the English language is fluent and clear. The student presents material that is clear, easy to read, and in a logical, coherent fashion that would impress tutors. The conclusion is evaluative and a judgement is properly made. Overall, it is definitely possible to succeed in writing good Economics essays if students learn how to write such essays under examination conditions, and exhibit these good attributes. However, of course it has to be said that the proper Economics diagrams and the relevant explanations of both oligopolies and monopolistic competitive firms are required for the best grades. Also, at some junctures, this Economics essay seems a bit repetitive, redundant, tautological, and perhaps even convoluted, but overall this issue seems more of a language or writing issue rather than problems with Economics knowledge and content. Do reflect on it and think through the comments; thanks for reading!

(a) What are the various sources of market failure? [10]

(a) What are the various sources of market failure? [10]

Market failure is the failure of the free market to allocate goods in an efficient manner. In a free market economy, there are many types of market failure. This economics paper focuses on three main types of market failure, namely: externalities, both positive and negative, public goods, and imperfect competition in the market. This paper argues that market failure or the inefficient allocation of resources occurs when production is not at the socially optimum level.

First, externalities are said to exist when the actions of producers or consumers affect third parties who are offered no compensation for sustaining the loss generated. Externalities can be known as external diseconomies and economies as well as third party spillover effects. They exist because the market cannot deal properly with the side effects of many economic activities. Externalities involve an interdependence on utility and production functions. An external benefit or a positive externality refers to the benefit from production or consumption experienced by people other than the producers or consumers. This occurs when an externality-generating activity raises the production or the utility of the externality-affected party. Hence, the economic activity provides incidental benefits to others for whom they are not specifically intended.

Suggested Market Failure Figure 1: External cost in production

A negative externality or external cost refers to the cost of production or consumption borne by people other than the consumers or producers. The undesirable effects on the allocation of resources by an externality can be explained by the Marginal Social Cost (MSC). The Marginal Social Cost is a sum of the Marginal Private Cost (MPC) and the Marginal External Cost (MEC). MPC is a share of marginal cost caused by an activity that is paid by the people who carry out the activity and MEC is the share borne by others. When the firm’s activities generate negative externalities, its MSC will be greater than MPC. Since, in equilibrium, the market will yield an output at which consumers marginal benefit is equal to a firm’s MPC. Thus, as shown in Figure 1, MPB is less than MPC, hence the costs that is incurred to society outweighs the benefit derived from the good. Consider the soap industry which, in a free market would discharge waste products into the air and into rivers. The owners of soap factories being profit maximisers will only consider their private costs and ignore the wider social costs of their activities. Thus, MSC is more than MPC.

Suggested Market Failure Figure 2: External benefit in consumption.

An example of an activity which generates an external benefit in consumption is vaccination. If an individual makes a decision to be inoculated against a particular disease, then he will receive the private benefit of not being infected by that particular disease. However, there are also other possible benefits to all others with whom he comes into contact as they will not contract the disease from him. The vaccination protects not only the person who is vaccinated but also the entire community that person lives in, by preventing the spread of contagious diseases. Thus, MSB is greater than MPB. The individuals consider only private benefits and costs in their consumption decisions. Hence, they will consume OQ1 units where MPB=MPC. However, the socially efficient output occurs at OQ2, where MSB=MSC. There is thus an underconsumption of Q1Q2 of the good which results in a deadweight loss equal to the area of E2BE1. Insufficient scarce resources are being devoted to the production of this product. The market has failed to allocate resources efficiently.

Secondly, one major source of market failure is the failure of the free market to provide public goods without government intervention. Economic goods can further be subdivided into public and private goods. A public good is one that has two characteristics that private goods do not. Firstly, public goods are non-exclusive. This means that a producer or seller cannot separate nonpayers from benefiting from the good, so that someone who has not paid for the good cannot be prevented from consuming it. As a result, the payer too, eventually does not want to pay, because of the so-called free rider problem. As a consequence, the market will not produce a public good. This is market failure.

Using the concept of externality for public goods, there are no private benefits or revenue for the producer at all but more benefit for the society. Examples of public goods are street lighting, defence and radio broadcasts. The second characteristic is that public goods are non-exhaustible or non-rival. This means that the use of the good by one person does not reduce the quality or the amount available to another. As a result, there is no rivalry in consumption. As a result, there is no additional opportunity cost for the second and third person to use. Assuming that the allocative efficient level is P = MC, and MC = 0, then it stands to reason that P = MC = 0, and the good should be provided free of charge if it is to be produced at the socially optimal level. 

Third, there is the existence of imperfect competition which distorts a free market economy. In a free market economy, there is nothing to prevent the emergence of oligopolies and a monopoly in various industries. An oligopolistic market can be defined as a market structure where there are a few dominant firms which are rivals to each other, each producing either homogeneous or differentiated products, while a monopoly can be defined as one dominant firm producing a highly differentiated good with no close substitutes. The more successful firm (or firms) acquires other firms or puts them out of business. When these imperfect market structures occur, there will be allocative inefficiency because they generate shortages in order to hike up prices and increase profits.

Insert Economics diagram. Either oligopoly or monopoly diagrams. 

Hence, market failure usually results from the presence of externalities, the lack of provision of public goods and the allocative inefficiencies from imperfect competition. Thus there is a role for government intervention in the market to achieve a better outcome in terms of allocation of resources.

JC Economics Essays: Tutor's Comments - This economics response is a well-written and well-crafted Economics essay, that was written under model examination conditions; good work MJ! Special thanks to MJ for her kind contribution. Excellent. NOTE: This economics essay has been edited to make the language flow better but the main points were still written under examination conditions. Thank you for reading and cheers. 

Since large firms enjoy EOS, they are therefore more efficient and should be welcomed by society. Do you agree? [25]

Since large firms enjoy EOS, they are therefore more efficient and should be welcomed by society. Do you agree? [25]

Economies of scale (EOS) refers to the cost savings derived from large scale production of the firm. EOS can be generated internally or externally. If the average costs decrease due to the increase in the scale of production of the firm itself, we say that the firm experiences internal EOS. EOS allows efficiency to be achieved. To be economically efficient a firm has to achieve productive and allocative efficiency. Productive efficiency refers to the least cost method of production. Allocative efficiency on the other hand, occurs when the right amount of the right kind of goods are being produced. This occurs when the marginal social benefit is equal to the marginal social cost, society welfare is thus maximized. On top of that, Pareto efficiency also has to be achieved. Pareto efficiency is when it is no longer possible to change the allocation of resources such that it makes at least one individual better off without making any other individual worse off.

Large firms are firms usually classified as oligopolistic or monopolistic firms. An oligopolistic market occurs where the industry is dominated by a few large firms which control a large proportion of the industry’s output. These firms have a large share of market power. Similarly, in a monopolistic market, there is market dominance because a single firm controls the whole supply of a product which has no close substitutes. As a result of the large market share, profits gained from production will allow these large firms to achieve efficiency through EOS. As long as these EOS can be filtered down to consumers in terms of lower prices and higher output, I agree that because large firms enjoy EOS, they are therefore more efficient and should be welcomed by society.

A firm enjoys internal economies of scale if its average cost of production falls as its scale of production increases. This is represented by a movement along the downward sloping portion of the Long Run Average Cost (LRAC) curve. Average cost refers to cost per unit of output. This is illustrated in the figure below.

Insert Economics diagram - thinking question: what will this economics diagram look like?

A large firm can enjoy internal economies of scale through marketing economies. This occurs when a firm gets bigger and it buys inputs such as raw materials in bulk. Suppliers of these inputs, in their eagerness to secure the firm’s orders, will often offer a discount on its purchase. This lowers the firm’s unit cost of production. A firm can also enjoy marketing economies when it enjoys the ability to spread its advertising costs. Since a bigger firm produces more output, its total advertising cost is spread over a large output, thus unit cost is reduced. Such large firms can also enjoy EOS through financial economies whereby larger firms may be able to obtain financial loans at lower interest rates due to more credit worthiness. It can also raise funds in the capital market by issuing shares to member of the public. Moreover when a firm expands, it is also able to hire professionals to specialize in different areas of work. Different departments can be set up, each led by an expert in the field. With these expertises, a firm’s output can be increased, thus lowering its unit cost of production. This may not be worthwhile or economical for a smaller firm. This is known as managerial economies of scale. As such EOS allows for large firms to be more efficient as they get to reduce costs of production, achieve a minimum efficient scale (MES) and be more productively efficient. This will eventually result in costs savings passed on to consumers in the form of lower prices for the goods and services provided.

However, in the case of a natural monopoly, society has no choice but to welcome it into the market. A natural monopoly occurs when a tremendous amount of capital is required to produce a product or service. This leads to very large economies of scale and the firm’s MES occurs at a very high level of output, such that there will only be one firm in the market. This huge capital requirement means that total fixed costs make up a very large part of the total cost. Such examples of a natural monopoly would include producers for utilities such as gas, water and telecommunications. In the case of Singapore, the telecommunication lines are monopolized by Singtel. Although a natural monopoly is allocatively inefficient in P=MC pricing, where the cost of the good is equal to the marginal cost of producing a good, it is definitely more efficient than trying to duplicate the number of firm through liberalization. This is because the new entrant will eventually collapse to form a monopoly again because the duplicity of firms would cause the new entrant to incur large losses. As such, society would still accept such natural monopolists in the industry. This can be depicted by the existence of Singtel.

However, society should not welcome such large firms because there are disadvantages of EOS when it is being reaped beyond MES. These are internal diseconomies of scale (disEOS). Internal diseconomies of scale are the cost disadvantages a firm experiences as it increases its scale of production. When a firm becomes too large, its average cost of production rises as its scale of production increases. This is represented by a movement along the upward sloping portion of the LRAC curve. Internal disEOS are largely managerial inefficiencies. This can arise from the increase in complexity in management and greater difficulty in co-ordination in a large organization. A firm grows so large that it becomes more cumbersome to manage. It becomes more bureaucratic and decision-can also making process slows down. Work efficiency can be reduced by excessive paper work which results in low productivity and higher unit cost. Management problems of co-ordination may also appear as the organisation of the firm becomes too big. It becomes increasingly more difficult for top management to co-ordinate and monitor all operations, thus inefficiency may creep in. This increases unit cost.

Insert diagram - how will this economics diagram look like? Remember now that it is about disEOS rather than EOS.

Society should also not welcome such large firms because these firms tend to be monopolies. Monopolists experiences static inefficiency, or a lack of dynamic efficiency. Static efficiency is attained when there are both productive and allocative efficiency. The monopolist is productive efficient as long as it maximises profits. However, a profit maximising monopolist produces output up to the level where P>MC. Since consumers value the last unit of the good more than it costs to produce, the good is underproduced and increasing the output can increase the welfare of the consumers. The underproduction of the good has led to the loss in welfare for the society. This can be illustrated in the diagram below.

Insert economics diagram. Apply usual thinking!

As such, under similar cost conditions, the output produced by a single monopolist is lower and the price charged higher than the perfectly competitive industry. The perfectly competitive industry will produce where demand equals to supply, at output Qpc, and charge a price Ppc. However, the monopolist would produce at Qm, and charge a price equal to Pm.

Moreover, society should not accept large firms because there will be an unequal income distribution. This is because the monopolist can earn supernormal profits even in the long run due to barriers to entry. If a monopolist makes supernormal profits, these profits will go to shareholders who may be mainly upper income earners, This may worsen the income distribution in the economy. The existence of supernormal profit suggests that producers receive greater income than is needed to induce them to undertake their operations. The lack of competition enables them to receive higher profits than is economically justified. Thus income is more unequal than it needs to be.

In conclusion, large firms who enjoy EOS are accepted in the economy but too much of it will be non-beneficial for the industry. Hence, to ensure that society benefits equally, government intervention is needed where policies such as AC-pricing and taxation of profits are carried out.

JC ECONOMICS ESSAYS: Tutor's Comments: A very good attempt! Covers the majority of the points needed to tackle this exam question. This model Economics essay was written under "A" level Economics examination conditions. Economics tutor's suggested grade: 20/25. How would you improve this essay, and how would you approach the task of crafting a well argued, nuanced, balanced, and evaluative Economics answer? Perhaps the evaluation in the conclusion could be better, more argumentative, and more justified with relevant examples. Thanks for reading and cheers. Stay here for more Economics essays and materials.