No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eight: Market Structure: From competition to monopoly 189 bolt from their current provider at the first opportunity embolden other potential suppliers, since they potentially would be able to capture the entire market demand from the incumbent provider. Most businesses spend a great deal of time not only to attract a customer, but also to create “brand loyalty” to keep that customer. Short-term opportunism of taking advantage of customers is therefore unusual for established firms. MONOPOLISTIC COMPETITION & OLIGOPOLY While true monopoly is relatively rare in actual market structure, many goods or services are provided by just a few firms (each with large market shares). Oligopoly (wow, can’t economists come up with a better name than this?!) and monopolistic competition market structures are both price searchers. Just like monopolists, firms in these market structures will be able to set the price—but they don’t exactly know the consumer’s demand. However, not only must they consider what the customer is likely to pay (they try to predict the customer demand), they must also carefully consider the reaction of other firms in the market to their own actions. While having market power— the ability to set their own prices—like a monopolist, they must nonetheless compete . A fundamental factor of this competition is the interdependence of a firm’s actions, which necessitates “strategic behavior.” Think of a firm’s strategic behavior as a chess game. Whenever you move your piece in chess, you not only consider how this advances your overall strategy, but you must also carefully consider how the other player may react to your particular move. Hopefully not “Checkmate!” An example of a monopolistically competitive market is the soft drink market. Coke and Pepsi ( Figure 8.6 ) products dominate, and while Coke has a monopoly on coca-colas, Pepsi is clearly a close substitute. In the broader market for soft drinks, there are always marginal buyers who are willing to switch brands if the price difference is high enough. So when setting the price of coca-colas, Coke has to consider Pepsi’s likely reaction to the price, in addition to the consumer’s reaction. Coke also has to consider whether its pricing policy might encourage additional competitors to enter the fray. Should Coke raise its price while Pepsi does not, rather than profits rising, Coke may see profits fall as buyers switch to the cheaper alternative (Pepsi). And just like in the game of chess, market participants need to anticipate multiple moves in the game, not just the initial reaction. You have likely watched commercials advertising both Pepsi and Coke, such as my favorite commercial here. Each of the firms tries to convince potential customers that their product is newer, better, or different enough such that the other firm’s product is not really a good substitute. This strategy is known as product differentiation : where brands of similar products attempt to convince consumers that their product really Oligopoly: a market structure with few firms and high barriers to entry. Figure 8.6, Pepsi and Coca-Cola Logos Pepsi Logo (public domain) 3 Coca-Cola Company Logo (public domain) 4 Product differentiation: a marketing strategy to show the differential advantage of a firm’s product over possible substitutes.