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

Chapter Eight: Market Structure: From competition to monopoly 190 is unique enough to justify a monopoly price. I have to admit, it works for me! I love my preferred brands, and once I get in a habit, I rarely change. At that point, the price difference has to be really large before I’ll switch. Can you think of brands that you consider “must” buys? Has Hollister convinced you that their clothes are much better than Levi’s? Monopolistically competitive firms will strongly emphasize their brand as part of their competitive posture; their competitive efforts tend to focus on non-price dimensions like quality, taste, “cool factor,” etc. In monopolistically competitive markets, entry barriers are relatively low. This is why companies in these markets tend to compete on non-price dimensions. If they competed primarily on price, the lack of substantial barriers to entry would keep them constantly at risk of competitors entering the market. But when brands are emphasized heavily, it’s much harder to convince a buyer that the quality, style, or taste is better. Consider this: what would it take to convince you to wear a “no-name” pair of jeans to a function with your peers? Would a cheap price work? If you’re like most students, probably not. Oligopoly markets are similar in many respects to monopolistically competitive markets, but the key difference is that oligopoly markets have high barriers to entry. If there were no significant barriers to entry, then any attempt by oligopolists to collude to raise prices would result in additional firms entering the market and undercutting their price. One of the barriers to entry may be large economies of scale that the current oligopoly firms have, where the large size of the firm enables them to produce the product much cheaper than a smaller market entrant. For example, it is much cheaper for Ford to produce cars than a new startup company; the large factories and capital equipment which enable cheap production would be hard for a small firm to duplicate. The fact that each oligopolist has a large market share ensures that individual firm decisions will impact the entire market. Since one firm’s action will influence the overall market, there is interdependence between all the firms; each firm must consider other firms’ possible reactions to their move (think back to our chess game). Since oligopolists have market power and can set prices, there is the potential that if they can secretly agree to form a cartel , they can restrict output to gain monopoly profits. As the famous economist Adam Smith said, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Or as Amos 3:3 says, “Do two walk together, unless they have agreed to meet?” If they could all agree on output levels for each firm, then they could restrict output to the monopolist quantity as in Figure 8.5 earlier, and could share in the monopolist’s profit (the orange shaded area between P* and P M ). As with monopoly, oligopoly does not engage in all mutually beneficial trades and therefore does not lead to allocatively efficient results, since consumers value additional production at a price greater than it would cost the producers to make. Cartel: a group of firms that enter into an agreement, usually to control output in order to split a monopolist’s profit. A cartel usually features a homogenous product. Oligopoly markets are similar in many respects to monopolistically competitive markets, but the key difference is that oligopoly markets have high barriers to entry.