Monopolistic Competition: Many Unique Products

Perfect competition and perfectly competitive markets exist in only a few businesses or industries. In fact, most businesses work very hard to make consumers believe that their products and services are special or unique. When many firms are selling similar products and services while explaining how they are “new and improved” or “used by professionals”, or “the best value for the lowest price” the market is no longer competitive. Economists describe a market with many sellers providing similar but not identical products as monopolistic competition.

Mary Lou and Hot Dog Harry operate competing sidewalk stands fairly close to one another on the same street in town. At lunchtime both Mary and Harry do a brisk business, and they both have their steady customers. Ask Mary’s regulars why they prefer her hot dogs and they might tell you that they think the sauerkraut she serves with them is something special or that they like the courteous way in which she treats her customers. Harry’s customers are equally enthusiastic about his frankfurters and about Harry. Harry charges $.90 for his hot dogs. Mary Lou charges $.95. There is another stand a few blocks away where the frankfurters sell for $.85, but that one does not do as well as Mary Lou or Hot Dog Harry.

Although Mary Lou and Hot Dog Harry sell similar products, they are not the same in the minds of those who prefer one over the other. The effort to make a product more attractive than the competition’s distinguishes monopolistic competition from perfect competition.

Although stock market trading is as close to perfect competition as anything you can find, stockbrokers provide an example of monopolistic competition in a service industry. Stockbrokers will not claim that the shares of General Motors stock they buy and sell for you are any different from the shares that anyone else buys or sells. But stockbrokers do compete with one another or the public’s business. They try to make their services more attractive than the competition’s so potential customers will think of them the next time they think of investing.

The process of creating uniqueness in products is known as product differentiation. Product differentiation, when it is successful, enables a firm to create product loyalty so its customers prefer its products over the competition’s.

Oligopoly: A Few Sellers

Oligopoly is a term applied to markets dominated by a few (roughly three to five) large firms. Breakfast cereals, automobile and computer hardware are examples of industries dominated by oligopolies. As the market structure of an industry changes from many firms selling differentiated products to a few firms dominating an industry, economists say that the “concentration ratio” is changing. The concentration ratio is determined by the percentage of an industry’s output accounted for by its four largest firms.

Oligopolies exist because it is difficult for competing firms to enter the market. Circumstances that make it difficult to enter the market are described as "barriers to entry." One such barrier is the high cost of entry. The capital needed to enter the automobile manufacturing business, for example, would run to billions of dollars.

Another barrier to trade is created by patent protections. The products of certain industries, such as aluminum, chemicals and electronics, are protected by patents. Competing firms cannot enter those industries unless they pay the patent holders for permission to use the process or find a new method of production not covered by existing patents.

Price competition is less effective where there is oligopoly. Firms know that if they reduce their prices the competition will do the same. Therefore, instead of increased sales (as would be the case in a competitive market), price reductions would simply reduce revenue. In place of competition, oligopolies often look to price leadership, collusion, and custom to determine their pricing policies.

Ø Price leadership is the practice of one firm in the industry, usually the largest, setting a price which other firms follow.

Ø Collusion is a secret arrangement between two or more firms to fix prices or share the market. These agreements are usually illegal.

Ø A Custom is the prac­tice of establishing prices and market shares based on long­standing tradition. Sometimes the courts have found such practices to be unlawful; in other instances they were found to be legal.

Monopoly: One Seller

A market in which there is only one seller is a monopoly. You will recall that under conditions of perfect competition market price could be found at the intersection of the supply and demand curves. In those circumstances both supply and demand reflect the thinking of many buyers and sellers; no individual or group could affect the market price. In a monopoly, however, supply is determined by a single firm. This gives that firm the power to select any price it chooses along the demand curve. Which price will it choose? The one that yields the greatest profit.

Monopolies have the following characteristics:

· A single seller or monopolist.

· No close substitutes. The product sold by a monopoly is different from those offered by other firms. Buyers must either pay the monopolist's price or do without.

· Barriers to entry. Competing firms are unable to enter a market where a monopoly exists.

Legal Monopolies

Although monopolies are generally illegal in this country, the law does provide for a variety of legal monopolies such as: public utilities, patents, copyright and trademarks.

Public Utilities are privately owned firms that provide an essential public service. They are granted a monopoly because it is felt that competition would be harmful to the public interest. Your local electric, gas and water companies are public utilities. Utilities are subject to extensive government regulation and supervision.

Imagine the complications that one electric company served your community. Each would have its own power lines, maintenance organization and generating plant.

Competition, however, provides businesses with the incentive to keep prices down and improve services. In place of competition, government protects the public by regulating the activities of the utilities. Government supervision is carried out by regulatory commissions which determine the services the utilities provide and how much they are permitted to charge for them.

Patents as Monopolies. How would you like to come up with a new idea – something that could be turned into a new product or service that would make you rich and famous? To encourage you, the federal government grants patents to cover new products and processes. In a sense, a patent is a monopoly. It gives the inventor exclusive use of a product or idea for 17 years. You may sell your idea or give it away, but it is yours to do with as you wish. Eventually, someone will develop a product or service that will be acceptable alternative to yours. It, too, might qualify for a patent and perhaps compete with yours.

Copyright and Trademarks as Monopolies.

Though the Federal Copyright Office, the government gives the authors of original writing and artistic work a copyright – the exclusive right to sell or reproduce their works. That copyright is a special monopoly for the lifetime of the author plus fifty years.

Trademarks are special designs, names or symbols that identify a product, service or company. “Coke” is a trademark of the Coca-Cola Company. Competitors are forbidden from using registered trademarks or ones that look so much like trademarks consumers will confuse them with the originals.

How Competition Benefit Us All

In a competitive market, producers constantly strive to reduce their production costs as a way to increase profits. The increased efficiency that allows them to reduce their costs also enables producers to sell their goods at a lower price. Thus, by promoting efficiency, competition leads to lower prices.

Competition also motivates producers to improve the quality and increase the variety of goods and services. Consumers soon learn which brand offers the best value, and that firm will earn greater profits than its competitors. Similarly, producers in a competitive market must constantly look for new and attractive goods and services to win a larger share of the market.

As firms compete for the consumer’s dollar in a market, their efforts lead to the production of a variety of better-quality products at the lowest possible prices. And since we are all consumers, it follows that competition benefits us all.

Federal Regulation: The Antitrust Laws

The American free enterprise system is based on the belief that competition is in the best interest of everyone. When competitors agree to fix prices, rig bids or divide the market, the public loses the benefits of competition. The prices that result are artificially high. This is unfair to consumers who must pay more for the things they buy. It is damaging to an economy that looks to the price system to signal what goods and services are in demand and the most cost-effective way of producing them.

For that reason, the federal governments and many state governments have enacted legislation known as antitrust laws – laws designed to safeguard competition. The major federal antitrust laws are The Sherman Antitrust Act, the Clayton Act, the Federal Trade Commission Act, and the Celler Antimerger Act. Nevertheless, many businesses are naturally interested in growing and controlling as much of a market – or several markets – as possible. One way to accomplish this goal is through merger.

Do Antitrust Laws Help or Hurt?

Many of those who favor competition, however, also feel that government interference in the marketplace is inappropriate. They are especially concerned about the effect of antitrust laws on the ability of corporations to compete with their foreign coun­terparts. They argue that many foreign companies operating in countries that have no antitrust laws have an unfair advan­tage. For example, Japanese computer firms can assist each other in developing and marketing new software. Such cooperation by American companies might violate antitrust laws. While the intent of the law is to protect American consumers against price-fixing and other conspira­cies, its effect in this situation may limit the American compa­nies' ability to compete.

Those favoring strict enforcement of the antitrust laws say that the foreign competition argument is simply a smoke screen by firms looking to eliminate their competition. The key to outperforming foreign competitors, they say, lies in a more efficient operation rather than ever-increasing size.