A. How do monopolistically competitive markets differ from perfectly competitive

Question

A. How do monopolistically competitive markets differ from perfectly competitive markets? If monopolistically competitive firms are making profits in the short run, what happens in the long run?

B. How do monopolistically competitive firms exhibit market power? In what ways can a firm increase market power?

C. Explain what strategic interdependence means and how it applies to oligopoly markets.

D. Why is it difficult for cartels to maintain high prices effectively over the longer term?

E. Why would the use of repeated games make overcoming the Prisoner’s Dilemma easier compared to a game that is played only once?

F. What is the difference between a tit-for-tat trigger strategy and a grim trigger strategy?

Explanation / Answer

A) A perfectly competitive market is fundamentally different from a monopoly and there lie monopolistically competitive and oligopolistic firms in between them. In a perfectly competitive industry, there are large number of firms with equal market share.

There are so many firms in the market that no one is able to influence the market price by altering its output or cost. In comparison, the presence of differentiated products is a specific feature of a monopolistically competitive market. Brand value and differentiated products with no close substitutes are the other two distinct features of monopolistic competition.

Perfectly competitive industries yield efficient outcomes while monopolies yield inefficient outcomes. Hence, an appropriate policy, whose goal is to increase efficiency, would be to reduce monopoly power and by increasing the level of competition in monopoly markets.

Perfect competition involves no deadweight loss. Monopoly involves deadweight loss

If monopolistically competitive firms are making profits in the short run, there is an attempt by new firms to enter the industry in the long run but these markets pose significant and effective entry barriers like patents, trademarks, etc. So even in the long run, these firms can make economic profit in the long-run

B) Perfectly competitive firms have the least market power (i.e., perfectly competitive firms are price takers), which yields the most efficient outcome. Monopolies have the most market power, which yields the least efficient outcome.

Legal restrictions and control over a key resource are two other sources of barriers that deter the entry of a potential entrant in the market.

The incumbents (existing firms) use trademarks, patents, licenses and service marks so that the new entrants cannot possibly access the resources of production, especially the available technology. A patent grants the holder the exclusive right to sell the product for 20 years from the day of its grant.

Controlling essential resources grants sufficient monopoly power to the firms. Monopoly profits often spring from supplying something that other producers cannot match. Local monopolies are more common. Technological advancement overtime breaks down the barriers to entry in the long-run

C)

Oligopolistic market structure involves few firms taking strategic decisions of production and price setting, given that the firms are interdependent. There is no single theory that can count its features but rather a set of theories, each based on the diversity of observed behavior. These theories suggest that firms profoundly analyze the behavior of their rivals before arriving at their own decisions.

Collusion, price leadership, and game theory are some of the theories that determine the governing principles. These models identify formal and informal efforts to collude and the strategic decision making process that firms employ when collusion does not occur

D) Cartels like OPEC operate in a manner similar to monopoly. Hence the optimal level of production is the one at which marginal cost equals the marginal revenue.

The Oil Cartel aims at delivering a constant supply of petroleum at steady and fair price to its consumers and simultaneously earn a fair return on capital for its investors. However this aim cannot be accomplished when it has to face stiff competition from other non-member countries.

When the total supply of petroleum world market is increased, prices are bound to fall. Hence the only way the Oil Cartel can maintain a steady price level (or at least prevent petroleum prices from falling) is by reducing its own supply. Then the non-member countries will be pressurized to cater the world market and this will reduce their profits.

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