Oligopoly and Perfect Competition: Concepts, Advantages and Disadvantages
What are an oligopoly and perfect competition?
An oligopoly is a market in which each company's product is not unique and the number of competitors is limited. It is characterized by :
- Basically homogeneous products, such as basic chemicals or gasoline.
- .Relatively few sellers, such as some large companies and many small companies that follow large companies.
- Demand curve of obviously inelastic industry. Here, competing companies carefully monitor each other's market prices.
Each company must expect to raise its own price above the market price without incurring a significant loss in sales, and if possible, competitors will follow the price up. Unlike oligopoly. Perfect competition, also known as pure competition, is a kind of market structure without any obstacles and interference, refers to those who do not exist enough to affect the price of enterprises or consumers of the market. It is the ideal state of market competition in economics and also one of several typical market forms. It can be proved that the result of perfect competition conforms to Pareto optimality. Perfect competition is a market structure in which homogeneous goods have many sellers, no seller or buyer controls the price, access is easy, and resources can be switched from one user to another at any time. For example, many agricultural markets can be viewed as infinitely close to perfect competition, but not equally so, since perfect competition is idealized.
As we can see through those big companies all over the world, some of them are great examples of oligopoly such as some world-famous car manufacturers, Mercedes, Lexus, and BMW. All these oligopoly companies have a lot of things in common, except for the points I mentioned above, there are also three typical features of oligopoly companies.
One: Oligopoly has the following three conditions: (1) the number of enterprises is very small. (2) interdependence. (3) it is not easy for enterprises to enter and exit.
Two: the most remarkable characteristic of oligopoly is that the seller must realize the interdependence among them.
Three: Price rigidity. The reason why the demand curve is bent is that other companies' response to the price change of an enterprise is asymmetric. The meaning of the bent demand curve model is that under the oligopoly market structure of companies that do not change their prices even if their marginal costs change significantly.
Perfect competition, The ideal state of market competition in economics. It also has some conditions that need to be met.
One: There are many market subjects, which is a large number of buyers and sellers. With a large number of sellers, each seller has a small share in the market, and the change of sales volume of individual buyers does not affect the market price of the goods; meanwhile, any one of the numerous buyers can not affect the market price with the change of demand.
Two: The market object is homogeneous, which means there is no difference between products, and the buyer has no special preference for the specific seller. In this way, the competition between different sellers can be completely equal.
Three: The total production resources of estrangement can flow freely, and each manufacturer can enter or exit the market freely according to their own wishes. Four: Information is sufficient, that is, consumers fully understand the market price, performance characteristics, and supply of products; The producer is fully aware of the prices of inputs, finished products, and production technology.
The efficiency of oligopoly and perfect competition
To my opinion, to measure the efficiency difference between these two marketing methods is simple, to use theories which is known as formulas. Let's start with perfect competition. In a perfectly competitive industry, all companies are price takers, which means they have no control over the market price of their products. In addition, all companies have relatively small market shares and consumers don't like a product. (Simon, 2018) The formula for a perfectly competitive market is simple:
‘Price = Marginal revenue = Marginal cost = Average cost’
‘P = MR = MC = AC’
As long as the marginal benefit of the enterprise is greater than or equal to its marginal cost, it should increase the production unit. In the short term, a company should be closed if its losses exceed its fixed costs. In the long run, in a perfectly competitive market, all enterprises will obtain economic profit = 0 (economic profit = total revenue - total cost = 0), and long-term equilibrium will occur when marginal cost = average total cost (MC = ATC), that is, the output of production efficiency.
Some economists claim that perfect competition is not a good market structure for high levels of R & D spending and the resulting product and process innovations.
In fact, a monopoly or oligopoly market may be more effective in the long run in creating a thriving environment for research and innovation. Under the assumption of complete information, cost reduction innovations from one manufacturer will be immediately transferred to all other suppliers at no cost. That is to say, a competitive market provides companies with discipline to control costs, minimize waste of scarce resources, and avoid exploiting consumers by setting high prices and enjoying high-profit margins. In this sense, competition can promote static and dynamic efficiencies over time. Therefore, the long-term performance of perfect competition is the optimal level of economic efficiency. But to achieve this, all conditions for perfect competition must be met-including in relevant markets.
Next, let's talk about oligopoly. Oligopoly is a state of limited competition in which the market is Shared by a small number of producers or sellers. If there is cooperation and trust between companies in an oligopoly, they can, in theory, maximize profits by setting monopoly prices. If the oligarchs succeed, they will set prices and production so that the industry's marginal revenue equals marginal cost (MR = MC). We can also think of oligopolies simply as a mixture of perfect competition and monopolistic markets.
In economics, people often think of 'best' as a synonym for 'most effective.' There are many different types of efficiency, but the most important are distributive efficiency and productive efficiency because they represent the degree to which goods and services are produced and sold at the lowest possible price. Intuitively, a perfectly competitive market seems to have the best management capabilities, because in the long run, a lack of market-driven firms and availability of complete information means that price equals marginal cost (the condition of distributive efficiency) and production is measured at average total cost -- the lowest point (the condition of productive efficiency) is finite. However, it is unrealistic to assume perfect competition, such as complete information and no barriers to entry. Moreover, while monopolistic markets are neither allocative nor productive, their companies tend to benefit from economies of scale because their privileged position allows them to expand. This shifts their cost curve downward, allowing them to produce and sell products at prices lower than those of perfect competitors.
Real-world growth-inducing properties of oligopoly and perfect competition
It’s pretty hard for an enterprise to live in such a competitive market nowadays. Not only for those oligopoly companies but also for those perfect competitions. To grow in such an economic environment needs many strategies and market-leading abilities. As we know, rivalry among sellers is indispensable, it exists with marketing.
Let’s make a simple example which clearly shows how oligopoly companies play against each other. In the simplest oligopoly, where there are few sellers and each one provides sufficient market share, any feasible, modest policy change will significantly affect the market share of all competitors and prompt them to react. For example, if the seller reduces the selling price is lower than the general level of prices charged to all the sellers in order to be able to get a lot of customers from rival competitors and keep sales at constant prices, they will probably respond, reduce the price of it, so any gains and group could reduce the cost of the overall profits. Alternatively, seller A's competitor could retaliate by lowering the price even more than he did, forcing him to react further. Conversely, if seller A raises its selling price above what all sellers would normally charge (so that at least some customers lose out to competitors), they may react by keeping the price unchanged. In this case, seller A can resume its price increase and restore its price to the previous level. But his competitors could also react by raising their prices, just as seller A raised his prices. In this case, the price level of the whole industry will rise, and the total profit of all sellers may increase.
Therefore, in the case of oligopoly, competitors are likely to reach a workable collusion agreement. They can be an explicit agreement by contract or tacit agreement. This tacit development evolved into the seller's reaction to each other's price changes, or market policy becoming a habit. In the United States, blatant collusion agreements are prohibited by law, but in the oligopoly industry, tacit agreement or 'gentleman's consensus' is common. However, these implied agreements may be interfered by many factors, including the decline of demand or technological progress, which make the enterprise reduce profits while making profits. In many other western countries, formal conspiracy agreements (often referred to as cartels if they are broad-based) are legal. Whether implied or explicit, legal or illegal, we can say that the price of oligopoly is usually 'manipulated' by the seller. In this sense, this is different from prices determined by non-individual market forces.
But to perfect competition, also, a simple example can tell us how this kind of firm runs their own business and what would they provide to buyers. If the temporary equilibrium price is high enough to make the profit of the existing seller exceed the normal investment interest income, more sellers will be attracted into the industry and supply will increase until the final equilibrium price equals the minimum average production cost (including interest income) of all sellers. Conversely, if the temporary equilibrium price is too low and established sellers suffer losses, some sellers will exit the industry, causing supply to decline until the same long-term equilibrium price is reached.
Therefore, the long-term performance of pure competitive industries shows the following characteristics: (1) the industrial output is at the feasible maximum, and the industrial sales price is at the feasible minimum; (2) the average cost commitment of all products is the lowest level that can be achieved because competition forces them down; (3) the distribution of income is not affected by the excess profits of the seller.
Why does oligopoly appear to be the most prevalent market structure in the contemporary business world?
There are many reasons why an oligopoly is a more realistic market. Many product markets in major countries have several major vendors. For sneakers, it's already Nike and Adidas. Soft drinks -- Coca-Cola and Pepsi. Like Samsung and apple. For cars and appliances, only a few names are common. One explanation is that companies need to invest a lot of money to start production. Modern technology is expensive. Gone are the days when one man could run a family business making shoes, furniture, and even cars. Today's market is characterized by mass production with lower unit costs and therefore lower prices. As a result, the number of new companies entering the market plummeted.
The second, is fierce competition. To maintain this, companies need to reduce costs by exploiting economies of scale. Companies increase capital through mergers and acquisitions. In return, they can enjoy big acquisitions, better chief executives, modern technology, Labor specialization, advertising, and a vertically and horizontally integrated economy.
The third reason is a change in consumer buying habits. Today, consumers are no longer willing to buy from small, unknown companies. They would rather buy from a big, famous company, even if the price is higher, because of the guarantee and better after-sales service. Modern electronics leave consumers helpless when their products fail. He has nothing to make up for. Therefore, it is best to buy from a reputable company.
Finally, another reason why markets become oligarchs is better entrepreneurship. Businessmen today are better educated. He knew that when producers cooperated on price and production, his company would be profitable. This is not at the expense of consumers.
References
- ADAM HAYES (2019) Perfect competition [Online] Available from: https://www.investopedia.com/terms/p/perfectcompetition.asp
- JIM CHAPPELOW (2019) Oligopoly [Online] Available from: https://www.investopedia.com/terms/o/oligopoly.asp
- Simon (2018) CFA – Perfect competition vs Monopoly vs Oligopoly [Online] Available from: https://analystprep.com/blog/cfa-perfect-competition-vs-monopoly-vs-oligopoly/
- Joe S. Bain (2019) Monopoly and competition – Economics [Online] Available from: https://www.britannica.com/topic/monopoly-economics
- Daniel E. What is the best market structure? [Online] Available from: https://www.mytutor.co.uk/answers/1810/A-Level/Economics/What-is-the-best-market-structure/
