Market Structures - Monopolistic Competition and Oligopoly

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CHARACTERISTICS OF MONOPOLISTIC COMPETITION

Large number of small firms

The firms seek to maximise profits where MC=MR

Firms possess some ability to set price

Products are differentiated

Abnormal profit only in the SR - LR (normal profit - AC=AR)

Low barriers to entry and/or exit

CHARACTERISTICS OF AN OLIGOPOLY

Dominated by a small number of large firms (high concentration) - largest 4/6 firms may have 60%+ market share

Significant barriers to entry and/or exit

Firms may/may not be profit maximisers (MC=MR) and may seek to maximise sales (AC=AR), or to maximise sales revenue (MR=0)

If abnormal profit is sought then its available in both the SR and the LR

Evidence of price rigidity - shown by the kinked demand curve

Potential for collusion - firms decide and agree to increase prices and restrict output (exert monopoly power). This is illegal - increases revenue

Potential for price wars - damages firms - decreases revenue

Existence of non price competition - due to price rigidity firms will differentiate their products/services to compete on a basis other than price

Interdependency - mutual reliance

ALTERNATIVE OBJECTIVES OF FIRMS

It would seem that all firms should operate at a level of output where MC=MR and profits are maximised but this doesn't always occur. There is a number of reasons for this:-

In practise it may be difficult to identify this output. It is also likely to be very difficult to calculate their marginal cost and their marginal revenue. Instead the firms may simply work out the cost per unit and add on a profit margin in order to determine the selling price

ST profit maximising may not be in the LT interest of the company

Large abnormal profits may attract new entrants into the industry making existing firms vulnerable

High profits may damage the relationship between the firm and its stakeholders such as consumers and the workforce

Profit maximisation may not appeal to the management who may have different objectives

High profits may trigger action by the firms rivals and it could become a target for takeover

Because of these problems in maximising profit there are other objectives which firms might adopt which are more practical in nature. The main ones are:-

Sales revenue maximisation - (where MR=0)

Might be consistent with increasing/sustaining market share eg in a recession

Higher revenues and market share can dissuade entrants to a market in the long run

Higher sales encourages exploitation of economies of scale

Sales maximisation - (AC=AR)

Maximising sales by volume

Might also be consistent with increasing/sustaining market share

Increasing output beyond the point where AC>AR would result in a firm making a loss

Satisficing

About achieving a minimum acceptable level in term of both revenues and profit

It is about satisfying stakeholders and making sufficient gains

Managerial objectives

These may conflict with objectives of other stakeholders

Managers may act to maximise their own utility at the expense of others

FIRMS OBJECTIVES: PROFIT MAXIMISATION

When MR=MC

The output which gives the maximum distance between TR and TC

The objective assumes that the owners control the management of the business

Also requires sufficient and accurate knowledge of cost and revenue conditions in the market so that the MR and MC can be found (Real world limitations + Hard to achieve)

QUESTIONING THE AIM IF PROFIT MAXIMISATION

Insufficient information on cost and demand

Short term objectives eg survival, VS long term objectives eg profit maximisation

Range of non-financial business objectives

Responses to changing market decisions eg a recession

Motivations of managers may differ from shareholders - want dividends based on profit

THE DIVORCE BETWEEN OWNERSHIP AND CONTROL

The majority of shareholders in a quoted company cant exercise day to day control over managers

Managers have different motivations than owners

There are some constraints on managerial behaviour as shareholders eventually expect to make returns on their investment

Managers may want to maximise their own utility from being in charge of a business

CONFLICTING OBJECTIVES?

Employees

High wages

Good working conditions

Job security

Career progression

Managers

High salaries

Company valuation

Power

Prestige/status

Perks

Shareholders

Good dividends - ie income from capital

Growth in share valuation - capital gain

Different stakeholders in the company want different things

HUGO SIMON - THE SATISFICING PRINCIPLE

In taking a decision no business can process all the factors affecting the marketing of a product in the hope of maximising profits - don't have perfect information

Most businesses tried to make a decision that was "good enough"

This theory is known as "bounded rationality"