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Question 3
a) Explain how the different features of monopolistic competition and
oligopoly affect price and output determination in these market structures.
[10]
b) Recession will affect firms in different ways depending, for example, on
what they produce and the market structure in which they operate. Discuss
the likely effects of a recession on different firms. [15]
(a)
Explain the different features of monopolistic competition and oligopoly
Explain the price and output is determined by profit-maximizing behaviour of the firm,
at MR = MC, where the last unit transacted. Different features of monopolistic
competition and oligopoly would affect the price and output determination for firms in
the different market structures
Barriers to entry and number of sellers
Barriers to entry for MC firms are usually low while high for oligopolistic firms. MC
firms like the hawker food industry have ease of entry and exit because of low start
up cost which means that there are a greater number of firms in the industry, as
opposed to oligopolistic firms, like the petrol industry. Because start-up costs are
high, and existing firms also institute artificial barriers to entry through the use of
price and non-price competition, not many firms can enter the industry resulting in a
lower number of firms, and hence higher market power for each firm as they have a
higher influence on price as compared to the monopolistic competitive firm.
Effect on DD and MR curve
This means that there are more substitutes for consumers to choose from in the MC
industry, leading to a more price elastic DD curve facing each firm. Quantity
demanded is thus more responsive to changes in price as consumers can switch
easily from one firm to another. In contrast, the oligopolistic firm faces a more price
inelastic DD as consumers do not have that many substitute to choose from,
resulting in higher market power and hence the power to set prices. DD curve for the
oligopolistic firm will be higher, as market DD is spread over less number of firms
compared to the MC industry This consequently leads to a steeper and higher MR
curve for the firm, and a lower profit-maximising price (P2 > P1 ) and higher profit
maximising output. (Q2 > Q1 ).
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Revenue/Cost
Revenue/Cost
S=MC
S=MC
P2
P1
B
O
Q1
D=AR
MR
Output
MR
O
Q2
D=AR
Output
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b)
Introduction
Explain recession usually accompanied by falling AD and lowering of business
outlook. Characterized by fall in domestic consumption and hence investment
spending, or fall in demand for exports, which affects firms operating in different
market structures. Thus, a recession can impact the DD and MC of a firm, which
may have implications on the strategies they employ, depending on what they
produce and what market structure they operate in.
Body
Fall in DD and prices and output
With a fall in AD and as consumers tighten their purse strings. Fall in DD for each
firm in different industries leading to a fall in DD curve and consequently MR curve
(MC vs Oligopoly) , leading to lower prices and lower output as firms re-calibrate
their profit maximizing price and output. This is especially so for firms selling goods
that are known as normal goods, which includes necessities or luxury goods. The
degree of the fall in demand thus depends on the income elasticity of the good. The
higher the income elasticity of the good, the more the DD will fall. In times of
recession, its common to see sales plummeting for many firms and prices revised
lower. However this is dependent on the nature of the good produced by the firms.
However, if the goods are dubbed as inferior goods, (with the income elasticity of
the good assuming a negative value) such as the house brands of many big
supermarket chains, the DD for such goods may actually rise in the face of recession
and falling incomes, as consumers switch from more expensive goods, resulting in
higher revenue for such firms.
Fall in profits (MC vs. Oligopoly)
With falling revenue as a result of fall in DD, profits margins will be squeezed for both
MC and oligopolistic firms. However, as MC firms usually earns normal profit in the
long run due to low barriers to entry , a fall in profit may force many firms to sustain
subnormal profits, and if P < AVC, some firms may be forced to shut down, leading
to a fall in number of firms in the MC industry.
Oligopolistic firms with their long-run supernormal profits will be able to withstand
the fall in profits to some extent, and still stay in business.
Hence firms that are more monopolistic competitive in nature are more likely to fold,
as can be seen from many small shops, in particular the newer F and B firms, that go
out of business during a recession.
Effect on strategies: price and non-price competition (oligopoly)
MC firms which may produce lower cost goods may engage in non-price competition
to establish a value for money image because such goods are regarded as inferior
goods. Therefore, during a recession, the DD for goods that may be dubbed as
inferior may actually increase, hence revenue may increase for an MC firm selling
such goods.
For oligopolistic firms, a fall in revenue because of lower demand may reduce the
incentive to increase product complexity and to engage in price or non price
competition. There may be even be an incentive to engage in collusive behaviour,
especially if the firms produce homogenous goods, such as engage in joint
marketing of R and D to share the cost.
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