Explain how the different features of monopolistic competitive and oligopolistic firms may affect their pricing and output behavior to protect their profits.

Intro

  • Define MC and oligopolistic market structures
  • Firms typically seek to profit-maximise i.e. produce at output level where MC=MR, and price according to AR
  • To protect their profits, firms may seek to maximise, to maintain or to increase profits

Body

Features of MC firms: numerous small firms in market, each with small market share and some degree of market power; low BTE; differentiated product; some degree of substitutability; reap normal profits in long-run

  • Demand for firms’ products tends to be relatively price elastic. Firms tend not to reap significant EOS with low output level.
  • Profit-maximising MC firm will produce at output level where MC=MR, and price according to AR. Though they can choose what price to charge, as each firm does have some degree of market power, they are constrained by the industry demand curve.
  • To protect profits, firms will seek to differentiate their product
    • In the long run, with low BTE, the number of firms in the market is likely to increase
    • To maintain and/or to increase TR, firms will seek to create new products or new niche areas to increase DD for their products; to advertise/ improvise on existing products to ↓PED

Features of oligopolistic firms: few large firms in market, each with sizeable market share and significant market power; mutual interdependence; high BTE; differentiated product; high degree of substitutability; able to retain supernormal profits in long-run

  • Able to reap significant EOS and thus face low AC, enabling retention of supernormal profits in the long-run.
  • With substitutes available, XED is positive and >1. To protect profits, oligopolistic firms tend to engage in non-price competition.
  • With high BTE and supernormal profits, firms have the ability and incentive to engage in R&D (product innovation, creation, etc.) to maintain BTE and profits.
  • Competitive oligopolistic firms are highly mutually interdependent.
    • Firms would not ↑P as doing so results in consumers switching to lower-priced rivals, hence a fall in profits. Firms would also not ↓P, as rivals would all follow suit in order to retain market share, hence the increase in sales is only modest. Thus, prices tend to be rigid as firms seek to protect profits – either raising or reducing price would both undermine this aim.
  • Collusive oligopolistic firms will behave as if they were a single monopoly seller as this enables them to increase TR.
    • Firms that form a cartel will agree on cartel price, overall output, market share, advertising expenditure, etc. Acting as a monopoly enables firms to increase TR as DD become more price inelastic.
    • In absence of a formal agreement, oligopolistic firms will follow the lead of the price leader
  • Should there be a new entrant to the market, firms can ↓P to maintain market share, such that profits in the long run can be protected.

Conclusion

  • Brief summary of points

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