A monopoly is a market structure that is characterized by one supplier of a particularly unique product or service which has got no close substitutes. The result is that the firm becomes a price maker for its products and services rather than being a price taker. The existence of monopolies results from the fact that there are established barriers that make it difficult for other firms to enter the industry. There are various sources of barriers to entry for a monopoly. These include;
- Government through franchising, licensing, copyrights, patents. Patents provide a firm legal monopoly of their products, or inventions for an average period of 17 years.
- Ownership of unique resources such as specific materials, makes the firm develop high economies of scale
- High capital requirement.
The existence of these barriers results in elimination of competition within the industry.
An example of a monopoly firm in US is the United States Postal Service which deals with the provision of a variety of ‘first-class mail services’. The source of monopoly for this firm is the US government which restricts entry of other firms into the industry (Horneberger Para.3).
Oligopoly is a market structure that is characterized by a few suppliers who sell identical or differentiated products. The existence of few sellers arises from the fact that it is difficult for new entrants to venture into the market. This makes the firms to be sensitive to marketing and pricing strategies of other firms in the industry. They either cooperate to create a monopoly effect or compete amongst themselves to gain a competitive advantage. This means that the firms are very interdependent. In the US, an oligopoly market structure is evident within the automobile industry. Examples of automobile manufacturing firms in this industry include General Motors and Chrysler (‘Automobile industry introduction’ Para. 1).
Cartels consist of a group of firms that operate in harmony. The firms agree to control the price of their products and services which are homogeneous. They also agree to control other operations such as production. Through this association, these firms’ can be able to exert a high degree of monopoly power (Shah 172). An example of cartel in US is OPEC.
Welfare effects of monopolies and oligopolies
Monopolies and oligopolies are more effective in their operation than other market structures which results in positive welfare effects. This is because they respond to changes in consumers’ demand more effectively resulting in increased consumer utility. These firms have the necessary resources to enable them conduct an effective research and development resulting in product and services innovation. This enables them to address the market demand effectively. Oligopolies pricing is relatively low since the firms are interdependent in pricing their products and services compared to other perfect competition. However, the consumers may be negatively affected through high prices if the strength of oligopolies restricts entry of rival firms or drives out existing rival firms (Mauris 698). In addition, the prices of products and services for monopolist firms are relatively high due to absence of competition. This makes the monopoly firms set their price above the marginal cost for them to maximize their profit. This result into negative welfare effects since consumer pays more (‘Monopoly 17).
Game theory explains the interactions of firms within oligopolies and cartels
According to Shah, game theory refers to a strategy that is used in the process of making decisions where multiple individuals are involved (171). When making decisions related to pricing their products and services, firms have to consider the market demand. This is because consumers make their consumption decisions based on the price of products and services. Oligopolies and cartels make their production and pricing decisions depending on the model of demand in the market. In addition, the firms make decisions basing on what they expect the other firms to respond. For example consider two firms which are price setters. These firms face a demand that is characterized by the quantity demanded and the price. They also incur fixed and variable costs in their production. Assuming that there are no fixed costs and that the marginal cost does not change, there are three possibilities available to these firm’s these include setting the price lower than the cost of production which is impossible or setting the price higher than the cost. In this case, the firm with the lower price will prevail in the market. The other firms use this price in setting their price by setting it at a relatively lower price. The final option is to set the price to equal the cost. This makes the firm sell at a marginal cost.
The economic purpose of OPEC
OPEC is economic integration of oil-producing countries. The economic purpose of OPEC is to collectively and individually protect the interest of the member countries. It is also aimed at ensuring that the price of oil is stabilized across the world thus eliminating harmful price fluctuations. It also ensures that there is a regular supply of oil in all the countries.
For the past five years, OPEC has not been able to regulate the price of oil which has resulted in increased price fluctuation. This is associated with the discovery of oil in the North Sea, Gulf of Mexico and Russia. In addition, from 2003, OPEC there has been a reduction in the pumping capacity of the member countries. This has limited OPEC’s capacity to control oil prices (Pierre Para. 7).
Action to be taken by OPEC
Currently, the US dollar is used in determining the exchange price for oil. In the recent past, there has been an increased fluctuation in the exchange rate of the dollar with other countries. This limits the revenue collected by the member countries resulting in a decline in their purchasing power. OPEC should consider changing its exchange currency to the relatively stable Euro.
“Automobile industry introduction.” 2009. Web.
Hornberger, Jacob. “Playing monopoly in the real world.” Freedom Daily. 1992. Web.
Limeux, Pierre. “The oil price mileage.” Ludwig Von Mises Institute. 2005. Web.
“Monopoly: welfare effects of monopoly pricing.” McGraw Hill Incorporation: New York. 2009. Web.
Schwartz Mauris. “ Investment in oligopoly: welfare effects and test for predation.” Oxford economic papers. 41(1989), 698-719. Web.
Shah, Ashesh. “Game theory: oligopolies”. Journal of Mathematics, MIT. 3:2,(1998), 171-177. Web.