| Industry Type | Number of Firms in the Industry | Presence of Competition in the Industry | Ease of Entry for New Firms Into the Industry |
| Perfect Competition | many | extremely competitive, firms produce identical goods. | very easy |
| Monopolistic Competition | many firms, or many product choices. | competitive, but firms can establish market share. | fairly easy |
| Oligopoly | few | restricted by collusion. | difficult due to high fixed costs. |
| Monopoly | one | none | usually prohibited for legal reasons. |
In this section we finish our survey of alternative market structures by looking at monopolistic competition and oligopoly.
Monopolistic Competition
Do you ever wonder why companies spend so much money trying to convince us that their laundry detergent will leave our clothes the cleanest or when a guy opens one of their beers, he will be suddenly surrounded by friendly women of great beauty? This describes the essence of monopolistic competition, an industry structure that combines aspects of perfect competition and monopoly.
Like perfect competition, firms produce goods that share many similar attributes with other goods of their class. Even the practiced palate will have a hard time tasting the difference between Coors, Bud, Miller, Rolling Rock and a dozen or so other beers. But lets face it, guys can be gullible. When a guy orders a Coors and suddenly the place is filled with young, healthy women in bikinis playing volleyball, even if it is snowing outside. For a variation on a common theme, Miller gives the rugged man the power to cross alligator infested swamps to visit a harem of lonely females; a game of checkers is not what is on their minds. Take home a six-pack of Budweiser and frogs will sing lullabies to you throughout the evening. Even if we are perceptive enough to realize that not all advertising is true, it must accomplish something or U.S. companies wouldn't have spent $33 billion on television advertising alone in 1996.
The obvious goal of advertising is to give information about the advantages of a product, or to create the perception of differences when none really exist. It doesn't really matter if there are actual contrasts in products, as long as the consumer believes there is.
As we know from perfect competition, if products are identical (and known to be so) then the firm faces a horizontal demand curve and accepts the market price. Firms would prefer to face a downward sloping demand curve where they have some degree of control over the price they can charge for the good, since by charging a higher price, they may be able to increase profits. Contrasting a perfectly competitive firm to a monopolist facing a downward sloping demand curve shows that monopoly profits are higher.
Firms advertise to create some degree of brand loyalty among consumers who believe their product is superior, and may be willing to pay a bit more for that brand than another. By creating differences in goods, firms then have a downward sloping demand curve for their product, like a monopolist.
Remember that in the perfectly competitive industry, if a firm tries to raise price above the market price, demand falls to zero as consumers switch to perfect substitutes. However, in monopolistic competition where the firm faces a downward sloping demand curve, the firm can raise prices without losing all of its customers. The amount of sales it will lose depends on the elasticity of demand in the range of the demand curve where it is raising prices. A firm that estimates that the demand for its good in the relevant price range is inelastic can raise prices and profits as well. Or it can lower price to increase profits if the relevant range of the demand curve is elastic.
In competitive industries entry is relatively easy and we see this with many popular consumer goods. In the 1970s Miller introduced Miller Lite, using retired athletes in its advertisements. The message to consumers (especially men) was simple. You could be a tough guy and still care about the development of your derriere by drinking a beer that has less calories. The beer was a hit, and soon every major and minor brewery had their own version, taking away part of Miller's share of the light beer market and the associated economic profits. Recently we have seen the same development in the microbrew market with the major brands releasing their own, in appearance, microbrew.
Oligopoly
The easiest way for a firm to compete is with price - charge less than the other firms for a quality product and take significant chunks of their market share. But cutting prices often leads to lower profits. Advertising is a way for firms to avoid serious price competition - look at the auto industry. An even better way for a firm to avoid price competition is to cooperate or directly collude with your competitors.
Note how two gasoline stations located across the street from each other charge an identical price. It would be easy for one station to undercut its competitor by a few cents and grab an increased market share. But the station owner knows that if he cuts his prices, the station across the street will match the price cuts and they will both end off with lower revenues and only the consumer will gain. Why cause trouble?
Direct collusion between businesses to restrict competition in the United States is illegal, but it certainly happens. One form of cooperation is through tacit collusion where firms have an understanding to avoid competition. We see this in the steel, auto, airline and other industries where the industry often exhibits price leadership. For example, when an airline announces a fare cut, their competitors immediately match the rate. From there, fares are allowed to move upward with little fanfare until the next slow period, when rate cuts are once again temporarily enacted. Price leadership implies that one firm in the industry sets prices and the other move in unison. If a gas station in a cluster changes its price per gallon, the others soon match the change in price.
How effective firms are in maintaining oligopolistic and anti-competitive behavior depends on the ease of entry for new firms into the industry. The auto industry has maintained good discipline due to the prohibitive cost of entry into the industry. In contrast, the airline industry has occasionally disintegrated into debilitating price wars as new firms can quickly establish a market share in certain routes.
A legal way to restrict competition and limit entry into an industry is to form a cartel. Examples of legal cartels include the medical and legal professions that restrict entry based on academic and certification requirements. To become recognized as a physician you must complete medical school and other required training. There are many legal cartels in sports. The NFL, NBA, and NCAA are just a few examples of organizations that restrict entry and therefore limit competition.
LINK TO MAIN SECTION OF UNIT 11 - MONOPOLISTIC COMPETITION AND OLIGOPOLY