I write a summary of market structure and how it affects the pricing and output strategy on the monopolistic and oligopoly market based on Keat, P., and Phillip Young. 2008. Managerial Economics, 6th edition. Pearson (KY) e-book.
Monopolistic competition and oligopoly are considered “imperfect” competition because the company in these markets have the power to set their prices within the limits of certain constraints. Monopolistic competition is a market in which there are many firms and relatively easy entry. What enables firms to set their prices is product differentiation. The monopolistic company somehow selling a product to the customer differs from the offering of other firms in the market.
A monopolistic competitor can set its price established by the forces of supply and demand under conditions of perfect competition. Oligopoly is a market dominated by a relatively small number of large firms.
The differentiation and standardized product is part of the control that a firm in oligopoly markets exercise over price and output. Market power also comes from their sheer size and market dominance.
Pricing Strategy In An Oligopolistic Market: Rivalry And Mutual Interpendence
In the oligopolistic market, the price behavior is mutual interdependence. This means that each seller is setting its price while explicitly considering the reaction by competitors to the price that it establishes.
In the 1930s, economist Paul Sweezy presented an initial insight into the pricing dynamics of mutual interdependence among oligopoly firms by developing a kinked demand curve model.
The basic assumption of the Sweezy model is that a competitor (or competitors) will follow a price decrease but will not make a change in effect to a price increase. If a firm lowers its price, this may have a critical impact on the competition.
This Firm takes its action to increase sales by bringing customers away from the higher-priced competitors, but when competitors realize what is happening (i.e., their sales are declining), they will swiftly follow the price cut to maintain their market share.
If this firm engages the opposite action—a price increase—incorrectly assuming competitors will follow suit, its sales will drop markedly if competitors fail to do so.
COMPETING IN IMPERFECTLY COMPETITIVE MARKETS
Nonprice competition is any effort made by firms other than a change in the price of the product question to influence the demand for their product. This includes include any factor that causes the demand curve to shift, the factors are taste and preference, income, prices of substitutes and complements, number of buyers, and future expectations of buyers about product price.
Nonprice variables are those factors that managers can control, influence, or explicitly consider in making decisions affecting the demand for their goods and services.
The nonprice variables :
- Location and distribution channels
- Market segmentation
- Loyalty programs
- Product extensions and new product development
- Special customer services
- Product “lock-in” or “tie-in” and preorder new product announcements.
STRATEGY: THE FUNDAMENTAL CHALLENGE FOR FIRMS IN IMPERFECT COMPETITION
The fundamental link between managerial economics and strategy is the decision regarding the allocation of a company’s scarce resources. The tools of this strategic analysis are Porter’s “Five Forces” model and his differentiation versus cost leadership approach is linked to the economic study of industrial organization and the economic models of a firm’s behavior in different market settings.