Economics (9214) | Non-competitive markets

👋 Welcome to Non-Competitive Markets!

Hi everyone! We’ve spent time looking at markets where lots of small firms compete perfectly (Perfect Competition). But let’s be honest, the real world is rarely perfect!

In this chapter, we explore "concentrated markets"—where a few large firms, or even just one firm, have significant control. Understanding these markets is vital because they affect the prices we pay, the quality of products we get, and how much choice we have.
Ready to dive into the world of market power? Let’s go!

💡 Quick Review: What is Market Power?

Market Power means a firm can influence the price of its product. In perfect competition, firms have zero market power; they are Price Takers. In non-competitive markets, firms have some degree of market power; they are Price Makers.

Section 1: The Monopolist (The Single Boss)

A Monopoly exists when there is only one dominant seller in a market.

The Key Characteristics of a Monopoly

• Single Seller: One firm supplies the entire market (or controls over 25% to be legally classified as a monopoly in many jurisdictions).
• Unique Product: The product has no close substitutes.
• Price Maker: The firm controls the supply, allowing it to set the price.
• High Barriers to Entry: It is extremely difficult or impossible for new firms to enter the market.

🔒 Understanding Barriers to Entry

Barriers to entry are the reasons why monopolies exist and why new firms can’t challenge them. These are crucial for understanding non-competitive markets!

1. Legal Barriers (Patents & Copyrights): The government gives a firm exclusive rights to produce a good for a certain time. (Example: A pharmaceutical company inventing a new drug.)
2. High Startup Costs: The cost of setting up the firm is huge, often in the billions. (Example: Building a national railway network or installing fibre optic cables.)
3. Control of Essential Resources: The monopolist owns the key inputs needed for production. (Example: Owning the only diamond mine in a region.)
4. Economies of Scale: The existing firm is so large that its costs per unit are extremely low. A new, smaller firm would not be able to compete on price.

💰 Outcomes of Monopoly: Costs and Benefits

The Downsides (Costs to Consumers and Society)

• Higher Prices and Lower Output: Monopolies tend to charge higher prices than competitive firms and produce less output, leading to reduced consumer surplus.
• Inefficiency: Without the pressure of competition, monopolists may become complacent, leading to poor customer service and a lack of innovation (unless the monopoly is protected by R&D).
• Less Choice: Consumers have only one product option.

The Upsides (Benefits)

• Economies of Scale: Because they produce on such a large scale, monopolies might achieve very low costs, and sometimes these lower costs are passed on to consumers (though this is rare).
• Research and Development (R&D): Monopolists often earn significant profits, which they can reinvest into expensive R&D to develop better technology or new products. (Think of large tech companies developing groundbreaking new software.)
• Natural Monopolies: Sometimes, it is simply more efficient to have only one provider (e.g., water supply or electricity grid) because duplicating the infrastructure would be incredibly wasteful.

Section 2: Oligopoly and Firm Behaviour (The Club)

An Oligopoly is a market structure dominated by a few large firms. Think of mobile phone networks, major airlines, or car manufacturers.

The Key Characteristics of an Oligopoly

• Few Dominant Firms: A small number of firms account for the majority of the market share.
• High Barriers to Entry: It is difficult, though not impossible, for new firms to join (often due to massive advertising costs or high capital requirements).
• Product Differentiation: Products are usually differentiated (e.g., Coca-Cola vs. Pepsi; they are similar but marketed as different).
• Interdependence: This is the most crucial characteristic!

🤝 The Power of Interdependence

Interdependence means that the actions (especially pricing decisions) of one firm directly impact and influence the decisions of the other firms.

Analogy: Imagine a boat race between three speedboats. If one boat accelerates or changes direction, the others must react immediately to stay competitive.

🤔 How Do Oligopolies Compete?

1. Competition (The Price War Risk)

If one firm drops its price, the others must follow suit to avoid losing all their customers. This can lead to a Price War, where prices spiral down until no firm is making much profit. Oligopolists usually try to avoid this destructive path.

2. Collusion (The Secret Agreement)

Instead of competing, firms might agree to work together. This is known as Collusion.

• Explicit Collusion (Cartel): Firms formally agree on prices or divide the market geographically. This is illegal in most countries. (Example: OPEC, an oil cartel, agrees on production quotas.)
• Tacit Collusion: Firms simply observe each other and match price rises, but they never formally meet or agree. This is harder to prove and regulate.

Why is Collusion bad? It acts like a monopoly, raising prices for consumers and reducing output.

3. Non-Price Competition

Since price wars are risky and collusion is often illegal, oligopolists focus heavily on competition that doesn't involve changing the price of the product.

• Branding and Advertising: Creating strong customer loyalty.
• Product Quality and Design: Improving features or durability.
• Customer Service: Offering excellent after-sales care, delivery, and guarantees.

Section 3: Price Discrimination

This happens in concentrated markets (monopolies or oligopolies) because the firm has the power to set the price.

What is Price Discrimination?

Price Discrimination occurs when a firm sells the same good or service to different groups of customers at different prices, even though the cost of producing for them is the same.

Conditions Needed for Price Discrimination to Occur:

1. Market Power: The firm must be a price maker (a monopolist or dominant oligopolist).
2. Ability to Separate Markets: The firm must be able to identify and separate different groups of buyers based on their price elasticity of demand (PED).
3. Prevention of Resale: Customers who buy at the lower price cannot be able to sell the product easily to those who would pay the higher price.

Common Examples:

• Age/Status: Student discounts, senior citizen discounts (these groups generally have more elastic demand).
• Time of Day/Week: Peak vs. Off-peak train tickets (business travellers have less elastic demand than leisure travellers).
• Location: Charging different prices for the same soft drink in different countries.

Did you know? Firms use price discrimination to increase their overall revenue by charging each group the highest price they are willing to pay.

Section 4: Market Concentration and Growth

Non-competitive markets are often the result of large firms growing through mergers and takeovers.

Definition: Mergers vs. Takeovers

• Merger: Two firms voluntarily agree to combine their businesses into one single, new firm.
• Takeover (Acquisition): One firm buys another firm, often against the wishes of the target firm’s management.

Types of Integration (The Direction of Growth)

It is vital to know the difference between these three types:

1. Horizontal Integration:

   This involves firms at the same stage of production and in the same industry joining together.
   Example: Two rival supermarket chains merge.

   Impact: This increases market concentration and reduces competition quickly, often leading to monopolies or tight oligopolies.

2. Vertical Integration:

   This involves firms in the same industry but at different stages of production joining together.

   • Backward Vertical: Firm integrates with a supplier. (Example: A car manufacturer buys a steel producer.)
   • Forward Vertical: Firm integrates with a distributor/retailer. (Example: A chocolate factory buys a chain of sweet shops.)

   Impact: This gives the firm greater control over the supply chain, ensuring stable supply and potentially locking out competitors from accessing raw materials or distribution.

3. Conglomerate Integration:

   This involves firms in unrelated industries joining together.
   Example: A shoe company merges with an insurance company.

   Impact: This increases diversification and spreads risk, but does not usually lead to a higher market concentration in a single market.

Section 5: Regulation, Deregulation, and Contestability

Governments play a role in concentrated markets to ensure firms do not abuse their market power.

⚖️ Regulation

Regulation involves the government imposing rules and restrictions on market activities.

Purpose of Regulation (especially for Monopolies):

• To protect consumers from excessively high prices.
• To ensure minimum standards of quality and safety.
• To prevent unfair trading practices (like predatory pricing designed to eliminate competitors).

Methods of Regulation:

• Price capping: Setting a maximum price (P-cap) the firm can charge.
• Quality targets: Requiring specific levels of service (e.g., speed of repairs for utility companies).
• Breaking up monopolies: Forcing a large firm to split into smaller competing units (rare, but possible).

📉 Deregulation

Deregulation is the removal of government controls and rules from a market.

Goal: To increase competition, efficiency, and consumer choice by making it easier for new firms to enter the market. (Example: Allowing new private bus companies to compete on routes previously run by a state-owned monopoly.)

🚪 Contestable Markets

Even if a market is highly concentrated, it might still behave competitively if the threat of competition is real.

A Contestable Market is one where there are very low Barriers to Entry and very low Barriers to Exit (called Sunk Costs).

• If a market is perfectly contestable, the existing firm (even a monopolist) must act efficiently and charge reasonable prices to deter new firms from entering and taking their profits (a practice known as "hit-and-run" competition).
• Low contestability means high barriers to entry, allowing monopolies to behave badly.