Monopolistic and oligolistic competition: effects of interest rates and consumer income

Monopolistic and Oligopolistic Competitions

Comparison between monopolistic competition and oligopolistic competition

Interest Rates

Monopolistic competition is a market structure where large number of firms sells differentiated products that are highly substitutes to one another but not perfect substitutes. There is a free entry and exist in the monopolistic competition, and the firms demand curves are downward sloping. Examples of a monopolistic competition are the firms producing clothing, toothpaste, restaurants etc. On the other hand, oligopolistic competition is a market structure where there are few firms competing among one another. There is a barrier of entry because of the economic of scale, patent, and the technology involved in setting up the firm and the presence of few firms give the firms advantage to make excess profits. Examples of oligopolistic competitive market structures are automobiles, steel, aluminium, petrochemicals, and electrical equipments. While there are few firms in the oligopolistic market, there are still competitions among firms. Example of the interest rates that the banks charge on loans reveals the competitive nature of the oligopolistic markets.

Interest rates are the prices that the banks charge for lending money to borrowers.

In the oligopolistic competitions, the interests rates that the bank charges large corporations for the short-term loans are called the prime rate. The changes in prime rates cause interest rates in the money markets to rise or fall substantially. The changes in the prime rates will make major banks to follow suit by changing their rates. The reactions of the major banks will make other banks to follow suit within few days. Changes in the interest rates will make the active banks to enter the market and non-active bank to exit the industry. (Totzek, 2011). In the long run, the firms in the oligopolistic market may form collusion to continue enjoy higher profits. For example, the interest rates charged by the commercial banks are very similar. The higher profits enjoyed by the commercial banks may not be affected with the change in the interest rates because major commercial banks charge the same interest rates on the money borrowed by customers.

However, in the monopolistic competitions, the increase in the interest rates will make the weaker firms to exist the market and strong firms to enter the market. In the contemporary business environment, many firms depend on the bank loans to raise capital. Since there are fierce competitions among firms in the monopolistic competitive markets, firms will likely to raise capital from banks to satisfy the market obligations such as advertising, packaging etc. With increase in the interest rates, many weak firms will be forced to exit the market.

Income

Under the monopolistic competition, change in the consumer income has different impact on product prices. In the short run, when entry into the market may not be possible, the increase in the consumer income make the demand for the products to be less elastic because firms will charge high prices for their products, and thereby making abnormal profits. From the illustration in Fig 1, in the short run, firms make profit when MR= MC and the MR < P. There is an also downward sloping demand of monopolistic competition where the demand is relative elastic because of the good substitutes.

Consumer Price Index

Consumer Price Index (CPI) measures the changes in the price level of the consumer goods. The tool economists use to compare the prices charged for the goods in the past and measure inflation is called CPI. The formula to calculate the CPI is as follows:

Using 100 as the base, if the CPI is 180 in 2007, this means there is increase in the prices of consumer goods by 80% in 2007. Changes in the price of consumer goods will affect firms under monopolistic competition than the firms under oligopolistic market competitions.

Under the monopolistic competitions, changes in the prices of the consumer goods will make the firms to enjoy abnormal profits in the short run. For example, with the increase in the prices of consumer goods, firms in the monopolistic competitive markets will enjoy higher profits where MC = MR. However, the consumer may be worst off with the increase in the prices of consumers goods if there is no corresponding increase in the consumer incomes. The level of profits that firms will make with the changes in consumer price will depend on the strength of demand. However, in the long run, the changes in the consumer prices will make more firms to enter the markets making firms to decrease the prices and leading to the corresponding decrease in the profits. Weaker firms will leave the markets because they will be making losses in the long run.

Under oligopolistic competitive market, firms will maximize their profits with the changes in the prices of consumer goods in the short run. Increase in the price of the consumer goods will make the firms to make abnormal profits in the short run. The economic of scale and technology in the oligopolistic competitive market will make only few firms to enter the market in the long run. Thus, firms will continue making abnormal profits in the long run. Moreover, firm may form collusion or cartel to continue maximizing the profits in the long run. ( Chapter 12: Monopolistic Competition and Oligopoly).

Wage Rates

Wage is the compensation received by labor. Compensation of workers is the monetary value given to the workers in return of the services provided. Wage rate is the amount paid to workers hourly, weekly or monthly. Wage determination under monopolistic market competition depends on the interaction of supply and demand of labor. As being revealed in the Fig 2, there will be surplus of labor in the market if the supply is greater than demand. In the case where there are surplus of labor in the market and the labor are ready to accept lower wages for the service provided, all firms will hire more workers. The difference in wage rates in the monopolistic market depends on the differential in skills, and labor productivity. Highly skilled workers will command higher wages than low skilled workers.

Fig 2: Interaction of Supply and Demand for labor

On the other hand, under oligololistic competition, labor may form cartel to continue to charge higher wages. In the United States, the basketball team form cartel to continue charging supernormal wages for their service. Moreover, firms in the oligopolistic may not pay lower wages to workers. The reason is that workers could form trade union to improve their bargaining power under oligopolistic market. In the United States, workers form trade union to bargain on behalf of worker to ensure that firms pay higher wages to workers irrespective of worker's supply.