Theory of the Firm 6

Sources of monopoly power

i) Control of an important input in production;

A firm may control a strategic input or the entire raw materials used in the production of a
commodity.

Such a firm will easily acquire monopoly by not selling the raw materials to potential competitors.

ii) Ownership of production rights;

where the right to production or ownership of commodity i.e. patent rights, copyrights and royalties belong to one person or firm, then, that creates a monopoly. Similarly, if the government gives licence to produce a commodity to one firm, then this will constitute a monopoly.

iii) Internal economies of scale;

The existence of internal economies of scale that enable a firm to reduce its production costs to the level that other firms cannot will force these other firms out of business leaving the firm as a monopoly.

iv) Size of the market;

where the market is rather small and can only be supplied profitably by one firm.

v) Additional costs by other firms;

A firm may enjoy monopoly position in a particular area if other firms have to incur additional costs such as transport in order to sell in the area.

These additional costs may increase the prices of the commodity to the level that it becomes less attractive hence giving the local firm monopoly status.

vi) Where a group of firms combine to act as one;

Some firms may voluntarily combine/amalgamate or work together for the purpose of controlling the
market of their product.Examples are cartels.

vii) Restrictive practices;

A firm may engage in restrictive practices in order to force other firms of business and therefore be left as a monopoly.

Such practices may include limit pricing i.e. where a firm sells its products at a very low price to drive away competitors.

viii) Financial factors;

where the initial capital outlay required is very large, thereby preventing other firms from entering the market.

ix) Where the government establishes a firm and gives it monopoly power to produce and sell ‘cheaply’(Government Policy).

Advantages of monopoly

i. A monopoly is able to provide better working conditions to employees because of the high profits realised.

ii. In some monopolies, high standards of services/goods are offered.

iii. Monopolies always enjoy economies of scale. This may help the consumer in that the goods supplied by a monopoly will bear lower prices.

iv. A monopolist may use the extra profit earned to carry out research and thus produce higher quality goods and services.

v. The consumer is protected in that essential services such as water and power supply is not left to private businesses who would exploit the
consumers.

Disadvantages of monopoly

i. A monopolist can control output so as to charge high prices.

ii. Consumers lack freedom of choice in that the product produced by a monopoly has no substitute.

iii. Low quality products may be availed to consumers due to lack of competition.

Monopolistic Competition

Monopolistic competition is a market structure that falls within the range of imperfect competition i.e. falls between perfect competition and purenmonopoly.

It is therefore a market structure that combines the aspects of perfect competition and those of a monopoly.

Since it is not possible to have a market that is perfectly competitive or a market that is pure monopoly in real world, all market structures in real world lie between the two and are thus known as imperfect market structures.

In a monopolistic market, there are many sellers of a similar product which is made to look different.

This is known as product differentiation. These similar products are made different through packaging, design, colour, branding e.t.c.

The following are the assumptions of a monopolistic competition.

i. A large number of sellers;

Who operate independently.

ii. Differentiated products;

Each firm manufactures a product which is differentiated from that of its competitors, yet they are relatively good substitutes of each other.

The differences may be real in that different
materials are used to make the product or may be imaginary i.e. created through advertising,branding,colour,packaging e.t.c.

iii. No barriers to entry or exit from industry;

There is freedom of entry into the industry for new firms and for existing firms to leave the industry.

iv. Firms set their own prices;

The prices are set depending on the costs incurred in production and the demand in the market.

v. No firm has control over the factors of production;

Each firm acquires the factors at the prevailing market prices.


vi. Presence of non-price competitions;

Since products are close substitutes of each other, heavy advertising and other methods of product promotion are major characteristics of firms in monopolistic competition.

vii. Buyers and sellers have perfect knowledge of the market.

Oligopoly

This is a market structure where there are few firms.

The firms are relatively large and command a substantial part of the market.

It is a market structure between the monopolistic competition and monopoly.

Types of Oligopoly

Oligopoly may be classified according to the number of firms or the type of products they sell.

They include:

a) Duopoly;

This refers to an oligopoly market structure which comprises of two firms.

Mastermind Tobacco and British American Tobacco
(BAT) are examples of duopoly in Kenya.

b) Perfect/Pure oligopoly

refers to an oligopolistic market that deals in products which are identical. Examples of pure oligopoly are companies dealing with petroleum products such as oil Libya, Caltex, Total, Shell, National Oil, Kenol and Kobil. These firm sell products which are identical such as kerosene, petrol and diesel.

c) Imperfect/Differentiated Oligopoly;

this is an oligopolistic market structure where firm have products which are the same but are made to
appear different through methods such as packaging, advertising and branding.

Features of oligopoly

i) Has few large sellers and many buyers.

ii) The firms are interdependent among themselves especially in their output and pricing.

iii) Non-price competition, firms are in a position to influence the prices. However, they try to avoid price competition for the fear of price war.

iv) There is barriers to entry of firms due to reasons such as; requirement of large capital, Ownership of production rights, control over crucial raw materials, Restrictive practices etc.

v) High cost of selling through methods of advertisement due to severe competition.


vi) Products produced are either homogeneous or differentiated.

vii) Uncertain demand curve due to the inter-dependence among the firms.

Hence the shifting of the demand curve is not definite.

viii) There is price rigidity i.e. once a price has been arrived at in an oligopolistic market, it tends to remain stable.

This feature explains why a firm in oligopolistic market faces two sets of demand curves resulting to a Kinked Demand Curve.

One curve, for prices above the determined one, which is fairly gentle and the other curve for prices below the determined one which is fairly steep.

Theory of the Firm 1 | Theory of the Firm 2 |
Theory of the Firm 3 | Theory of the Firm 4 |
Theory of the Firm 5 | Theory of the Firm 6 |