Monopolistic competition and oligopoly are the two most common types of imperfectly competitive market structures. Since the average company has less market power than a monopoly and faces less harsh competition than implied by the perfect competition scenario, most industries fall under one of those models (Mankiw, 2020). Both cases allow companies to set prices above the marginal cost, but in the longer run, economic profit still trends towards zero as businesses remain subject to market forces. Despite those similarities, oligopoly and monopolistic competition also exhibit considerable differences. Whereas the former is defined by having a small number of sellers competing in a market with significant entry barriers, relatively high ease of entry and numerous competitors characterize the latter (Hubbard & O’Brien, 2017). Product differentiation is vital to the existence of monopolistic competition while being less critical for an oligopoly (Mankiw, 2020). Nevertheless, the two structures can emerge from similar market conditions. Cellini and colleagues (2020) use their article to outline a general model explaining both structures as the outcomes of strategic choices. Their findings reinforce the course’s emphasis on company strategies as a determining factor behind market structures.
The article examines an industry in which multiple sellers of horizontally differentiated products compete with each other. While those companies can all freely access information on their rivals’ individual impact on aggregate output, they may choose not to do so. The authors state that the extent to which a company’s profit depends on aggregate output is negatively affected by higher product differentiation and marginal costs (Cellini et al., 2020). If all companies choose to disregard their influence of aggregate impact and equilibrium prices, the market structure will be monopolistically competitive. Cellini et al. (2020) assert that such outcomes occur in real market conditions when control over the output is delegated to managers who are “rewarded (penalized) for profit above (below) industry average” (p. 5). Conversely, when all companies base their output decisions on aggregate conditions, the market becomes oligopolistic. Thus, the decision to manipulate aggregate output to maximize profit is the defining feature of oligopoly.
Which market structure will prevail in any given industry depends on varying parameters. The basic model suggests that oligopoly and monopolistic competition are the “only two equilibrium market structures,” with deviation from either structure being unprofitable in most cases (Cellini et al., 2020, p. 8). The authors also acknowledge the possibility of a “mixed strategy equilibrium” in which some companies base their decisions on aggregate output, and some do not (Cellini et al., 2020, p. 9). Such disparities may arise from industry heterogeneity and information costs, which were not included in the model. While marginal price and product differentiation can influence the equilibrium, the most significant factor is the number of competing companies. If this number is below a lower threshold determined by other factors, oligopoly becomes the advantageous option, and strategic delegation is less likely. Monopolistic competition becomes the natural outcome if the number of companies exceeds a higher threshold, making manipulation of aggregate outcome an ineffective strategy. Mixed strategy outcomes may occur in complex markets that allow companies to pursue different strategies.
As shown throughout the course, the nature of competition in an industry is essential for understanding its dynamics and outcomes. The market structure depends on companies’ strategic choices, which are primarily determined by profit-seeking considerations and industry-specific factors affecting profit. Cellini et al. (2020) examine “aggregate dependence” and closely connected strategic inattention to aggregate output as crucial parameters influencing whether a market is going to be oligopolistic or monopolistically competitive (p. 3). In other words, market conditions may make it more profitable for companies to operate as monopolistic competitors or oligopolies, adjusting their output strategies accordingly. These strategic choices can significantly affect market prices and welfare outcomes. While both forms of imperfect competition are socially inefficient, oligopoly has higher social costs than monopolistic competition (Mankiw, 2020). Oligopolistic sellers enjoy more economic power over their buyers, allowing them to drive up prices in excess of marginal costs. By contrast, monopolistic competition is more competitive and may offer other advantages to consumers, such as a greater choice of products.
Imperfect competition describes the market structures of many industries, with monopolistic competition and oligopoly being the most commonly seen varieties. While both structures offer companies more market power than they would see under perfect competition, they also incorporate more structural constraints than pure monopoly. The current article proposes a general model that examines both structures as a result of companies’ strategic choices to ignore or consider aggregate outputs in their decision-making. The former option naturally occurs when companies delegate output decisions to managers who are incentivized based on relative performance. Factors affecting either choice include the number of competitors, product differentiation, and marginal cost gradients. Depending on these factors, oligopoly or monopolistic competition will form a market equilibrium, ensuring that no single company will be likely to deviate from it. Other considerations, such as aggregate information acquisition and processing costs, may lead to the emergence of a mixed-strategy market equilibrium. These outcomes influence how companies interact with each other and with buyers, proving the relevance of this model for a broader understanding of economics.
References
Cellini, R., Lambertini, L., & Ottaviano, G. I. (2020). Strategic inattention, delegation and endogenous market structure. European Economic Review, 121, 1-10. Web.
Hubbard, R. G., & O’Brien, A. P. (2017). Economics (6th ed.). Pearson.
Mankiw, N. G. (2020). Principles of economics (9th ed.). Cengage Learning.