Differences Between Perfectly Competitive And Monopolistically Competitive Essay.

(a) What are the differences between the long-run equilibrium of a perfectly competitive firm and the long-run equilibrium of a monopolistically competitive firm? Compare the productive and allocative efficiency of monopolistic competition and perfect competition.

In answering this question, as a minimum, you need to

• Discuss the key features of each market structure such as number of sellers, type of product, and entry conditions
• Using diagrams, explain how short run and long run profits or losses might arise
• Describe the process by which profits or losses are eroded
• Compare productive and allocative efficiencies

(b) What are the characteristics of an oligopoly market? Choose an Australian industry that represents oligopoly. Justify your example by relating them to the characteristics of oligopoly market.

As a minimum, you should

• Discuss key features of oligopoly
• Provide a brief description of the industry
• Justify by providing actual and reliable data

(c) How can Australia address the housing affordability crisis?

In answering this question, you need to

• explain the demand side factors affecting housing affordability
• explain the solutions that have been attempted or are proposed to address housing affordability
• explain the possible supply side solutions to housing affordability

Characteristics of an Oligopoly Market

Market signifies an ideal place for exchanging goods and services between consumer and producers. Consumers come in the market place with demand of certain goods. Based on consumers demand sellers or producers supply goods. Transaction of goods occur when interest of buyers coincides with that of sellers’ interest. Different form of market exists each having their own characteristics. There are different means of classifying market. Number of market participants is an important attribute of market differentiation (Zinn et al., 2016). The two main categories of market are perfectly competitive market and imperfectly competitive market. Under imperfect competition, there are monopoly, oligopoly and monopolistic competition. Monopolistically competitive market and perfect competition are closely related with each other. The two markets though have various similarities but also have distinguishing features. The similar and discriminatory features of these two markets are as follows.

Buyers and sellers: Number of buyers and sellers are basic means of market classification. Under perfect competition, there are several buyers and sellers in the marketplace. The presence of many buyers strengthens competition among the sellers. There are so many sellers in the market that every seller has opportunity to capture only a small share of the market. Similar is the case for monopolistically competitive market (Frank, 2014). This form of market as well has numerous sellers.

Market power: In the competitive market, several sellers compete in the market place. As each seller has only a small share in the market, there does not exist any market power in the hands of sellers. As the sellers do not have any market power, they sell products at price determined in the market. Sellers are price taker in perfectly competitive market. In monopolistic competition also, there are many sellers causing a significant reduction in market power. However, as sellers sell a differentiated product they enjoy some market using, which they decide price of their own brand.

Type of good: The perfectly competing sellers sell an identical or homogenous product. As similar product is available to every seller if any one of them charges a high price, buyers automatically shift their demand to other seller. With monopolistic competition, sellers though have similar type of product by nature, but they make it different with differentiation mechanism (Mankiw, 2016). A differentiated product is sold in monopolistically competitive market in contrast to identical product under perfect competition.

Representation of Oligopoly in an Australian Industry

Advertising: As all the goods are identical or homogenous, there is no need of advertising in perfectly competitive market. In the monopolistically competitive market, since differentiated product is sold sellers spends a significantly large amount on advertising to promote their own products.

Free entry and exit: In both the market, there is little or no barriers to entry or exist the market. When existing sellers enjoy significant amount of profit then new firms enter the market. In times of economic loss, firms leave the industry (Cowen & Tabarrok, 2015).

Short run equilibrium

In production operation, short run defines a period where firms cannot fully have expanded because of constraint in input. Sellers are price takers under perfectly competitive market. Because of fixed price, average and marginal revenue in the perfectly competitive market are both equal to price. The demand curve and marginal revenue curve are horizontal straight line (Baumol & Blinder, 2015). Profit maximization of firms occur at the point where marginal revenue equals with the marginal cost. Under perfect competition, price coincides with marginal revenue and price is set at the level equal to the marginal cost. This is the first order condition for profit maximization in the short run. The second order condition that needs to be fulfilled is that slope of marginal revenue is less than the slope of marginal cost.

In the short run, competitive firms have opportunities to enjoy an above normal profit. When price is more than average cost then total revenue exceeds total cost giving firms a supernormal profit. Total revenue fell short of total cost when price goes below the average cost. Firms in the perfectly competitive market thus in shirt run can enjoy either profit or may suffer from a loss (Stein & Allione, 2014). The various short run situation in a perfectly competitive market is shown in the following figures.

Figure 1: Short run profit in competitive market

(Source: as created by Author)

Figure 2: Short run normal profit in competitive market

(Source: as created by Author)

Figure 3: Short run loss in competitive market

(Source: as created by Author)

Addressing the Housing Affordability Crisis in Australia

Long run equilibrium

As described above, in the short run there can be three different situations; supernormal profit, normal profit or loss. In the long run however, this is very unlikely to happen. Any situation yielding other than normal profit leads adjusted in the long run and lead to a normal profit. Consider a situation where competitive firm enjoying more than normal profit by charging a price higher than average cost. The resulting profit in the industry attracts new firms to enter the market. When new firms enter the market then supply in the industry increases leading to a low price and thus erode all the profit (Pindyck & Rubinfeld, 2015). When competitive firms suffer from economic loss then existing firms leave the industry. This raises industry price and the adjustment continues until normal profit is achieved. The long run equilibrium of the competitive industry is shown in the figure below.

Figure 4: Long run equilibrium under perfect competition

(Source: as created by Author)

Short run equilibrium

The demand curve or average revenue curve in monopolistically competitive market is downward sloping. Firms here have market power and can control price to some extent. The equilibrium is found where marginal revenue and marginal cost matches with each other. Like a perfectly competitive firm monopolistically competitive firm in the short run can make either economic profit or loss depending on the extent of market power (Hill & Schiller, 2015). These two short run conditions are shown in the figures below.

Figure 5: Short run profit of monopolistically competitive market

(Source: as created by Author)

Figure 6: Short run loss of monopolistically competitive market

(Source: as created by Author)

Long run equilibrium

The free entry and exit mechanism both in the perfectly competitive and monopolistically competitive market eliminate all the excess profit or loss in the long terms leaving the industry only with normal profit. However, the industry output is different in the two markets. In the long run competitive firm operates to the minimum point of average cost while monopolistically competitive firms conduct its long run operation to the left of minimum average cost (Coto-Millán, 2013). This results in an excess capacity in the industry.

Figure 7: Long run equilibrium monopolistically competitive market

(Source: as created by Author)

Production is considered to be conducted efficiently when firm is able to produce output with an efficient combination of input. The productive efficiency is achieved when production is done with least possible cost indicated by minimum average cost.

Figure 8: Productive Efficiency

(Source: as created by Author)

Allocative efficiency signifies socially preferred production and allocation points. This implies production points where marginal benefit equals to marginal cost.

Figure 8: Allocative Efficiency

(Source: as created by Author)

In a perfectly competitive market, firms comply conditions of productive and allocative efficiency. Under long run equilibrium of the perfectly competitive market, firms produce at minimum point of average cost and hence achieve productive efficiency. Monopolistically competitive firm by contrast stop operation to the left of minimum average cost leaving excess capacity and therefore is productively inefficient.

Under perfect competition price always equal marginal production cost. This means marginal benefit equals to marginal cost yielding allocative efficiency. In monopolistic competition firms always charge a price above marginal cost and hence never achieve allocative efficiency (Holmes, Hsu & Lee, 2014).

Features of Oligopoly market

The market having relatively small number of sellers and numerous buyers is known as oligopoly market.

Followings are some major features of an oligopoly market

• In the oligopoly market a few firm are present in the market marketplace. There is severe competition among the few sellers capturing a significant market share. They have considerable market power to affect price and output volume.
• The marketing strategy of each firm depends on strategy taken by its rival firms. Strategic interdependence of firms is one if the major features in this form of market (Lee & Johnson, 2015).
• In this form of market non-price competition exists among firms. To prevent price war, firms generally does not involve in price competition. Instead they compete in terms of advertisement, brand promotion, betterment of service quality and others.
• To increase sales volume firms, make significant investment for advertising expenditure.
• In the oligopoly market, the demand curve has a kink. In one part of the demand curve there is elastic demand while in other part there is inelastic demand (Rubinfeld & Pindyck, 2013).

Figure 9: Oligopoly market and kinked demand curve

(Source: as created by Author)

Market that is recognized as the oligopoly market is separated from some of the sellers that are selling similar but with slight differences. The market generally has higher barriers for entry however the behaviour of the companies is subjected to be predicted based on the competition of the firm (Canto et al., 2014). The banking industry of Australia signifies the features of oligopoly market and the Australian banking is the example of the oligopoly market. Major banks such as NAB, ANZ Banking Group, Westpac and Commonwealth Bank.

For a country it is isn’t very astonishing to operate under the banking sector. As evident from the feature of the banking industry the scale of the economies and the retail margin makes the industry to be inevitably fall under the oligopoly banking sector. Australia is considered to be not only the industry that has oligopoly banking industry (Schwager & Etzkorn, 2017). However, in the nations such as Norway and Finland, there are three largest banks that capture the market share of around 84 and 85 percent individually.

There is a higher amount of barrier for entry in the market for the Australian Banking Industry and such barriers are not in the form of regulatory or capital requirement but also due to the higher amount of market power of the big banks operating in the industry. Entry of the new companies with greater dominants of incumbents involves higher amount of cost and risk. Even though these banks is are considered to be separate distinct unit, researches have revealed that majority of the shareholders and members of the board is identical (Rios et al., 2013). These people are generally the overseas banks, fund managers of the HSBC, JP Morgan Chase. The below stated tabular representation represents the four major banks;

Table 1: Table representing four major banks

(Source: Jones et al., 2016)

Herfindahl-Hirschman Index (HHI) is one of the most common determinant of the present degree of level industry. This represents that the size of the industry and the extent to which the competition prevails in the industry. Depending upon the index of HHI it is understood that the Australian banking industry is turning out to be more focused (Hildenbrand, 2014). The rising amount of concentration in the banking sector has paved the acquisition of the St. George Bank Ltd and CBA acquisition of Western Australia Bank in the year 2008. The below stated tabular representation provides the measurement of the HHI index for the Australian Banking Sector

Table 2: Tabular representation of the Australian Banking Sector

(Source: Daganzo, 2014)

Political Support for the Australian Oligopoly:

Politicians generally oppose oligopolies in the country but as evident in the situations of the Australian Banks the success of the oligopoly structure often gains the support of the politicians. From the spokesperson of Finance, it is understood that the supported structure of the oligopoly and has suggested that the nation must assist in forming an oligopoly structure. The structure of the oligopoly is considered to introduce innovations and increase the overseas competition (Daganzo, 2014). The oligopoly structure of the market is regarded to introduce innovation and has increased the overseas competition. The support is not restricted to the politicians and it extends to the central bank.

Economic consequences of oligopoly in Banking Industry:

Unlike the other industry attention in the banking industry helps in reducing the degree of competition that results in higher price. Higher amount of interest is generally regarded as the by-product of the increased competition (Taussig, 2013). The higher amount of profit lowers the incentives of banks that helps in acting in different manner given there is only external pressure. The external sources of pressure are viewed as the intervention, action groups and the competition from the mutual banks.

Some of the major capital cities of Australia has to go through the rise in the price of property from the year 1998. States such as Sydney and Melbourne has experienced increase in the property prices to greater than 105% after the year 2009. The higher pricing of the housing sector is combined with the lower rise of wages (Bernanke et al., 2015). The lower amount of interest rates promotes the individuals to borrow and consequently result in higher amount of debt. In terms of GDP the household debt has risen to 130 percent of the GDP. This leads to unjustifiable rise in demand for the property. As evident from the report of the housing affordability crisis has suggested that the average price of the houses Australian capital cities is nearly equivalent to the average income for more than seven years. below listed are some of the factors that have contributed to the housing affordability crisis are stated below;

1. Financial deregulations raise the accessibility of the credit
2. After the GFC, lower amount of interest rates prevails in Australia and the lower amount of interest rate helps in increasing the capacity of the due to the lower amount of repayment(Laibson & List, 2015).
3. Government restricts the availability of new land and results in limited supply of housing
4. Greater demand for housing from the increased populations
5. Higher amount of foreign investment in the real estate market
6. The favourable system of taxation helps in influencing the investment in the property market.

Higher income:

With increase in the productivity and greater amount of earnings from the export the average income of the household and the level of wealth have risen. The household sector is willing spend a portion of their earnings and their wealth (Case et al., 2014). As a result of this there is an improved value of the housing. In this phase, the demand for the holiday homes especially those that are situated in the coastal regions. Opposing to the rising demand there is restricted reaction from the supply side.

Demographics:

A fall in the average size of the housing sector is accompanied with the declining size of the household. This comprises of the marriage, increasing incidence of the separations and divorce has paved the way for the demand in the housing sector for the given set of populations. Australia generally has greater growth of populations being the advanced economy. Greater incidence of immigration to Australia has contributed greatly to the increased population rise and the rising population raises the demand for the housing sector.

Higher rents:

The increasing trend of the rents leads to the change in the desire of people giving from taking rent to purchasing their own house instead of renting them.

Lower amount interest rate:

The standard amount of interest rate on the housing loans has resulted in considerable fall during the mid-1990 to the early years of 2000. As a result of this there was availability of the funds in purchasing the new houses and increases the demand.

To address the affordability of the crisis the government has undertaken numerous policies (Miller & Benjamin, 2015). The Australian government budget allocated large amount of fund to provide the people with the facilities of purchasing house and a detailed discussion of the same has been stated below;

First house purchasers:

The policy of the first house purchasers makes the use of the superannuation deposits to purchase the house however the government contribution has contributed to the solution of bridging the gap of housing crisis.

Retired individuals:

The government has declared in its policies that it would providing exemptions to the superannuation limit in order to increase the supply of the housing (Paciorek, 2013). To promote the housing affordability, the retired person is provided exemption on the stamp duty in the case of purchasing the small house and offering tax rebates based on the profit generated from the sale of their present house.

Land:

To increase the housing affordability, the Australian government has released the supply of commonwealth land to meet the demand.

International purchasers:

The Australian government has undertaken strong measures for overseas purchasers and the government promotes housing affordability with demand concertation in few of the areas.

To assess the problems of increasing housing price and continuous housing affordability crisis and the supply of household must be met with the demand (Jones et al., 2016). The solution of supply side is stated below;

The primary challenge is to locate the land for making house with the access to land being the major constraint in the supply of housing affordability. The use of land to great extent is to assist the lowering of standard housing cost and the country wise mapping reveals the mapping of several opportunities.

Cities should cut down the barriers of building houses by promoting the structure of governance to represent the stakeholders. The original execution of the houses must be rationalized.

Increasing the supply of the houses could be done by promoting the construction industry. With lower amount of productivity from the building codes, procedure of permitting and changes in the demand. It is also recommended that incentives must be provided at the reasonable rate as this helps in increasing the housing supply.

References 

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.

Bernanke, B., Antonovics, K., & Frank, R. (2015). Principles of macroeconomics. McGraw-Hill Higher Education.

Canto, V. A., Joines, D. H., & Laffer, A. B. (2014). Foundations of supply-side economics: Theory and evidence. Academic Press.

Case, K. E., Fair, R. C., & Oster, S. E. (2014). Principles of Economics, Harlow.

Coto-Millán, P. (Ed.). (2013). Essays on Microeconomics and Industrial Organisation. Springer Science & Business Media.

Cowen, T., & Tabarrok, A. (2015). Modern Principles of Microeconomics. Palgrave Macmillan.

Daganzo, C. (2014). Multinomial probit: the theory and its application to demand forecasting. Elsevier.

Frank, R. (2014). Microeconomics and behavior. McGraw-Hill Higher Education.

Hildenbrand, W. (2014). Market demand: Theory and empirical evidence. Princeton University Press.

Hill, C., & Schiller, B. (2015). The Micro Economy Today. McGraw-Hill Higher Education.

Holmes, T. J., Hsu, W. T., & Lee, S. (2014). Allocative efficiency, mark-ups, and the welfare gains from trade. Journal of International Economics, 94(2), 195-206.

Jones, T., Gatzlaff, D., & Sirmans, G. S. (2016). Housing Market Dynamics: Disequilibrium, Mortgage Default, and Reverse Mortgages. The Journal of Real Estate Finance and Economics, 53(3), 269-281.             

Laibson, D., & List, J. A. (2015). Principles of (behavioral) economics. The American Economic Review, 105(5), 385.

Lee, C. Y., & Johnson, A. L. (2015). Measuring efficiency in imperfectly competitive markets: An example of rational inefficiency. Journal of Optimization Theory and Applications, 164(2), 702-722.

Mankiw, N. G. (2016). Economics-Microeconomics-Principles of Microeconomics.

Miller, R. L., & Benjamin, D. K. (2015). The economics of macro issues. Pearson.             

Paciorek, A. (2013). Supply constraints and housing market dynamics. Journal of Urban Economics, 77, 11-26.

Pindyck, R. S., & Rubinfeld, D. L. (2015). Microeconomics; Eight Edition, Global Edition.

Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.

Rubinfeld, D., & Pindyck, R. (2013). Microeconomics. Pearson Education.

Schwager, J. D., & Etzkorn, M. (2017). Supply?Demand Analysis: Basic Economic Theory. A Complete Guide to the Futures Market: Technical Analysis and Trading Systems, Fundamental Analysis, Options, Spreads, and Trading Principles, 359-371.

Stein, R., & Allione, G. (2014). Mass attrition: An analysis of drop out from a Principles of Microeconomics MOOC. Retrieved May 18, 2015.

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