Competition And Market Power Economics Essay

For a long period of time, De Beers has been successfully raising consumer demand for diamonds. The company is famous for its monopolistic policies during the last century, when it used its leading position to control the international diamond market. De Beers had a number of methods to ensure its control in the market: thus, it joined some independent manufacturers to its single channel monopoly, it pushed the manufacturers who refused to join the cartel out of the market by overfilling the market with diamonds, it bought and stored the diamonds of other producers in order to regulate the prices (De Beers Company).

Pure monopoly means the conditions in the market, when only one company produces and sells a product that has no substitutes. The market access is limited and the company has complete control over prices. Thus, in pure monopoly, the market is dominated by a big enterprise-monopolist fully controlling the prices. Establishment of extremely high prices is restrained by the risks of a fall or a lack of consumer demand. Monopolist assesses demand and sets the price at a level that ensures the greatest return on investment (Larue, Gervais & Pouliot, 2008).

Monopolies are also public utilities, the services of which are used by any business. The existence of natural monopolies is justified by the fact that they best meet the public interest. In rural areas, such monopolies can be companies supplying agricultural machinery, chemical fertilizer, seed and breeder farms, businesses that provide repair services. The main features of monopoly are as follows (Larue, Gervais & Pouliot, 2008):

There is only one firm in the market, which affects the prices, adjusting the proposal;

There are no identical products in the market;

Controlling the market of raw materials in the industry, the company-monopoly excludes the emergence of new producers.

Thus, the market of pure monopoly is the market of one seller. Most frequently, these are the governmental organizations, with the state monopoly able to solve various problems through pricing policies:

To set a price below the cost for socially important goods to maintain their standard of living;

To set a price covering the costs or providing a good income;

To set a high price to reduce consumption.

Returning to De Beers Company, for the last decade it has been undergoing changes turning into a more reliable company. A number of factors led to the necessity for transformation in the De Beers model (De Beers Company).

In 2004 the company was declared guilty according to the 1994 accusation that De Beers had merged with General Electric to control the price of industrial diamonds; the company paid $10 million to the United States Department of Justice.

Contemporary diamond industry is noticeably differs from that of the last decade, as it is now a complicated and continuously developing geopolitical notion. Today, apart from De Beers, the most important players in the diamond business are the African producer countries (e.g., Botswana and Namibia), Rio Tinto, Lev Leviev, BHP Billiton, Alrosa, Harry Winston, etc (De Beers Company).

3. Monopolistic Competition

Luxury Watch Industry: Go to http://images.businessweek.com/ss/06/05/watches/source/1.htm (Retrieved May 17, 2010). This is an interesting article on luxury watches. Click on the slide show in the upper right window (check out the prices!). Are these three firms participating in a monopolistically competitive market? What characteristics of the good make the market monopolistically competitive? Explain.

A recent study by the Luxury Institute has determined the watches that are considered by the wealthy consumers to be the best out of the top 17 ultra luxury watch producers: Franck Muller, Vacheron Constantin and Audemars Piguet, Patek Philippe and Breguet, though Rolex and Cartier were most famous brands. Nowadays, even not so well-known watchmakers take an equal part in monopolistic competition with the world leaders (Business Week, 2010).

The market with monopolistic competition is characterized by the following features (Yomogida, 2010):

The presence of multiple buyers and sellers (the market consists of a large number of independent companies and customers), the number of which doesn’t exceed the one present in pure competition.

Low barriers for the entry into the industry. This does not mean that it is easy to start a monopolistically competitive firm; such difficulties as problems with registration, patents and licenses are still present.

To survive in the market in the long run, monopolistically competitive firms need to produce diverse, differentiated products, which differ from that is offered by competing firms. Moreover, products may differ from one another by one or several properties (e.g. chemical composition of watches);

Buyers and sellers are perfectly informed about market conditions;

Predominantly non-price competition; advertising of products is very important for the development.

Companies of this type have a negative slope of the demand curve. In monopolistic competition, the output is set at the level of profit maximization (marginal revenue equals marginal cost). However, when deciding on the establishment of prices for products, a monopolistic competitor acts like a monopolist: the price for the goods is set at the highest possible level, i.e. at the level of the demand curve for products.

Just as at the market of perfect competition, in monopolistic competition the firm relies on the value of the average total costs, deciding whether to remain in the industry or leave the market. Thus, if the company continued to suffer losses, it means that the average total production costs exceed the established price per unit, and the firm will leave the market in the long run. It should be noted that, since the monopolistic competitor is dynamic in the decision-making, it cannot effectively allocate resources, which leads to inefficiency of such firms in the long run. It is practically impossible to have a positive profit at the market of monopolistic competition in the long term (Yomogida, 2010).

4. Oligopoly

The OPEC Oil Cartel Go to www.opec.org (Retrieved May 17, 2010). What are the organization’s stated goals, which countries are members, and when was it founded? Is it normal for them to be successful in keeping oil prices high, or have they faced difficulties in keeping the cartel united in the past?

The Organization of the Petroleum Exporting Countries (OPEC) is an international intergovernmental organization (also called a cartel), established by oil-producing powers and including 12 countries: Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador and Angola. The aim of OPEC is to coordinate and develop a common policy with regard to oil production among members of the organization, maintaining stable oil prices, providing a stable supply of oil to consumers, and benefit from the investments in the oil industry (OPEC).

OPEC members control about 2/3 of world oil reserves. Their share in the world oil makes 40%, or nearly the half of the world oil exports. At different periods of its history, the Organization of Petroleum Exporting Countries controlled from 25% to 60% of oil production in industrial countries (Hansen & Lindholt, 2008).

At the same time, the cartel represents a very unstable structure, based on collusion in order to establish a monopoly price in the market, which can be unsatisfactory for some members of the cartel; this finally leads to the violation of the cartel agreement.

At first glance, the similarity of the cartel and monopoly is obvious. But the cartel very rarely (in contrast to the monopoly), controls the entire market, because the policy has to deal with non-cartelized enterprises. In addition, the cartel members have quite a powerful temptation to cheat their partners, reducing prices or actively promoting their product, which creates the conditions for the capture of the market (Hansen & Lindholt, 2008).

Failure to fully and consistently use the cartel for the interaction of oligopolistic firms is forcing them to conduct secret economic policy in price changes and in the delineation of the spheres of influence. Such cooperation may manifest itself in the form of price rigidity or leadership in price formation, and through special organizations such as patent pools.

The rigidity of prices is the oligopolistic practice, when, even with changes in costs or demand, an organization is not inclined to change prices, believing that if it has to raise the price, others will follow, which will lead to loss of market share. In this way, the cartel stays away from changing prices due to the fear to unleash “the war of prices.” Leadership in prices means the practice, when the formation of prices for the product is focused on the prices set by the leader – often dominant in this industry. This demonstrates the kind of implicit collusion, although its presence is usually not proven (Böckem, 2004).

Patent pools represent an agreement on specialization and cooperation of production, and the consortium – the union of firms to conduct joint scientific research and joint construction of large investment projects. Both of these organizations perform cartel functions and are the basis for the organization of conspiracy to divide the market.

Thus, the oligopoly is characterized by three features: – there are two or more competing firms in the industry, so that the industry is not monopolized (OPEC and Russia relation); – demand curve has a falling character, so the industry does not have rules of free competition; – at least one large organization operates in the industry, any action of which causes a reaction of competitors (OPEC oligopolistic practices), so that there is no monopolistic competition (Böckem, 2004).