QUESTION

Question 3 (44 marks)

Please note that this question requires substantial research

Part A – (8 marks) Explain monopoly and monopolistic competition market structures, and identify the key factors that distinguish them

Part B – (18 marks) Choose two different industries from your home country representing monopoly and monopolistic competition market structures. Identify their key characteristics in relation to the factors used to differentiate between the market structures. Using the real 5/5 data from your case studies analyse how well each case study fits with the different market structures.

Part C – (6 marks) For the monopoly firm in your case study, identify the potential market power that it has and the types of controls (if any) that are in place to limit this.

Part D – (6 marks) For the monopoly firm in your case study, identify if there are other benefits generated by the monopoly that would be difficult to gain from a monopolistic competition market structure.

Part E – (6 marks) For the monopolistic competition industry, identify the extent to which firms are able to differentiate their products, and whether this allows them to gain some price advantages.

SOLUTION

Monopoly and monopolistic competition market structures

Monopoly Market Structure

The monopoly is understood to be the market structure associated with single seller of a product which has huge demand either as a result of necessity or because of the huge customer base (Gillespie,2011). However this may not be correct that in case of monopoly there is single seller. But the essence of monopoly in today’s world is that the seller which attribute to majority of the needs of the customer and is very difficult and almost impossible to have competitive edge.

The major characteristics of monopoly are:

1. Monopoly in most of the cases is characterized by single seller.
2. The one in monopoly has no close substitutes. For example in case of Bangladesh Electricity supply is monopolized, which has no substitute. The public ha to depend and buy the product (electricity) from single centralized seller (government)
3. The one in monopoly is the price maker. The price of the commodity is decided by the monopolist. However the general perception is that the marginal revenue is equal to the marginal cost.
4. Barrier to entry is there in case of monopoly. The new entrant in the market is either not allowed or the entry of new entrant is made difficult or almost impossible. The entry to the new entrant is restricted either by economies to scale for the monopolist or the legal bindings that have been imposed b the government. This is some times referred to as natural monopoly.

The monopoly market does have some pros and cons. The monopoly market is in better position to pursue research and development activities this is at the same time the disadvantage as the efforts been put are limited because there is no incentive in the sense that there is no competition being offered to the monopolist. Another major point is that of economies of scale. At the same time is not favorable as the consumers face the issue of high prices in the monopolistic markets.

There are a large number of sectors that enjoy monopoly; this is because the investments required in such sectors are huge. Thus it may lead to pressure on the sector and may lead to effects which are not desirable and may become difficult to handle and put pressure on growing economies.

Monopolistic Competition

In perfectly competitive market there are a large number of firms competing in the same market. There is huge competition in such markets. In case of monopoly there is single seller, generally(Gillespie,2011). The monopolistic competition lies in between the two types of market.

In the monopolistic competition market structure there are a large number of firms that are selling differentiated products to the consumers. There are a few barriers to entry for the new entrants in the market which distinguishes it from monopoly.

Below are the characteristics of the monopolistic competition market structure

1. There are many sellers in the market but these do not take into account the rivals activities as these are having differentiated products.
2. Product differentiation is there in this market structure, this is to say that the products being produced are not homogenous and thus are different based on the seller in the market.
3. There are multiple dimensions to competition and thus it becomes difficult to analyze the specific industry as the products are not homogenous and there are other dimensions that govern the competitive nature of the market structure.
4. There are no significant barriers to entry thus the barriers to entry are significantly lower than the monopoly market.

Thus with the similarity of the monopoly and monopolistic competition it can be said that the marginal cost is set to be marginal revenue.

Examples of Monopoly and Monopolistic Competition Market Structure from Bangladesh

In the context of Bangladesh there are a large number of sectors which can be characterized as monopoly market structure. These are water supply, Railways, Infrastructure, Electricity supply etc. For the purpose of this paper the railways will be discussed. The example of monopolistic competition market structure in the context of Bangladesh, the best example is that of banking industry. The characteristics of both the market structures discussed above can be related to the two industries of Bangladesh. Firstly railway in Bangladesh has the monopoly in the market because of the support of the government. Thus there is single seller in the market for the services. Secondly the price maker for the railways is the government. Thus the government decides what the prices are to be set. Railways have their own segment in the transportation thus it does not have any close substitutes when the prices and facilities are to be considered. Thus the railways are not having any close substitutes. Lastly the entry is restricted. There can be no competition to the railways in Bangladesh. The new entrants are not allowed.  This is because if the government loses control over this segment the public might be exploited. Thus to protect the public from increased burden of fares the government has maintained monopoly of railways by having full control over it and not allowing new entrants in the market

The example discussed for monopolistic competition the banking industry will be discussed. The banking sector in Bangladesh suffers due to high Interest Rate Spread. This puts pressure on the banking industry to increase the profits because of higher interest rate spread. In the financial and economic environment of Bangladesh this could not be possible, thus resulting in reduced competitive nature of the market. This is one of the characteristic of the monopolistic competition (Monzur Hossain, 2010).

Secondly the banking industry of the Bangladesh I quite open and offer little barriers to entry. The foreign banks are also allowed to operate with the advantage that in their base country the interest rate spread is on the lower side.

It has been argued that the steps should be taken to improve the competition in the market but the steps have not been fruitful looking at the market structure wherein the banking facilities will have to be provided to the masse who will be dependent on the banks.

Thus the banking industry in Bangladesh possess the characteristics of monopolistic competition of which two most important is the little barriers to entr and reduced competition between the sellers. The other aspect is that the similar et different products are being provided by the banks in Bangladesh which is the most important characteristicof the monopolistic competition.

Monopoly: Control and Power

The railways of Bangladesh enjoy all the powers that has to be provided or that are there with the seller in the monopoly. In case of railways in Bangladesh they have the full control over the fare, services and on the level of restrictions. Firstly the fares are set as per the requirement of the public and not as per the targets of the firms which is the case in perfect competition. There is no need for the railways to reduce the margin as there is no competition in the market.

Secondly the entry to the new entrant is restricted, this is in order that the government has the full control over the railways and does not have to take steps to handle the competition in the market thus it will become price maker and the decision maker in the industry. Thus the barrier to entry is that no one can enter in this sector and thus maintaining the full control of the government.

Thirdly since government is having full control, it exercises the power of setting the rules in this sector, which is related to pricing and the service being provided. However the government can take innovative step in order that the satisfaction of the public is achieved, but this has been restricted in order to reduce the cost.

Government also controls the investments that have to be made in this sector, thereby controlling the cash flow in the railways and restricting the changes as per the requirement of the railways and the need of the public.

The railways is monopolistic also because huge investments are required which is very difficult for private firms to raise funds. In such a case the railways project will not remain viable and thus will lead to the government intervention. In order to avoid such situations also the monopoly in railways is maintained.

Lastly no substitutes being present increase the dependency on the railways thereby putting the pressure on the railways to deliver. Thus the absence of substitutes is beneficial as it will help in taking the advantage of economies of scale and at the same time impact the services being provided because of the pressure of delivering to masses.

Monopoly: Benefits to Railways in Bangladesh

The government or the railways enjoy a lot of benefits from the monopoly they enjoy in Bangladesh. Firstly control over the prices. With the control over the prices in the railways and not considering the prices as per the demand the government has been able to take step to fulfill the requirements of the public. In case the funds are not available suitable bail out has been done by the government. Also the government has been able to assign separate funds for this.

Secondly due to monopoly the government does not have to worry about the competition. Thus this provides comfort to the government to act freely. There are no threats to the share in the market as there is no competition. Thus the government can have low prices and at the same time there wont be issue as they would be enjoying the economies of scale thereby keeping lower costs in the interest of the public.

However there have been a few issues, firstly in the level of service. However it was expected that with the role of government in the management the service would be of highest quality but the monopoly has resulted in wastage of resources and thus lower level of services. If the sector would have been competitive such wastages could have been reduced and the service level might have been improved. But this is due to the corruption in the sector and not in the characteristic of the monopoly that the railways is having.

Monopolistic Competition Market Structure in Bangladesh

The firms in Bangladesh are not able to exactly differentiate their product but the pressure of various aspects such as interest rate spread and the presence of international banks make them provide the services to the customers. In this effort the banks in Bangladesh are able to create differentiated products. The basis for the differentiated products is different which another reason for is differentiated products. These are market size in the region, returns for the banks and the risks that are associated. Based on this the banks are differing their costing and in different manner. For example some banks are offering flexible rates and others are offering fixed rates for interest. The banks also vary there services based on the tenure of loans. Few banks are providing short term loans and other are providing medium and some of them come with long term loans. With different treatment being done to the non performing assets, banks are also differing on the kind of services being offered

However in order to make the market more competitive as the target of the government I here need to be some changes made so that the market shifts from being monopolistic competitive to perfectly competitive (Monzur Hossain, 2010). These efforts include increasing the liquidity in the market and some other factors along with this are also there.

Although the banking sector in Bangladesh is open with little entry barriers even for the international players the operational efficiency is on the lower side. With the improvement in operational efficiency of the banks the profits of the banks will improve thereby improving the competition in the market.

References

Monzur Hossain. (2010). Determinants of interest rate spread.Available: http://www.thedailystar.net/newDesign/news-details.php?nid=124283. Last accessed 21st Apr 2012.

Greusning, H. v., & Bratanovic, S. B. (2003). “Analysis of Managing Banking risks  ” A f r a m e w o r k   f o r   a s s e s s i n g   c o r p o r a t e g o v e r n m e n t   a n d   F i n a n c i a l   r i s k ”  Washington DC: The World Bank.

Herring R. J & Vankudre P. (1987). “Growth Opportunities and Risk-Taking by Financial

Intemiediarie”.  The Journal of Finance. 42(3), 583-599.

Nadim Jahangir, Shubhankar Shill and Md. Amlan Jahid Haque. (2007).EXAMINATION OF PROFITABILITY IN THE CONTEXT OF BANGLADESH BANKING INDUSTRY. Available: http://www.journal.au.edu/abac_journal/2007/may07/abacjVol27o2_article05.pdf.

B. Douglas Bernheim, Michael D. Whinston (2008) Microeconomics

David Besanko, Ronald Braeutigam (2007) Microeconomics: Study Guide: An Integrated Approach

David Besanko (2008) Microeconomics: International Student Version

The Economist (2010) Guide to Economic Indicators: Making Sense of Economics

Neil Fuller, Nigel Proctor (rev.) (1997) Fundamental Economics

Andrew Gillespie (2011) Foundations of Economics

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