Monopolistic competition

Another case warranting public intervention is when in reality the conditions for perfect competition are not fulfilled, for example, when there are situations of monopoly or oligopoly, product differentiation (monopolistic competition) or other factors preventing or restricting competition. Public intervention in this case might be in the direction of restoring or promoting this competition. 

In chapter 4 of his thesis, Borrell17 studies selective financing and price-cap regulation. The model he applies, Dixit and Stiglitz s monopolistic competition model, poses certain problems. The preference for variety and the fact that utility depends on the number of units consumed are not so clear as in other markets. The model does not take into account the complex relationship between doctor and patient. The fact that innovation only represents a fixed cost also raises doubts. 

The question of why a seller would choose to dispose of such a product becomes an important one. In a consolidating market the most usual cause is the forced divestment of assets during a merger or acquisition where agencies such as the Federal Trade Commission or the anti-competitive activities arm of the European Commission must rule on the combination of portfolios between prospective partners to ensure that a monopolistic position or market dominance does not result from the merger or acquisition and so disadvantage the consumer. 

The Bertrand model of competition assumes simultaneous price setting between firms. This results in a zero economic profit equilibrium, where price equals marginal cost. The pure Bertrand competition model obviously cannot apply to an industry with fixed costs, as a price equals marginal cost rule would, in the long run, lead to closure of the entire industry. The pure Bertrand model would appear to be inapplicable to all the industries under examination here, as they all have significant fixed costs. A modified price-setting model, such as under monopolistic competition, however, could be employed. 

For a monopolist (N = 1) facing a constant elasticity demand curve, the cost pass-through rule is thus e / (e + 1), which corresponds to that found by Bulow and Pfleiderer (1983). Note that because e < -1 for a monopolist, isoelastic demand therefore implies cost pass-through of more than 100% of any price change, and the pass-through would decline towards 100% for more competitive markets. 

In the pharmaceutical industry, motivations for analog design are often driven by competitive and economic factors. Indeed, if the sales of a given medicine are high and the company is found in a monopolistic situation, protected by patents and trade marks, other companies will want to produce similar medicines, if possible with some therapeutic improvements. They will therefore use the already commercialized drug as a lead compound and search for ways to modify its structure and some of its physical and chemical properties while retaining or improving its therapeutic properties. 

Producers of ethical pharmaceuticals are monopolists to the extent that they have patents on their prodncts. Instead of conventional competition on price and quality, there is competition in innovation between rival producers, so that a number of manufacturers may offer, for example, different H2-antagonists for the treatment of gastric nlcers. Insofar as the patient requires a particular product when it is under patent, however, he or she is faced by a monopoly producer. 

Proprietary research is carried out only by individuals and firms in an oligopoly, with the aim of developing more desirable products and more efficient processes. The results are protected by trade secrets and patents. In a monopolistic market, proprietary research need not be done, and in an atomistic competition, companies cannot afford it. Proprietary research has been responsible for most of the technical innovations that have enriched and improved our standard of living. Examples are nylons and polyesters for fibers and catalysts for cracking hydrocarbons. This type of research is expensive, and the payoffs are uncertain. Adequate rewards must be probable before such research will be undertaken, and the firm must be able to recover the research cost by exploitation of the market for a limited time period. 

The story is more complicated than the simplest case of imperfect competition that was told in the introduction to this chapter (where the output choice of a single monopolistic firm was examined). The strategic interactions between a small number of firms in the same industry must now be included in the analysis. This requires a set-up different from the one developed in the discussion of externalities the demand for the products of different firms must be derived firom first principles, rather than dealing directly with an inverse demand curve for a single good (the reason for this shouldbecome clear below). 

The social planner seeks to maximise the sum of total surplus from purchases of the products minus the costs of production, hy choosing quantities purchased q) and the accumulation constant of these products (a). Entry occurs freely until firms profits are driven to zero this is known as monopolistic competition and is analysed in the papers hy Spence (1977) and Dixit (1979). The social planner s problem is then ... 

Stiglitz, J. E. and Dasgupta, P. (1982). Market structure and resource depletion a contribution to the theory of intertemporal monopolistic competition. Journal ofEconomic Theory, 28,128-64. 

The problem with this depiction is that it is not grounded in reality. The chemical industry is one of the most concentrated industries that exists at hoth national and global levels. Not only is the industry concentrated, but (on account of the availability of chemical patents) much of production takes place in a monopolistic environment rather than a competitive one. Firms in such an environment will respond strategically rather than automatically to regulatory policies. 

Competitiveness is the fourth C in our list of concepts. Managing the competitiveness of a supply chain requires two sets of choices—the choice of the metrics of competition as well as responses to competitors choices. Typical metrics used include lead time, cost, profit, product variety, consistency, service level, fill rate, and others. For a monopolist, it is important to identify appropriate metrics to coordinate optimal choices across the supply chain. However, competition has an impact on the feasible... 

This example illustrates the counterintuitive effects of competition it can cause actions that can worsen overall performance even when it would have been beneficial in a monopolistic context. The bottom line for companies is that not all actions can generate the planned benefidal outcome in the presence of competition. 

This chapter showed how the choice of metric of competition and the existence of competitors affects the performance of a supply chain. The first part of the chapter examined the many alternate metrics that can determine performance, including costs, profitability, service, variety, and lead time. Each of these alternate metrics implies different choices for supply chain architecture as well as for the details of operation. In addition, in the presence of competitors, agreements that are good for the supply chain in a monopolistic setting may be bad for the supply chain in a competitive environment. Thus one may find an industry supply chain stuck in a bad equilibrium with frequent harmful promotions or advance order discounts, unable to pull itself out of this state due to competitive pressures. This chapter thus su ests that competitiveness can be a significant driver of supply chain performance. 

Thus, supplier competition to obtain the order results in lower buyer prices than in a monopolistic supplier supply chain. The lower wholesale price increases buyer profits and decreases supplier profits. 

But, it has been trenchantly argued, if the domain of a theory is properly taken to be the class of happenings in the world the theory can actually desctibe and explain, then foundational physical theories have no such universal scope. First, consider the fact that for most of what we want desctibed and explained in the world, such theories have no applicability at all. Who ever provided a description of the behavior of a chimpanzee, say, in terms of relativistic quantum field theory, and who ever explained failure of competitive equilibrium in markets with natural monopolistic aspects, say, by reference to the elementary particles of the world and their dynamics in spacetime ... 

The reader will recognize that there will be a trade off in such a market between the prices charged and the number of firms, and hence the number of safety choices. Theoretical models such as Dixit (1979) in the case of oligopoly, and Spence (1976), Dixit and Stiglitz (1977) and Koenker and Perry (1981) in the case of monopolistic competition show that the market can either produce a large number of safety choices at high prices, or a limited number at low prices. 

Dixit, Avinash, and Joseph E. Stiglitz. (1977). "Monopolistic competition and optimum product diversity." American Economic Review, vol. 67(3), pp. 297-308. 

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