Oligopsony (from the greek «oligoi», few, and «opsõnía», purchase) is a market structure form of imperfect competition characterized by the existence of a relative small number of buyers, and many sellers. It is a similar case to oligopoly but were the oligopolistic powers come from the demand side. Monopsonies, a term first coined by Joan Robinson in her book “The Economics of Imperfect Competition”, 1933, are a particular case of oligopsonies, where there is only one buyer, which holds all the negotiating power.

Monopsony (from the greek «mónos», single, and «opsõnía», purchase) is a market structure form of imperfect competition characterized by the existence of a unique buyer and many sellers. It is a similar case to monopoly but were the monopolistic powers come from the demand side and not from the supply one. Joan Robinson first coined this term in her book “The Economics of Imperfect Competition” 1933.

There are not many cases of real monopsonies in the world, however the many occur in any input market. Examples of this include the one of the United States over defence and security assets in the economy, which started during the cold war. Nevertheless, the most significant case analysed is monoposony in the labour market. Frictions between the job searching progress and joining to it, causes employees to be uncomfortable about leaving their workplace.

This position gives the employer monopsonist powers and allows them to push wages down to the marginal revenue product providing them with higher profits. Governments have the possibility to set a minimum wage to prevent wages dropping to very low levels.

Markets with the same features as monopsonies but where there are more than one buyer, being the number of buyers still small enough, are known as oligopsonies.

Monopolistic competition is a market structure defined by four main characteristics: large numbers of buyers and sellers; perfect information; low entry and exit barriers; similar but differentiated goods. This last one is key to distinguish monopolistic competition from perfect competition since in the latter all products are homogenous. This product differentiation leads consumers to perceive products in this market as unique, providing firms with a monopolistic-like property that enables them having price-making power. There is a distinction to be made between horizontally and vertically differentiated products in order to be able to understand different strategies that monopolistic firms might adopt. The former is given when consumers base their purchasing decision on subjective preferences when comparing products, e.g. colours or flavours. The latter occurs when the product can be evaluated with another one in terms of measurable and qualitative factors, e.g. technological differences or technical properties in engines.

The extent to which each firm can take advantage of their monopoly condition depends on the flexibility of their demand curve. If it is too rigid (steeper), in order for the monopolist to achieve a higher price, it has only to reduce some of its production. However the more flexible (flatter) the demand curve is, the less market power the firm has to increase prices. Naturally, every monopolist in an imperfect market tries to expand the size of the market in which its product dominates. For this they have to compete with other monopolists leading them to a series of costs other than production (manufacturing and transportation costs), which are defined as selling expenses. These expenses are incurred with the aim of modifying the demand curve so quantities demanded for the product increase for each level of prices.

If a firm fails to have its product differentiated, the market would be shared with other firms, turning into a duopoly, oligopoly or even, if other conditions are met, a perfectly competitive market.

Within the field and existing research of monopolistic competition, the most prominent model is the one devised by Edward H. Chamberlin (the Chamberlin model), which he developed from monopoly models. Even tough there are other models and theories, most have followed Chamberlin’s model, being this the most widely used and recognized in economics.

Duopoly (from the Greek «duo», two, and «polein», to sell) is a type of oligopoly. This kind of imperfect competition is characterized by having only two firms in the market producing a homogeneous good. For simplicity purposes, oligopolies are normally studied by analysing duopolies. What strategies firms follow and their interactions are a key feature of this market structure.

In duopolies there are two variables of interest: the prices set by each firm and the quantity produced by each firm. Several models have been developed through time, from which we must highlight the Cournot, Stackelberg, Bertrand and the Edgeworth solution. The first two models seek the optimum quantity a firm should produce. Both have different conclusions as they have a different initial assumption. With time, and as the next two models proved, the focus changed to target the optimum price a firm should set in order to maximise profits.

There are also different perspectives in the analysis of duopolies, which deal with game theory. While the models by Antoine Cournot and Joseph Bertrand occur under a basis of simultaneous games, Heinrich von Stackelberg’s model depends on sequential games.

In the real world, firms interact with each other and have to consider the potential negative effects a price war may report in the long-run. Edward Chamberlin suggested that in an oligopolistic market, firms would soon recognise their interdependence and hold monopolistic prices without the implications of collusion, but that would give the same equilibrium point. Collusion equilibrium will be maintained for as long as a firm finds it more beneficial to do so. The moment a firm thinks it can achieve higher profits by deviating from it, it will do so.

Oligopoly (from the Greek «oligos», few, and «polein», to sell) is a form of market structure that is considered as half way between two extremes: perfect competition and monopolies. This kind of imperfect competition is characterized by having a relatively scarce amount of firms, but always more than one, which produce a homogeneous good. Due to the small number of firms in the market, the strategies between firms will be interdependent, thus implying that the profits of an oligopolistic firm will highly depend on their competitors’ actions.

Firms in oligopolistic market can have a wide range of behaviour patterns making it difficult to have a single model.  Static models are used as they present a simple way of analysing equilibriums in this market. However, the maximisation problem faced by the firm will be marked by the different strategic interdependence context in which that market works. Therefore, the firm must estimate and collect the reactions of its competitors in its optimisation problem to choose the best strategy to follow. As a result we must propose a conjectural variation on how competitors modify their behaviour as the firm varies strategies.

Let’s see how conjectural variation affects each firm’s behaviour and final output. We start with the profit (π_i) maximisation problem, where Q is total output, q corresponds to each firm’s output and C is its production costs:

Setting this to zero for maximisation, we have:

Therefore, rearranging the previous function we have: 

From this last function, we can assume the following:

-each firm’s profits are directly related to its competitors’ behaviour, which determines the conjectural variation (CV).

-each firm’s behaviour depends on the conjectural variation of their competitors: if CV>0, the firm will react by striking back with the same action (lowering prices, for example); if CV<0, the firm will choose the opposite strategy; if CV=0, the firm will accommodate its competitor’s strategy, as the Cournot duopoly model assumes.

-each firm’s behaviour, understood as reactions to each other’s strategies, define the market structure and the degree of competition.

For simplicity purposes, oligopolies are specially studied in cases in which there are only two competitors in the market. These are known as duopolies and its analysis and conclusions can be extrapolated for oligopolies.

Monopoly (from the greek «mónos», single, and «polein», to sell) is a form of market structure of imperfect competition, mainly characterized by the existence of a sole seller and many buyers. This kind of market is normally associated with entry and exit barriers.

All of these features give the monopolist the ability to set prices with the only limitation of consumers’ willingness to pay. Therefore, in monopolies, the seller is a price-maker and consumers will be price-takers.  The firm will choose its production output (q) and price (p) in order to maximise revenue (π). The optimal condition, where we’ll have marginal cost (MC) equals marginal revenue (MR), is given by: 

The extent to which a firm can take advantage of its monopolistic condition will highly depend on the flexibility of its demand curve. If it is more rigid (steeper), it will only have to reduce its production in order to achieve a higher price. However the more flexible (flatter) the demand curve is, the less market power the firm has to increase prices. This relationship between price elasticity of demand and market power can be described using the Lerner index. This index measures the firm’s level of market power by relating price to marginal cost, 

The result will always be between 0 and 1: the closer it is to 0, the closer it is to perfect competition; the closer it is to 1, the higher market power the seller has and hence closer to a monopoly. A monopolist seeking to maximise profits will never be on the inelastic part of the demand curve, E < 1, which is why elasticity will always be such as ∞ ≥ E ≥ 1. The Lerner index is equivalent to the inverse of the elasticity in its absolute value faced by the firm when price is set to maximise profits.

The implications of monopolies in terms of loss of efficiency and social welfare have been largely studied and discussed. If we compare the monopolistic price setting with the perfect competition one, we will find that while in the former price is greater than marginal cost, in the latter, they are equal. This implies that in general, price will be higher and output lower, if a firm behaves in a monopolistic manner, instead of a competitive one. And also in general, results for the firms will be to be better off, while it will be just the opposite for consumers. However, the gain for the firm will not sum up the total loss for the consumers. This is known as the deadweight loss of monopoly that comes as a result of the Pareto inefficiency of monopolies. From the equilibrium output of a monopoly to that of a perfectly competitive market, the consumers will be willing to pay more than marginal cost. This leaves space for improving efficiency, but monopolistic firms choose to produce less and set higher prices. This deadweight loss is represented by the areas A and B in the adjacent figure: while the monopolist gains area Cˈ and loses B, consumers transfer area Cˈ and lose A. As a result, firms increase their surplus, consumers lose part of it and in aggregate terms, society as a whole, will bury the deadweight loss.

Types of monopolies:

As we have previously explained, monopolistic firms maximise their profits with the level of output in which marginal cost equals marginal revenue. However we can distinguish different types of monopolies depending on how they achieve this. We can distinguish different types of monopolies:

Multiplant monopoly: firms which have many production plants and hence different marginal cost functions will have to choose the individual output level for each plant.

Bilateral monopoly: this market structure consists of a single buyer (monopsony) and a single seller (monopoly). Depending on who has greater negotiation power there can be different outcomes. Two possible scenarios may be in either one of them having all of the power, an intermediate solution may be found or a vertical integration may occur.

Multiproduct monopoly: instead of selling one product, the monopoly sells several. The firm will have to take into account how the changes in the price of one affect the rest of its products.

Discriminating monopoly: firms may want to charge different prices to different consumers, depending on their willingness to pay. Depending on the level of discrimination we have different degrees. The first degree or perfect discrimination is given when the monopolist sets the highest price that each consumer is willing to be pay. The second degree or nonlinear price fixing is given when price depends on the amount bought by the consumer. And finally, the third degree or market segmentation of price discrimination occurs when there are several differentiated consumers segments to which the firm will apply different prices, e.g. student or third age discounts.

Natural monopoly: this kind of monopoly occurs in industries in which, due to cost-technological factors, it is more efficient to have a single firm dealing with all of the production, as average costs are lower in the long run; a phenomenon known as subadditivity.

Imperfect competition or imperfectly competitive markets is one in which some of the rules of perfect competition are not followed. Virtually, all real world markets follow this model, as in practice, all markets have some form of imperfection. When dealing with imperfect competition the equilibrium price can be influenced by the actions of agents. In imperfect competition the price of goods can increase above their marginal cost and thus have customers decrease their level of purchase, and so reach inefficient levels of production. Governments try to avoid these situations and take measures to stop imperfect competition.

The most common forms of imperfect competition include: monopolies, oligopolies, duopolies, monopolistic competition and monopsony.

Roy Harrod was the first economist to develop the theory of imperfect competition and, other authors, such as Edward Chamberlin and Joan Robinson renewed its interest and made major contributions. Nevertheless, it is important to point out that Cournot, in his “Researches into the Mathematical Principles of the Theory of Wealth”, 1838, was the first to model this kind of markets.

Perfect competition or competitive markets -also referred to as pure, or free competition-, expresses the idea of the combination of a wide range of firms, which freely enter or leave the market and which considers prices as information, since each bidder only provides a relative small share of the good to the market and thus do not exert a noticeable influence on it. Therefore, perfect competitors cannot influence the levels of market clearing prices. Also, buyers are numerous and disperse, which also means that they cannot influence prices.

This market model is based on a set of assumptions, each of them representing a necessary but insufficient condition to ensure perfect competition. These assumptions are:

-Homogeneous product: all firms offer the same goods, with the same characteristics and quality as the others, without any variations.

-Large number of agents: there should be a sufficient quantity of buyers and sellers, so that no action from a single agent will affect the market structure or its prices.

-No entry or exit barriers: there has to be free entry and exit of agents in the market. This assumption is of special interest for firms, which must be able to enter or leave the market freely.

-Price flexibility: price adjustments to changes happen as fast as possible. Usually, price changes are assumed instantaneous.

-Free and perfect information: all agents have perfect knowledge of products and their prices, and everything else related to them, as well as free access to this information.

-Perfect factor mobility: all factors should be able to change so adjustments processes can be carried out with the greatest efficiency.

-No government intervention: markets should be left alone as government intervention would only lead to imbalances in perfectly competitive markets. 

Perfect competition markets are almost impossible to find in the real word as all markets have some type of imperfection. This is the reason they are mostly considered only theoretically. However, its study helps understand real world markets and their phenomena.

It must be noted that the theory of contestable markets, developed by William J. Baumol in his “Contestable Markets: An Uprising in the Theory of Industry Structure”, 1982, that perfect competition prices and output can be reached with just a few of these assumptions. Furthermore, Bertrand’s duopoly model determines that oligopolistic markets can reach the same prices as in perfect competition as long as oligopolists compete by changing their prices, instead of the quantity offered.