What are some of the factors responsible for market dynamics

What are some of the factors responsible for market dynamics as the structure moves from monopoly to say monopolistic competition? How important is this dynamic in determining optimum pricing strategy for businesses within such industry?

Solution

The main factor of a monopolistic market shifting toward monopolistic competition (or even oligopoly) is entry of new entrants. That signifies that, if it were a natural monopoly, then the barrier to entry (for example, high start-up costs) was broken by the new entrant which has entered the market in a large scale. And if it were an artificially (government) created monopoly, then the government had decided to open up the market to other firms by removing regulations barriers.

A second factor to consider is the scale of operations. With higher output, average cost of production falls (economies of scale operates). So, the new entrant(s) most likely enter being equipped with large scale production capabilities, to ensure unit cost of production is not too high compared to existing monopolist, so that the new firm(s) can price their products competitively.

The pricing strategy is crucial because, a competitive pricing will extend perfect substitution to the monopolist\'s product, increasing demand for the new firm(s). And if new firm(s) can price their goods lower than the monopolist price, their demand will increase more because consumers will switch from the monopolist to the new firm. In a non-monopoly market structure, there cannot be much price variations across different firms, because higher number of firms make market demand more elastic, and more responsive to a difference in price.