Managerial decision making is important for the growth and success of a business enterprise. The kind of decision made will be affected by among others, the industry and the market that the firm operates in. in this case, the decision made in a perfectly competitive market will be different from the decision made in a monopolistic market and also different from the decision made in an oligopolistic market. This paper will discuss the differences and similarities in managerial decisions making in the three markets – competitive, monopolistically competitive and oligopoly markets.
Managerial Decisions in Competitive Markets
A competitive market is one where there are many buyers and sellers and none has enough power to alter or influence the price or conditions in the market. This market may be said to be perfectly competitive, and as Thomas and Maurice (2005) explain, all firms are price takers since each firm is too small compared to the total market size to influence the price of goods in the market. In addition, the market is characterized by freedom of entry and exit of firms, homogeneous products, perfect information, perfectly elastic price and horizontal demand and supply curves. The optimal market condition in the long run occurs where the market price equals the average costs such that there is no economic profit or abnormal profit realized by the firms.
The manager’s aim in a firm is to maximize the value of the shareholders by ensuring that the profit margin is as high as possible. However, in a perfectly competitive market, the manager has no such powers due to the higher number of players producing homogeneous products such that any interference with the price of the goods will influence buyers to switch to the substitute goods in the market. Being a price taker, the manager can only adjust the level of output in order to minimize the average costs to the optimal level (i.e. where the average cost will be equal to marginal costs, price and marginal revenue). In other words, the level of output should equate the price to the minimum average cost below which the firm will have to shut down.
In making decisions, fixed costs are ignored because they don’t have any influence in the marginal costs of the firm (i.e. they will remain constant regardless of the production level). Variable costs are important components of costs for they determine the break even point of the firm based on the marginal variable costs and marginal revenue. Where the marginal costs are high, and given that the price in competitive market is constant, the manager will have to increase the output until the marginal costs falls or the marginal revenue rises to the optimal level.
The freedom of entry requires the manager to be aggressive in determining the output that will maximize the profits of the firm. This can be more effective in the short run when there are abnormal profits, after which the freedom of entry will see many firms entering the industry attracted by the short run abnormal profits. The result will be an increase in supply in the market leading to decline in the price and therefore elimination of the abnormal profits. In the long run, economic losses due to excessive competition may push some firms to exit the industry, forcing supply to decline and price to shoot up again.
Due to intense competition, the firm’s best response will be to make managerial strategic decisions that will involve product quality and internal organizational restructuring as well as technological advancement. Given that the products are identical and price can not be adjusted by a single firm, improved quality of products, faster channels of distribution, technological advantage and competent and talented workforce may enhance a firm to gain a competitive advantage and reap economic profits in the competitive market (Hirschey, 2009, p. 438).
Managerial Decisions in a monopolistically competitive Market
A monopolistically competitive market may be describe as a market with many buyers and many firms but the firms have some powers to set up prices, given that the products in the market are not perfect substitutes (they are close but not identical substitutes). In other words, there exists differentiation of products in the market such that the firms become price setters and not price takers, while the demand curve in the market is downwards slopping (Hirschey, 2009, p. 502). The market conditions are almost similar to perfectly competitive market in terms of free entry and exit, perfect market information and normal long run profits except for product differentiation.
Although abnormal profits may occur in the short run, barriers to entry and exit are relatively low and thus competing firms will enter into the industry to take up the abnormal profits, and thus pushing the profits down to risk-adjusted rate of returns in the long run. Most of business settings in the current real world are in monopolistically competitive market; for example, in automobile industry, Toyota, Isuzu, Honda, BMW and the rest are close substitutes but differentiated in terms of quality, brand name and model. Here, consumers’ purchase behavior will not necessarily be based on the price, but on the difference they perceive in these vehicles. Managers’ discretions in setting prices of the products can be also coupled with product differentiation in order to counter any countermeasures made by the competing firms. However, the maximizing profit output will equate the marginal revenue to the marginal cost just like in perfectly competitive market, although there will be no particular time that the firms will operate at the minimum average cost (Webster, 2003, p. 373). In addition, at the optimal level of output, the price of the products will always be higher than the marginal revenue and marginal cost but will be equal to the average total cost. This means that the price is higher and the output is lower in monopolistically competitive market than in a perfectly competitive market. Although this may be implied to mean that firms in this market are inefficient, the reality is that, the reason behind firms not operating at minimum average cost is based on the tendency of consumers to differentiate the products.
Due to intense competition in the market, the manager always influences the performance of the product in the market through market segmentation decisions as well as through advertisements. In this case, the manager’s decision is to ensure the product produced is far much different, although serving the same purpose, to other products in the market in order to win a large market share and consumer loyalty.
Managerial Decisions in Oligopoly Market
An oligopoly market may be described as a market with few sellers who have discretionally power to influence the price of the products in the market. In addition, the barriers of entry and exit are high and the firms have the tendency of entering into cartels to make price-output decisions. For example, the oil industry has witnessed the formation of OPEC as a cartel for oil products, whereby the member companies influence the price and the output in the market. This means that, in an oligopoly market, only a few rival firms control the total output whose products may be identical of differentiated (mostly by heavy advertisement) and the decision of one firm has a predictable reaction of the other firms (Hirschey, 2009, p. 511).
The interdependence of the firms gives rise to game theory where the managers have to make strategic decisions based on the likely reaction of the rival firms. According to Holloway (2008, p.216), any firm making strategic decision must weigh the probable reactions of the rival firms knowing very well that the rivals will also weigh its reaction when they make their decision; that is, every firm should realize that every player in oligopoly market is rational in decision making. This interdependence of decision making makes the managerial decision making a complex exercise in a firm, which may be faced with three decision situations including simultaneous decisions, sequential decisions and repeated decisions.
Due to rigidity of price in the oligopoly market, managerial decisions are always directed towards maximizing sales and increasing market share, with advertising and other non-price strategies being put into use (Bridge and Dodds, 1975, p. 217). According to Foss (2000, p. 33), this is a deviation from the perfect competitive and monopolistically competitive markets where the main motive is profit maximization in order to survive i.e. the oligopoly market firm will be more entrepreneurial with more desires other than profit. For instance, in a non-cooperative oligopoly, when one firm reduces price, other firms may also reduce their prices in order to protect their market share and therefore shifting the demand curve to the right. However, in cooperative oligopoly, cartels, formal collusions and tacit collusions may be employed to fix price above the marginal level and allow the firms make abnormal profits. Since power and capital strength play a key role in the oligopoly market, managerial decisions involving mergers and acquisitions are common as has been witnessed recently in banking and airline industries.
Bridge, J. and Dodds, J. C. (1975). Managerial decision making. London: Taylor & Francis.
Foss, N. J. (2000). The theory of the firm: critical perspectives on business and management. London: Taylor & Francis.
Hirschey, M. (2008). Managerial Economics. KY: Cengage Learning.
Holloway, S. (2008). Straight and Level: Practical Airline Economics. Surrey: Ashgate Publishing, Ltd.
Thomas, S. R. and Maurice, S. C. (2005). Managerial Economics. McGraw-Hill. Web.
Webster, T. J. (2003). Managerial economics: theory and practice. Emerald Group Publishing.