Monopolistic Competition &
Oligopoly
ECO 2023
Chapter 11
Fall 2007
Monopolistic Competition
• A market structure with many firms selling
products that are substitutes but different
enough that each firm’s demand curve slopes
downward, firm entry is relatively easy
Characteristics
•
•
•
•
•
•
Relatively large number of sellers
Differentiated product
Ease of entry and exit
Low barriers to entry
Price makers
Advertising
Monopolistic Competition
• Product Differentiation
• Physical differences
• Differences in appearance and qualities
• Evian vs Dasani
• Location
• The number and variety of locations where a
product is available are other ways
• Services
• Product image
Monopolistic Competition
• Short-run Profit Maximization
• Because each monopolistic competitor offers
a product that differs somewhat from what
others supply
• Each has some control over the price
charged
• Demand curve slopes downward
• Elastic demand
• Marginal revenue = marginal cost
Monopolistic Competition – Short run
Price
Profit
Marginal Cost
Average Total
Cost
Price
Profit
Cost
Demand
Marginal
Revenue
Q
Monopolistic Competition – Short run
Price
Cost
Price
Loss
Marginal Cost
Average Total
Cost
Loss
Demand
Marginal
Revenue
Q
Long run Economic Profit
• If short run has economic profit
•
•
•
•
Firms enter the industry
Output increases
Price decreases
Profit in long run disappears
• If short run economic loss
•
•
•
•
Firms exit the industry
Output decreases
Price increases
Loss disappears
Long run
No economic
Profits or
Losses
Oligopoly
• Market structure characterized by a few firms
whose behavior is interdependent
Characteristics
•
•
•
•
A few large producers
Homogeneous or differentiated products
Control over Price
Mutual interdependence and strategic
behavior
• Barriers to entry
• Mergers
Mergers
• Oligopolists have a tendency to merge and
become monopolists
• Increases market share
• Greater economies of scale
• Caused by desire for monopoly power
Measures of Industry Concentration
• oligopolistic industries are concentrated in the hands of their
largest firms
• Concentration ratios
• Reveals the percentage of total output produced and sold
by an industry’s largest firms.
• When largest four firms control over 40% then it is
oligopoly
• Automotive 81%
• Sugar cane 99%
• Shortcomings
• Localized markets
• Interindustry competition
• World trade
• Herfindahl Index
• The index is the sum of squared percentage market
shares of all firms in the industry.
• Larger the index, the more market power within the
industry
Oligopoly
• Models of Oligopoly
• There is no general theory but rather a set of
theories
• Each based on the diversity of observed
behavior in an interdependent market
• Collusion
• an agreement among firms to increase
economic profit by dividing the market or
fixing the price
• CARTELS are created
Oligopoly
• Collusion
• Cartel
• A group of firms that agree to coordinate their
production and pricing decisions to act like a
monopolist
• Problems with Collusion and Cartels
• Differences in Average Cost
• Number of firms in the cartel
• New entry into the industry
Oligopoly
• Price Leadership
• A firm whose price is adopted by other firms
in the industry
• Tacit form of collusion
• Typically a dominant firm in the industry
• Set prices and others follow avoiding
competition
• Violates antitrust laws
Oligopoly
• Game Theory
• An approach that analyzes ologopolistic
behavior as a series of strategic moves and
countermoves by rival firms
• Outcome is achieved when each player’s
choice does not depend on what the other
player does