Monopolistic
Competition and
Oligopoly
These slides supplement the
textbook, but should not
replace reading the textbook
What is
imperfect competition?
A market structure
between pure
competition and
monopoly
2
What is
monopolistic
competition?
A market structure in which
a large number of firms sell
close substitutes which are
different enough that each
firm’s demand curve
slopes downward
3
How can firms
differentiate under
monopolistic
competition?
Physical differences
Location
Services
Product image
4
What are examples of
monopolistic
competition?
 Restaurants
 Clothing stores
 Grocery stores
 Jewelry stores
5
Where are profits
maximized or
minimized ?
MR = MC
6
Dollars per unit
The Firm Monopolistic
Competition in the Short Run
p
b
c
c
e
MC
ATC
Profit
MR D = AR
0
Exhibit 1 (a)
q
Quantity per period
7
Dollars per unit
The Firm Monopolistic
Competition in the Short Run
c
c
Loss
b
p
MC
ATC
AVC
0
Exhibit 1 (b)
D=AR
MR
q Quantity per period
8
In monopolistic
competition, can
economic profit be made
in the short run?
Yes!
Positive or negative
economic profit can be
made in the short run
9
What is long-run profit
in monopolistic
competition?
Zero
10
Why is economic profit
zero over the long-run?
Because if economic profits
are being made more
firms will enter into the
industry; if losses are
being made more firms
will leave the industry
11
Dollars per unit
Long Run Equilibrium in
Monopolistic Competition
MC ATC
p
b
a
D = AR
MR
0
Exhibit 2
q Quantity per period
12
How does
monopolistic
competition compare
with perfect
competition?
They both make a normal
profit over the long-run
13
Dollars per unit
Perfect Competition
MC ATC
p
d = AR
0
Exhibit 3 (a)
q Quantity per period
14
What is an oligopoly?
A market structure
characterized by a small
number of firms whose
behavior is interdependent
15
What are examples
of oligopoly?
Automobiles
Steel
Soup
Cereals
16
What is a possible
explanation for the
formation of
oligopolies?
Barriers to entry, such
as economies of scale
or a high cost of entry
17
Dollars per unit
Economies of Scale as Barriers to Entry
ca
a
b
cb
0
Exhibit 4
Autos per year
S
M
18
What is a collusion?
An agreement among
firms to divide the
market or to fix the
market price to maximize
economic profit
19
What is
explicit collusion?
Cooperation involving
direct communication
between competing firms
about setting prices
20
What is
implicit collusion?
Cooperation involving
indirect communication
between competing firms
about setting prices
21
What is a cartel?
A group of firms that
agree to coordinate
their production and
pricing decisions,
thereby behaving as a
monopolist
22
What are two
examples of cartels?
Organization of
Petroleum Exporting
Countries (OPEC)
International Electrical
Association (IEA)
23
Dollars per unit
Cartel Model Where Firms
Act as a Monopolist
MC
P
D = AR
0
Exhibit 5
MR
Q Quantity per period
24
What are the
problems of stability?
Differences in costs
Number of firms
New entry
Cheating
25
What distinguishes
oligopoly?
Interdependence - No
firm will not take an
action unless it
considers the reaction
from the other firms
26
Imagine 3 identical firms in
an industry – A, B, C. What
happens if A raises price?
B and C will not
raise their price
27
Imagine 3 identical firms in
an industry – A, B, C. What
happens if A lowers price?
B and C will lower
their price
28
What is a price leader?
A firm whose price is
adopted by the rest
of the industry
29
Who is the price leader?
barometric-firm
dominant firm
most innovative
30
What is
cost-plus pricing?
A method of determining
the price of a good by
adding a percentage
markup to average
variable cost
31
What is game theory?
A model that analyzes
oligopolistic behavior as a
series of strategic moves
and countermoves by rival
firms
32
What is a duopoly?
A market with only two
producers, who compete
with each other; a type
of oligopoly market
structure
33
What is strategy?
In game theory, the
operational plan
pursued by a player
34
What is a
payoff matrix?
In game theory, a table
listing the payoffs that
each player can expect
based on the strategy
that each player pursues
35
What is a
kinked demand curve?
A demand curve that
illustrates price
stickiness; if one firm
cuts prices, others will
cut theirs, but if the firm
raises prices, others will
not change theirs
36
Price per unit
The Kinked Demand Model of Oligopoly
more elastic
more inelastic
P
D
'
D
0
Exhibit 7
Q
Quantity per period
37
Price per unit
D and MR Curves for the
Kinked Demand Model
1
D
P
1
MR
0
Exhibit 8
Q
2
D
2
MR
Quantity per period
38
How does price under an
oligopoly compare to
price under perfect
competition?
Price is usually higher
under an oligopoly
39
How do profits under an
oligopoly compare to
profits under perfect
competition?
Profits are higher
under an oligopoly
40
What is a
horizontal merger?
A merger in which one firm
combines with another
firm that produces the
same product
41
What is a
vertical merger?
A merger in which one firm
combines with another from
which it purchases inputs or
to which it sells output
42
What is a
conglomerate merger?
A merger involving
the combination of
firms producing in
different industries
43
END