Monopolistic Competition,
Oligopoly, and Strategic
Pricing
Chapter 13
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Introduction
Market structure is the focus real-world
competition.
 Market structure refers to the number of
firms and their size distribution.


Usually market share can be use as a proxy for
the firm’s size (qi / Q where Q = sum of the output of all
firms) .
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Introduction

Market structure involves the number of
firms in the market and the barriers to
entry.
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Introduction
Perfect competition, with an infinite number
of firms, and monopoly, with a single firm,
are polar opposites.
 Monopolistic competition and oligopoly lie
between these two extremes.

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Introduction
Monopolistic competition is a market
structure in which there are many firms
selling differentiated products.
 There are few barriers to entry.

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Introduction
Oligopoly is a market structure in which
there are a few interdependent firms.
 There are often significant barriers to entry.

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Monopolistic Competition

The four distinguishing characteristics of
monopolistic competition are:
Many sellers.
 Differentiated products.
 Multiple dimensions of competition.
 Easy entry of new firms in the long run.

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Many Sellers
When there are many sellers, they do not
take into account rivals’ reactions.
 The existence of many sellers makes
collusion difficult.
 Monopolistically competitive firms act
independently.

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Differentiated Products
The “many sellers” characteristic gives
monopolistic competition its competitive
aspect.
 Product differentiation gives monopolistic
competition its monopolistic aspect.

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Differentiated Products
Differentiation exists so long as advertising
convinces buyers that it exists.
 Firms will continue to advertise as long as
the marginal benefits of advertising
exceed its marginal costs.

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Multiple Dimensions of
Competition
One dimension of competition is product
differentiation.
 Another is competing on perceived quality.
 Competitive advertising is another.
 Others include service and distribution
outlets.

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Easy Entry of New Firms in the
Long Run
There are no significant barriers to entry.
 Barriers to entry prevent competitive
pressures.
 Ease of entry limits long-run profit.

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Advertising and Monopolistic
Competition
Firms in a perfectly competitive market
have no incentive to advertise
 Monopolistic competitors have a strong
incentive to do so.

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Goals of Advertising
The goals of advertising include shifting the
demand curve to the right and making it
more inelastic.
 Advertising shifts the ATC curve up.

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Does Advertising Help or Hurt
Society?
There is a sense of trust in buying brands
we know.
 If consumers are willing to pay for
“differentness,” it’s a benefit to them.

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Characteristics Oligopoly
Oligopolies are made up of a small number
of mutually interdependent firms.
 Each firm must take into account the
expected reaction of other firms.

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Models of Oligopoly Behavior
No single general model of oligopoly
behavior exists.
 Two models of oligopoly behavior are the
cartel model and the contestable market
model.

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The Cartel Model
A cartel is a combination of firms that acts
as it were a single firm.
 A cartel is a shared monopoly.
 In the cartel model, an oligopoly sets a
monopoly price.

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The Cartel Model

If oligopolies can limit the entry of other
firms and form a cartel, they can increase
the profits going to the firms in the cartel.
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The Cartel Model

The cartel model of oligopoly:
Oligopolies act as if they were monopolists,
 That have assigned output quotas to
individual member firms,
 So that total output is consistent with joint
profit maximization.

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How do you analyze strategic behavior in
the below situations?

Cement industry
 Manufacturers
vs importers
Construction industry
 Telecommunication companies
 Rice millers in Sri Lanka

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Implicit Price Collusion
Formal collusion is illegal in the U.S. while
informal collusion is permitted.
 Implicit price collusion exists when
multiple firms make the same pricing
decisions even though they have not
consulted with one another.

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Implicit Price Collusion

Sometimes the largest or most dominant
firm takes the lead in setting prices and the
others follow.
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Cartels and Technological
Change
Cartels can be destroyed by an outsider
with technological superiority.
 Thus, cartels with high profits will provide
incentives for significant technological
change.
 Eg: OPEC cartel vs electric and hybrid
autos

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Labor Unions as Cartels
Union is a worker association that
 bargains (use of labor market power) with
employers over wages, benefits, and
working conditions.
 So wages are not determined by the
demand and supply

 Sri
Lanka Government sector workers
 Plantation sector workers
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Price Wars
Price wars are the result of strategic pricing
decisions gone wild.
 Sometimes a firm engages in this activity
because it hates its competitor.

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Price Wars
A firm may develop a predatory pricing
strategy as a matter of policy.
 A predatory pricing strategy involves
temporarily pushing the price down in
order to drive a competitor out of business.

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