MONOPOLISTIC COMPETITION AND
OLIGOPOLY
ECO 2023
Principles of Microeconomics
Dr. McCaleb
Monopolistic Competition and
Oligopoly
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TOPIC OUTLINE
I.
Monopolistic Competition
II. Oligopoly
III. Cartels
IV. Making Markets Competitive
Monopolistic Competition and
Oligopoly
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Monopolistic Competition
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Characteristics of Monopolistic Competition
Definition
A market in which there are many sellers, each selling a
differentiated product, with unrestricted or low-cost long-run entry
and exit of resources.
Key characteristics
• Many buyers and sellers (same as perfect competition)
• Product differentiation
• Unrestricted entry and exit (same as perfect competition)
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Characteristics of Monopolistic Competition
Product differentiation
Supplying a good that is slightly different from the goods of
competing suppliers.
Consumers view each supplier’s product as a close, but not a perfect,
substitute for any other supplier’s product.
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Characteristics of Monopolistic Competition
Examples of product differentiation
• Design (for example, Macintosh computers compared with
PC’s).
• Reliability (for example, warranties or brand names).
• Location (for example, gasoline marketers near interstate
highways).
• Costly information (for example, the same good sold in
different stores at different prices).
Monopolistic Competition and
Oligopoly
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The bookstore market portrayed in the video clip is
monopolistically competitive and not perfectly competitive
because
1. there are many bookstores.
2. each bookstore offers a slightly different set of products
and services
3. there are no significant barriers to entry into the
bookstore market
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Characteristics of Monopolistic Competition
Demand and marginal revenue are negatively-sloped
Because of imperfect substitutability, suppliers in a monopolistically
competitive market have some market power. Consumer demand for
each supplier’s output is negatively-sloped.
Negatively-sloped demand curvemarginal revenue is less than
price at each quantity.
Marginal revenue curve is negatively-sloped and lies below the
demand curve.
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Long Run Equilibrium
Sellers earn zero long-run economic profit
Short-run economic profits induce entry
Same as perfect competition. Short-run economic profits provide an
incentive for new resources to enter the market in the long run.
Entry of new competitors reduces each seller’s market share.
Demand for each individual seller’s product decreases and price falls
until economic profit is competed away.
Long-run equilibrium: Sellers earn zero economic profit (or a normal
accounting profit).
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
 Long Run Equilibrium
Short-run economic losses induce exit
Same as perfect competition. Short-run economic losses create
incentives for existing competitors to leave the market in the long
run.
Exit of existing sellers increases each remaining seller’s market
share. Demand for each remaining seller’s product increases and
price rises until economic losses are eliminated.
Long-run equilibrium: Sellers earn zero economic profit (or a
normal accounting profit).
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
Short-Run Equilibrium
The profit-maximizing quantity
where marginal revenue equals
marginal cost . . .
is 150 pairs of jeans per day.
The maximum price consumers are
willing to pay for 150 pairs is $70
per pair.
The average total cost to produce
150 pairs is $20 per pair, . . .
so economic profit is $50 per pair or
$7,500 a day.
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
Adjustment from Short Run
to Long Run
Short-run economic profit creates
an incentive for entry of new
resources.
With increased competition,
demand decreases to D' and
marginal revenue decreases to MR'.
Monopolistic Competition and
Oligopoly
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MONOPOLISTIC COMPETITION
Long-Run Equilibrium
Profit-maximizing quantity is 50
pairs of jeans a day.
The price consumers are willing to
pay for 50 pairs is $30 per pair.
Average total cost is also $30 per
pair so economic profit is zero.
Monopolistic Competition and
Oligopoly
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In monopolistic competition
1. the demand curve facing each supplier is (vertical,
horizontal, negatively-sloped, positively-sloped).
2. marginal revenue is (greater than, equal to, less than)
price and the marginal revenue curve is (below, the same as,
above) the demand curve.
3. equilibrium quantity is where (total revenue, price,
marginal revenue) is (greater than, equal to, less than)
(total cost, average total cost, marginal cost).
4. equilibrium price is shown by (demand, marginal
revenue, marginal cost, average total cost) curve.
Monopolistic Competition and
Oligopoly
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In monopolistic competition
5. profit is
a.
b.
c.
positive if (price, marginal revenue) is
(greater than, equal to, less than) (average
total cost, marginal cost).
zero if (price, marginal revenue) is (greater
than, equal to, less than) (average total cost,
marginal cost).
negative if (price, marginal revenue) is
(greater than, equal to, less than) (average
total cost, marginal cost).
6. long-run economic profit is (positive, negative, zero,
either positive or zero).
Monopolistic Competition and
Oligopoly
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In monopolistic competition, equilibrium quantity is where
_____ and equilibrium price is shown by the _____ curve.
1. MR=MC; MR
2. MR=MC; demand
3. P=ATC; ATC
4. MC=ATC; MC
Monopolistic Competition and
Oligopoly
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In monopolistic competition, suppliers earn _____ profit in
the long run.
1. positive
2. zero
3. negative
4. positive or zero
Monopolistic Competition and
Oligopoly
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Oligopoly
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Characteristics of Oligopoly
Definition
A small number of suppliers in a market with substantial barriers to
entry by potential competitors.
Key characteristics
• Market dominated by a few large suppliers
• High cost entry into the market because of natural (economic)
or legal barriers to entry
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Characteristics of Oligopoly
Examples
Do sellers in these markets behave competitively or monopolistically?
• Beverages (soft drinks)
• Music (CD’s)
• Tobacco
• Automobiles
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Characteristics of Oligopoly
U.S. Market Share of Largest Sellers in Market
Beverages
Seller
Share
Music
Seller
Share
Tobacco
Seller
Share
Cars
Seller
Share
Coke
44.5% Polygram 24.5% PM
49.4% GM
29.3%
Pepsi
31.4% Warner
24.0% Ford
24.9%
Cadbury 14.4% Sony
Total
18.2% RJR
16.6% B&W 15.0% Chrysler
EMI
12.9%
BMG
12.2%
90.3% Total
84.4% Total
88.4% Total
16.1%
70.3%
Each of these industries is an oligopoly even though the sellers often
behave competitively.
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Equilibrium in an Oligopoly
Range of possible oligopoly equilibria
Suppliers in some oligopolistic markets may behave as if they were
competitive. Suppliers in other oligopolistic markets may behave as if
they were monopolists.
Equilibrium in an oligopoly market can lie anywhere along the
continuum from perfect competition to pure monopoly.
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Equilibrium in an Oligopoly
Competitive equilibrium
If the market behaves competitively, the marginal cost curve is the
market supply curve.
Equilibrium occurs where quantity demanded equals quantity
supplied with P=MC.
Economic profit in equilibrium is zero.
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
Example: Competitive Equilibrium
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Equilibrium in an Oligopoly
Monopolistic equilibrium
If the market behaves monopolistically, the suppliers cooperate to
choose the price and quantity that maximizes total profit.
The monopolistic equilibrium quantity is where MR=MC.
Economic profit is positive.
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
Example: Monopolistic Equilibrium
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
 Equilibrium in an Oligopoly
Range of possible equilibria
Oligopoly equilibrium price is equal to or less than monopoly
equilibrium price but greater than or equal to competitive equilibrium
price.
Oligopoly equilibrium quantity is equal to or greater than monopoly
equilibrium quantity but less than or equal to competitive equilibrium
quantity.
Economic profit is positive unless oligopolists behave exactly as
perfect competitors in which case economic profit is zero.
Monopolistic Competition and
Oligopoly
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OLIGOPOLY
Example: Range of Possible Equilibria
Monopolistic Competition and
Oligopoly
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The equilibrium quantity in an oligopoly market is
1. always the same as the perfectly competitive equilibrium
quantity.
2. always the same as the monopoly equilibrium quantity.
3. always the same as the monopolistically competitive
equilibrium quantity.
4. equal to or greater than the monopoly equilibrium
quantity but less than or equal to the perfectly
competitive equilibrium quantity.
5. less than the monopoly equilibrium quantity or greater
than the perfectly competitive equilibrium quantity.
Monopolistic Competition and
Oligopoly
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Cartels
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Definition
A group of suppliers acting together to limit output, raise price, and
increase economic profit. Suppliers in a cartel attempt to act as if
they were a monopolist so as to maximize their joint profits.
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
The short, unhappy life of a cartel
Every cartel faces three problems:
• Reaching agreement
• Detecting and preventing cheating
• Enforcing the agreement
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Reaching agreement
A profit-maximizing cartel must limit the market quantity to raise price
to the monopoly level.
Cartel must reach agreement about how to allocate the resulting
monopoly profits among all the suppliers in the cartel.
But each supplier’s share of the monopoly profits depends on its share
of the market quantity so each supplier wants a larger quantity for itself
but a smaller quantity for all the other suppliers.
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Too many or too few?
Trade-off between including enough sellers to effectively limit
market quantity and including so many sellers that high negotiation
costs and small individual gains prevent reaching an agreement.
More suppliers means greater control over the market but
• higher negotiation costs because each supplier has incentive to
hold out for larger share of profits
• smaller gains to each supplier relative to going it alone.
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Stability of demand and supply
Frequent changes in demand or supply require frequent renegotiation
which is costly.
Possibility that each renegotiation will be unsuccessful and
agreement will fall apart.
Cartels more likely to be successful in markets characterized by longrun stability in demand and supply.
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Detecting and preventing cheating
Each cartel supplier has an incentive to expand its share of the
market by reducing price below the cartel’s monopoly price or by
engaging in other activities to gain a competitive advantage.
If all cartel suppliers engage in competitive behavior to expand
market share, the cartel disintegrates into a competitive market.
Trade-off again—The larger the number of sellers, the more difficult
it is to detect cheating and to identify the cheaters.
Monopolistic Competition and
Oligopoly
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CARTELS
 Cartels
Enforcing the agreement
If cheating is detected, cartel must be able to take credible action to
punish the cheaters.
Trade-off again—More suppliers make it harder to take action
against each one.
Most successful cartels are either government-sanctioned with legal
enforcement of the agreement or they are engaged in criminal
activities and use extra-legal or illegal enforcement.
Monopolistic Competition and
Oligopoly
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CARTELS
 Example: Duopoly in the airframe industry
Suppliers are interdependent
Two major airframe manufacturers worldwide, Boeing (U.S.) and
Airbus (European)—a form of oligopoly called duopoly (a market
with two suppliers).
The market price of airplanes depends on how many airplanes are
produced. Market demand is negatively-sloped.
Each manufacturer’s profits depend on how many airplanes it
supplies and on how many airplanes its competitor supplies.
Monopolistic Competition and
Oligopoly
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CARTELS
 Example: Duopoly in the airframe industry
Range of equilibria
Competitive equilibrium: Q=12, P=$1 m. Total industry revenues are
$12 m. and economic profits are zero.
Monopoly equilibrium: If Boeing and Airbus agree to limit quantity to
the monopoly level, they maximize total industry profits. They
produce 6 planes at a price of $13 m. each, and the industry generates
$72 m. in economic profits.
Monopolistic Competition and
Oligopoly
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CARTELS
 Example: Duopoly in the airframe industry
Reaching agreement
If Boeing supplies 4 of the 6 planes, its share of the $72 m. profit is
$48 m. and Airbus’s share is $24 m. If Airbus supplies 4, its share is
$48 m. and Boeing’s share is $24 m.
Boeing and Airbus must agree on some allocation of the joint profits,
and more profits for one means less for the other. Failure to reach an
agreement means the attempt to form a cartel fails.
Monopolistic Competition and
Oligopoly
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CARTELS
 Example: Duopoly in the airframe industry
Detecting and preventing cheating
Suppose they reach an agreement to split the market. Each supplies 3
planes and earns $36 m. in economic profits.
If Boeing increases production to 4 planes, its profits increase to $40
m. even though industry profit decreases to $70 m. Boeing’s increased
profits come at Airbus’s expense.
Each supplier has an incentive to expand its market share at the
expense of the other.
Monopolistic Competition and
Oligopoly
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CARTELS
 Example: Duopoly in the airframe industry
Enforcing the agreement
If Boeing expands its production to 4 planes per week in violation of
the cartel agreement, what can Airbus do? Without legal or extra-legal
enforcement, Airbus can only retaliate.
If Airbus retaliates by increasing its production to 4 planes per week,
its profits increase to $32 m. but industry profits fall again to $64 m.
Both suppliers now have the same incentive to continue expanding
production, and the cartel disintegrates into a competitive market,
moving down the demand curve toward the competitive equilibrium.
Monopolistic Competition and
Oligopoly
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According to the video clip, a key to DeBeers’s success as a
cartel was
1. Economies of scale
2. Technological superiority
3. Government limits on entry into the diamond market
4. Inelasticity of demand because consumers perceive there
are no close substitutes for diamonds
Monopolistic Competition and
Oligopoly
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CARTELS
Anatomy of a Cartel:
OPEC
In the 1970’s, OPEC succeeded in
limiting the supply of crude oil
produced by member countries so
as to increase the price.
After 1980, however, the market
imploded. Price fell almost as
much as it had risen.
What happened? Why was the
cartel’s success so short-lived?
Monopolistic Competition and
Oligopoly
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CARTELS
 Anatomy of a Cartel: OPEC
Reaching agreement
OPEC reached an agreement to limit quantity and to allocate market
share among its members. But, the agreement disintegrated as
OPEC’s share of the world oil market declined and demand fell
because of . . .
Monopolistic Competition and
Oligopoly
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CARTELS
 Anatomy of a Cartel: OPEC
New sources of supply
In the 1980’s OPEC faced new sources of supply from non-OPEC
countries who expanded their market share at OPEC’s expense:
• North Sea (Great Britain and Norway)
• Russia and former Soviet republics
• Technology made Alberta tar sands and deep ocean drilling
profitable
Monopolistic Competition and
Oligopoly
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CARTELS
 Anatomy of a Cartel: OPEC
Greater energy efficiency and consumer substitution
The high price of oil in the 1970’s and early 1980’s created
incentives for greater energy efficiency. Instead of remaining stable,
world oil demand became quite volatile. Worldwide consumption fell
and did not return to its 1980 level for 15 years.
The short-run elasticity of demand for oil and petroleum products is
low, but the long-run elasticity is much higher as consumers adopt
alternative energy sources and substitute more non-oil-intensive
activities for oil-intensive activities.
Monopolistic Competition and
Oligopoly
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CARTELS
 Anatomy of a Cartel: OPEC
Detecting and preventing cheating
Because crude oil is a relatively homogeneous product and the oil
market is worldwide, it is difficult for OPEC to verify that each of its
members is abiding by the agreed-upon production quotas.
By the 1980’s, member states with smaller market shares were
clearly exceeding their production quotas. In particular, the 8-year
Iran-Iraq war drove each country to maximize its own production to
finance the war.
Monopolistic Competition and
Oligopoly
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CARTELS
 Anatomy of a Cartel: OPEC
Enforcing the agreement
Short of going to war, OPEC lacks any mechanism to punish the
cheaters, even if it could determine who they are.
Monopolistic Competition and
Oligopoly
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Is each of the following true or false: To be successful, a
cartel must
1.
be able to engage in price discrimination.
2.
include enough sellers to effectively limit quantity but
not so many sellers that high negotiation costs and small
individual gains prevent reaching an agreement.
3.
be able to detect cheating
4.
be able to enforce the cartel agreement against
cheaters.
5.
have few or no close substitutes for its product.
Monopolistic Competition and
Oligopoly
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Making Markets Competitive
Monopolistic Competition and
Oligopoly
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MAKING MARKETS COMPETITIVE
 Benefits of Competitive Markets
Competitive markets, efficiency, profits and losses
The possibility of earning short-run economic profits and the threat
of economic losses provide incentives for suppliers in competitive
markets to
• use resources to satisfy consumer demand
• adopt the most efficient, least-cost operating methods
• be innovative.
Monopolistic Competition and
Oligopoly
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MAKING MARKETS COMPETITIVE
 Benefits of Competitive Markets
Benefits and costs accrue to consumers
In the long run, entry into and exit from competitive markets drive
prices up or down to equal costs so that suppliers earn only a normal
accounting profit (zero economic profit).
Changes in demand or in cost are passed on to consumers through
changes in prices and quantities. Suppliers gain or lose in the short
run, but in the long run both the benefits and the costs are passed on
to consumers.
Monopolistic Competition and
Oligopoly
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MAKING MARKETS COMPETITIVE
 Public Policy and Competition
Unrestricted entry and exit is the key
What makes a market competitive? Unrestricted entry and exit of
resources
As long as there are no barriers to the entry of new resources or the
exit of existing resources, suppliers will behave competitively—the
market will be competitive.
Lack of competition in a market arises from barriers to entry and
exit—from limitations, often imposed by government, on the entry of
new competitors or the expansion of existing competitors.
Monopolistic Competition and
Oligopoly
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MAKING MARKETS COMPETITIVE
 Public Policy and Competition
Government policy is schizophrenic
Some government policies—the antitrust laws, for example—
prohibit sellers from engaging in certain business practices if those
practices have the effect of limiting competition or creating
monopoly.
At the same time, most true monopolies are created or sanctioned by
government—public franchises, government licenses, patents, and
copyrights, for example—and many government regulations limit
competition in the marketplace.
Monopolistic Competition and
Oligopoly
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MAKING MARKETS COMPETITIVE
 Public Policy and Competition
Lessons for public policy
It is not the number of sellers or their size that makes markets
competitive. It is the freedom of competitors and potential
competitors to reallocate resources efficiently in response to the
profit and loss signals of the market.
Whether the market is perfectly competitive, monopolistically
competitive, or oligopolistic is irrelevant. In fact,even a monopolist
behaves competitively if there is sufficient threat of competition from
outside its market.
The key to improved competitiveness is the elimination of
restrictions on the ability of resources to enter or exit a market in
response to short-run economic profit or loss.
Monopolistic Competition and
Oligopoly
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True (T) or false (F): In any market where a few large sellers
dominate the market, the sellers will act as if they were
monopolists.
Monopolistic Competition and
Oligopoly
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The key to ensuring competitive behavior in any market is the
absence of
1. price discrimination.
2. a few large sellers.
3. product differentiation.
4. barriers to entry into the market in the long run.
5. strategic behavior.
Monopolistic Competition and
Oligopoly
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