Chapter 7
Monopolistic Competition and
Oligopoly
Section 3
Economics and You
• Different companies produce different brands
that are similar. However, to attract customers,
they must make their products unique:
– Perfect Competition is one with a large number of
firms all producing the same product. No single seller
sells too much of the product thus never controlling
the supply or price.
– A Monopoly is a market in which a single seller
dominates and controls price and supply.
– Monopolistic Competition is when many companies
compete in an open market to sell products that are
similar but not identical.
– An Oligopoly is a market dominated by a few large,
profitable firms.
Monopolistic Competition
• Companies hold a Monopoly over its own
particular product design.
• These firms sell goods that are similar enough
to be substitutes but are not identical
• Jeans are an example (names, styles, colors,
and sizes). Also bagel shops, ice cream, gas,
retail stores.
Four Conditions of Monopolistic Competition
• Many Firms: They do not have high start-up costs. They
can begin selling goods and earning money after a small
initial investment (new firms can join the market quickly)
• Few Artificial Barriers to Entry: Very few barriers to
entry. Patents do not protect against slightly different
products and too many firms do not allow them to work
together to keep others out.
• Little Control Over Price: Each firm’s goods are a little
different so people are willing to pay more for the
difference. Firms have more freedom to raise or lower
their prices. However, if prices rise too high, people will
buy a substitute.
• Differentiated Products: Firms can control their price
because they can differentiate their products from
others. The firms can profit from the differences
between his or her products.
Non-Price Competition
• Because products are a little different, non-price
competition is created or competition through
ways other than lower prices.
• Physical Characteristics: Offer a new size, color,
shape, texture, or taste (shoes, pens, cars, etc).
These will model a person’s personality, job,
family, or income.
• Location: Goods can be separated by where they
are sold (gas stations, movie theatres, and
grocery stores).
• Service Level: Firms can charge higher prices if
they offer higher levels of service (restaurants)
• Advertising, Image, Status: Advertising is used to
point out differences (t-shirts)
Prices, Output, and Profit
• Monopolistic competition looks just like perfect competition.
• Prices: Prices will be higher because firms have some power
to raise prices. However, the ease at which new firms can
enter the market keep prices down (elastic demand).
• Output: In monopolistic competition, firms sell their products
at higher prices than do perfectly competitive firms, but at
lower prices than monopolies
• Profits: The firms earn just enough to cover all of their costs.
If it makes too much profit, a rival firm will work to steal its
competition away, or a new firm will enter the market and
offer a cheap substitute.
• Production Costs and Variety: There will be many firms, each
producing too little output to minimize costs and use
resources efficiently, however, consumers can benefit from
having a wide variety to choose from.
Oligopoly
• A market dominated by a few large firms (if the 4 largest
firms produce 70%-80% of the total output). They can
set prices higher and output lower. Firms include air
travel, cars, breakfast cereals, and household appliances.
• Barriers to Entry: There can be barriers that keep new
firms from entering the market. They can be
technological or they can be created by a system of
government licenses or patents. Also economic realities
of the market discourage competition (Coke and Pepsi).
High start-up costs present additional barriers to entry.
Creates economies of scale (the average cost of
production decreases as output increases). Therefore, 34 firms can reach a profitable level of output before the
market becomes too crowded.
Cooperation and Collusion
• Many times these firms will act like a monopoly. The
government tries to regulate this.
• Price Leaders: can set prices and output for entire
industries as long as other member firms go along with
the leader’s policy. This can also start a price war
(undercutting prices)
• Collusion: an agreement among members of an
oligopoly to illegally set prices and production levels.
One outcome is called price fixing (same or similar
prices)
• Cartel: an agreement by a formal organization of
producers to coordinate prices and production. Illegal
in the US, but OPEC exists internationally. These can
collapse if output levels are controlled, but most try to
produce more (cheat) and prices will eventually fall.