CHAPTERS OUTLINE
Monopolistic Competition
Product Differentiation, Advertising, and Social Welfare
Price and Output Determination in
Monopolistic Competition
Economic Efficiency and Resource Allocation
Oligopoly
Oligopoly Models
Game Theory
Repeated Games
A Game with Many Players:
Collective Action Can Be Blocked by a Prisoners’ Dilemma
Oligopoly and Economic Performance
Characteristics of Different Market Organizations
Perfect competition, with an infinite number of firms, and
monopoly, with a single firm, are polar opposites.
Perfect
competition
Monopolistic
competition
Oligopoly
Monopoly
Monopolistic competition and oligopoly lie between these two
extremes.
Characteristics of Different Market Organizations
Monopolistic competition
Monopolistic competition
is a mixture of monopoly and perfect competition.
A monopolistically competitive industry has the following
characteristics:
- A large number of firms - No barriers to entry - Product differentiation -
Product Differentiation, Advertising,
And Social Welfare
product differentiation
A strategy that firms use to achieve market power.
Accomplished by producing products that have
distinct positive identities in consumers’ minds.
The Case for Product Differentiation and
Advertising
The advocates of spirited competition believe that differentiated
products and advertising give the market system its vitality and are the
basis of its power. They are the only ways to begin to satisfy the
enormous range of tastes and preferences in a modern economy.
Product differentiation also helps to ensure high quality and
efficient production.
Advertising provides consumers with the valuable information on
product availability, quality, and price that they need to make efficient
choices in the marketplace.
The Case Against Product Differentiation
and Advertising
Critics of product differentiation and advertising argue that
they amount to nothing more than waste and inefficiency.
Enormous sums are spent to create minute, meaningless, and
possibly nonexistent differences among products.
No Right Answer
There are strong arguments on both sides of the
advertising debate, and even the empirical evidence
yields to conflicting conclusions. Some studies show
that advertising leads to concentration and positive
profits; others, that advertising improves the
functioning of the market.
Product Differentiation and Demand Elasticity
Although the demand curve faced by a monopolistic competitor is likely to
be less elastic than the demand curve faced by a perfectly competitive firm,
it is likely to be more elastic than the demand curve faced by a monopoly.
Price/Output Determination in the Short Run
To maximize profit, the monopolistically competitive firm will increase
production until the marginal revenue from increasing output and selling it no
longer exceeds the marginal cost of producing it. This occurs at the point at
which marginal revenue equals marginal cost: MR = MC.
Price/Output Determination in the Long Run
The firm’s demand curve must end up tangent to its average total cost curve for
profits to equal zero. This is the condition for long-run equilibrium in a
monopolistically competitive industry.
Economic Efficiency And Resource Allocation
Because entry is easy and economic profits are eliminated in the long
run, we might conclude that the result of monopolistic competition is
efficient.
There are two problems, however.
 First, once a firm achieves any degree of market power by
differentiating its product (as is the case in monopolistic
competition), its profit-maximizing strategy is to hold down
production and charge a price above marginal cost.
 Second, the final equilibrium in a monopolistically competitive
firm is necessarily to the left of the low point on its average total
cost curve.
Oligopoly
An oligopoly
is a form of industry (market) structure characterized by a
few dominant firms.
Products may be homogeneous or differentiated.
The behavior of any one firm in an oligopoly depends to a
great extent on the behavior of others.
Oligopoly Models
Because many different types of oligopolies exist, a number of different
oligopoly models have been developed.
All kinds of oligopoly have one thing in common:
The behavior of any given oligopolistic firm depends on the behavior
of the other firms in the industry comprising the oligopoly.
Oligopoly Models:
The Collusion Model
The collusion model argues that when there are few firms in the industry, it is
possible for the firms to get together and acts like a monopolist.
cartel
A group of firms that gets together and makes joint price and output decisions
to maximize joint profits.
Collusion occurs when price- and quantity-fixing agreements are explicit.
tacit collusion
occurs when firms end up fixing price without a specific agreement, or when
agreements are implicit.
Oligopoly Models:
The Cournot Model
Cournot model
A model of a two-firm industry (duopoly) in which a series of
output adjustment decisions leads to a
final level of output between the output that would prevail if
the market were organized competitively and the output that
would be set by a monopoly.
duopoly
A two-firm oligopoly.
Oligopoly Models:
The Price-Leadership Model
price leadership
A form of oligopoly in which one dominant firm sets prices and
all the smaller firms in the industry follow its pricing policy.
Oligopoly Models:
Game Theory
game theory
Analyzes oligopolistic behavior as a complex series of strategic
moves and reactive countermoves among rival firms. In game
theory, firms are assumed to anticipate rival reactions.
Oligopoly Models:
Game Theory
The strategy that firm A will actually choose depends on the information
available concerning B’s likely strategy.
Regardless of what B does, it pays A to advertise. This is the dominant
strategy, or the strategy that is best no matter what the opposition does.
Oligopoly Models:
Game Theory
dominant strategy
In game theory, a strategy that is best no matter what the
opposition does.
prisoners’ dilemma
A game in which the players are prevented from
cooperating and in which each has a dominant strategy
that leaves them both worse off than if they could
cooperate.
Oligopoly Models:
Game Theory
The Prisoners’ Dilemma
Both Ginger and Rocky have dominant strategies: to confess.
Both will confess, even though they would be better off if they both kept
their mouths shut.
Oligopoly Models:
Game Theory
tit-for-tat strategy
A company’s strategy that lets a competitor know the company
will follow the competitor’s lead.
Payoff Matrix for Airline Game
Oligopoly Models:
Game Theory
Nash equilibrium
In game theory, the result of all players’ playing their best
strategy given what their competitors are doing.
maximin strategy
In game theory, a strategy chosen to maximize the minimum
gain that can be earned.
A Game Wıth Many Players: Collectıve Actıon
Can Be Blocked By A Prısoners’ Dılemma
A market is perfectly contestable if entry to it and exit from
it are costless.
In contestable markets, even large oligopolistic firms end up
behaving like perfectly competitive firms. Prices are pushed
to long-run average cost by competition, and positive profits
do not persist.
Oligopoly and Economic Performance
Oligopolies, or concentrated industries, are likely to be inefficient for
the following reasons:
 They are likely to price above marginal cost. This means that
there would be underproduction from society’s point of view.
 Strategic behavior can force firms into deadlocks that waste
resources.
 Product differentiation and advertising may pose a real danger
of waste and inefficiency.