Monopolistic Competition
and Oligopoly
© 2003 South-Western/Thomson Learning
The Concept of Imperfect
Competition
Imperfect competition: market structures
between perfect competition and monopoly
• more than one seller, but too few to create
a perfectly competitive market
• often violate other conditions of perfect
competition, such as the requirement of a
standardized product or free entry and exit
Monopolistic Competition
•Monopolistic Competition in the
Short Run
•Monopolistic Competition in the
Long Run
•Excess Capacity Under Monopolistic
Competition
•Nonprice Competition
Monopolistic Competition
A monopolistically competitive
market has three fundamental
characteristics:
1. Many buyers and sellers
2.No significant barriers to entry/exit
3.Differentiated products
Monopolistic Competition
Because it produces a differentiated
product,
–a monopolistic competitor faces a
downward-sloping demand curve
–when it raises its price a modest amount,
quantity demanded will decline
–but not all the way to zero
Monopolistic Competition in
the Short Run
Under monopolistic competition,
firms can earn positive or
negative economic profit in the
short run.
Monopolistic Competition in the Short Run
Dollars
$70
A
MC
ATC
d1
30
MR1
250
Homes Serviced
per Month
Monopolistic Competition in
the Long Run
But in the long run, free entry
and exit will ensure that each
firm earns zero economic profit,
just as under perfect competition.
Monopolistic Competition in
the Long Run
In long run, a monopolistic
competitor will operate with
excess capacity - that is, it will
produce too little output to
achieve minimum cost per unit.
Monopolistic Competition in
the Long Run
Dollars
MC
ATC
$40
E
d
MR2
100
200
d2
Homes Serviced
per Month
Excess Capacity Under
Monopolistic Competition
In the long run, a monopolistic
competitor will operate with
excess capacity; it will produce
too little output to achieve
minimum cost per unit.
Nonprice Competition
Nonprice Competition
Any action a firm takes to
increase the demand for its
product, other than cutting its
price.
Oligopoly
•Oligopoly in the Real World
•Why Oligopolies Exist
•Oligopoly Behavior
•Cooperative Behavior in Oligopoly
•The Limits of Oligopoly
Oligopoly
Oligopoly
A market structure in which
a small number of firms are
strategically interdependent.
Why Oligopolies Exist
•Economies of scale: natural
oligopolies
•Reputation as a barrier
•Strategic barriers
•Government-created barriers
Why Oligopolies Exist
Minimum Efficient Scale (MES)
The level of output at which
economies of scale are exhausted
and minimum LRATC is
achieved.
Why Oligopolies Exist
Oligopoly Behavior
Game Theory
An approach to modeling the
strategic interaction of
oligopolists in terms of moves and
countermoves
Oligopoly Behavior
Payoff Matrix
A table showing the payoffs to
each of two players for each
pair of strategies they choose
Oligopoly Behavior
Colin’s Actions
Confess
Colin
gets
20 years
Confess
Rose’s
Actions
Don’t
Confess
Don’t Confess
Rose
gets
20 years
Colin
gets
30 years
Rose
gets
3 years
Colin
gets
3 years
Rose
gets
30 years
Colin
gets
5 years
Rose
gets
5 years
Oligopoly Behavior
Dominant Strategy
A strategy that is best for a
firm no matter what strategy
its competitor chooses
Oligopoly Behavior
Duopoly
An oligopoly market with
only two sellers
Oligopoly Behavior
Gus’s Actions
Low Price
Low
Price
Filip’s
High
Price
High Price
Gus’s
profit =
$25,000
Filip’s
profit =
$25,000
Gus’s
profit =
–$10,000
Filip’s
profit =
$75,000
Gus’s
profit =
$75,000
Filip’s
profit =
–$10,000
Gus’s
profit =
$50,000
Filip’s
profit =
$50,000
Oligopoly Behavior
Repeated Play
A situation in which
strategically interdependent
sellers compete over many
time periods
Cooperative Behavior in
Oligopoly
Explicit Collusion
Cooperation involving direct
communication between
competing firms about setting
prices
Cooperative Behavior in
Oligopoly
Cartel
A group of firms that selects
a common price that
maximizes total industry
profits
Cooperative Behavior in
Oligopoly
Tacit Collusion
Any form of oligopolistic
cooperation that does not
involve an explicit agreement
Cooperative Behavior in
Oligopoly
Price Leadership
A form of tacit collusion in
which one firm sets a price
that other firms copy
Cooperative Behavior in
Oligopoly
Tit for Tat
A game-theoretic strategy of
doing to another player this
period what he has done to
you in the previous period
When Is Cheating Likely?
Cheating will be likely, and
collusion least successful, under the
following conditions:
–Difficulty observing other firms’
prices
–Unstable market demand
–Large number of sellers
Limits to Oligopoly
•Antitrust legislation and
enforcement
•Globalization of the
marketplace
•Technological change