Monopolistic Competition and Oligopoly

2002 South-Western College Publishing

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What is imperfect competition?A market structure between the extremes of perfect competition and monopoly2

What is monopolistic competition? many small sellers differentiated product easy entry and exit3

What is product differentiation?The process of creating real or apparent differences between goods and services4

What does many small sellers mean?Each firm is so small relative to the total market that each firms pricing decisions have a negligible effect on the market price5

What is nonprice competition?A firm competes using advertising, packaging, product development, better service, rather than lower prices6

How easy is entry and exit in monopolistic competition?Not as easy as in perfect competition because of product differentiation7

Why is a monopolistic competitive firm a price maker?Product differentiation gives the firm some control over its price8

What are examples of monopolistic competition? grocery stores hair salons gas stations video rental stores restaurants9

How efficient is monopolistic competition?Less resources are used and a higher price is charged than would be the case under perfect competition10

What is oligopoly? few sellers either homogeneous or a differential product difficult market entry11

How few are a few sellers?When the firms are so large relative to the total market that they can affect the market price12

What is a significant barrier to entry? Economies of scale

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What is nonprice competition?Competition in ways other than pricing policies

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What is the distinguishing feature of oligopoly? mutual interdependence15

What is mutual interdependence?A condition in which an action by one firm may cause a reaction on the part of other firms16

How do oligopolists determine price?They play the game follow the leader that economists call price leadership17

What is price leadership?A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow18

What is a cartel?A group of firms formally agreeing to control the price and output of a product

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What are examples of cartels? Organization of Petroleum Exporting Countries (OPEC) International Telephone Cartel (CCITT) International Airline Cartel (IATA)20

Key Concepts

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Key ConceptsWhat is imperfect competition? What is monopolistic competition? What is product differentiation? What is nonprice competition? Why is a monopolistic competitive firm a price maker? How does a firm decide what price to charge and how many units to produce? Why is a normal profit made in the long-run? 22

Key Concepts cont.How efficient is monopolistic competition? What is oligopoly? What is nonprice competition? What is the distinguishing feature of oligopoly? What does a kinked demand curve show? How do oligopolists determine price? What is a cartel?

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Summary

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Imperfect competition is the market structure between the extremes of perfect competition and monopoly Monopolistic competition and oligopoly belong to the imperfect competition category.

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Monopolistic competition is a market structure characterized by (1) many small sellers, (2) a differentiated product, and (3) easy market entry and exit. Given these characteristics, firms in monopolistic competition have a negligible effect on the market price.26

Product differentiation is a key characteristic of monopolistic competition. It is the process of creating real or apparent differences between products.

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Nonprice competition includes advertising, packaging, product development, better quality, and better service. Under imperfect competition, firms may compete using nonprice competition, rather than price competition.

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Oligopoly is a market structure characterized by (1) few sellers, (2) a homogeneous or differentiated product, and (3) difficult market entry. Oligopolies are mutually interdependent because an action by one firm may cause a reaction on the part of other firms.29

The nonprice competition model is a theory that might explain oligopolistic behavior. Under this theory, firms use advertising and product differentiation, rather than price reductions, to compete.

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Price leadership is another theory of pricing behavior under oligopoly. When a dominant firm in an industry raises or lowers price, other firms follow suit.

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A cartel is a formal agreement among firms to set prices and output quotas. The goal is to maximize profits, but firms have an incentive to cheat, which is a constant threat to a cartel.

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Quiz

2002 South-Western College Publishing

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1. An industry with many small sellers, a differentiated product, and easy entry would best be described as which of the following? a. Oligopoly. b. Monopolistic competition. c. Perfect competition. d. Monopoly. B. An oligopoly has only a few sellers. A monopoly only has one, and perfect competition has homogeneous products.34

2. Which of the following industries is the best example of monopolistic competition? a. Wheat. b. Restaurant. c. Automobile. d. Water service. B. Wheat would be in a perfectly competitive market. Automobiles would be an oligopoly. And the water service is an example of a regulated monopoly.35

3. Which of the following is not a characteristic of monopolistic competition? a. A large number of small firms. b. A differentiated product. c. Easy market entry. d. A homogeneous product. D. A characteristic of monopolistic competition is differentiated products.

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4. A monopolistically competitive firm in the long run earns the same economic profit as a a. perfectly competitive firm. b. monopolist. c. cartel. d. none of the above. A. In the long-run, a normal profit is made because of the ease of entry and exit. Once economic profits are made, more firms will enter the industry, driving price down. When losses are made, firms leave the industry, driving price up, restoring profits. 37

10. The Big Three U.S. automobile industry is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly. D. An oligopoly is a market form with only a few sellers.

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11. The cigarette industry in the United States is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly. D. The cigarette industry has only a few sellers.

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12. A characteristic of an oligopoly is a. mutual interdependence in pricing decisions. b. easy market entry. c. both (a) and (b). d. neither (a) nor (b). A. The distinguishing feature of an oligopoly is mutual interdependence. No one firm will make a decision without first considering the reaction of its competitors to its policy change.40

15. Which of the following is evidence that OPEC is a cartel? a. Agreement on price and output quotas by oil ministries. b. Ability to raise prices regardless of demand. c. Mutual interdependence in pricing and output decisions. d. Ability to completely control entry. A. A cartel is characterized by collusion, the coming together and agreeing to certain policies, for example, the level of prices. 41

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