Monopolistic Competition &

OligopolyECO 2023Chapter 11Fall 2007

Monopolistic Competition• A market structure with many

firms selling products that are substitutes but different enough that each firm’s demand curve slopes downward, firm entry is relatively easy

Characteristics• Relatively large number of sellers• Differentiated product• Ease of entry and exit• Low barriers to entry• Price makers• Advertising

Monopolistic Competition• Product Differentiation

• Physical differences• Differences in appearance and

qualities• Evian vs Dasani

• Location• The number and variety of

locations where a product is available are other ways

• Services• Product image

Monopolistic Competition• Short-run Profit Maximization

• Because each monopolistic competitor offers a product that differs somewhat from what others supply

• Each has some control over the price charged

• Demand curve slopes downward• Elastic demand

•Marginal revenue = Marginal revenue = marginal costmarginal cost

Monopolistic Competition – Short run

Demand

Price

Average Total Cost

Marginal CostProfit

Marginal Revenue

Price

Cost

Q

Profit

Monopolistic Competition – Short run

Demand

Price

Average Total Cost

Marginal CostLoss

Marginal Revenue

Cost

Price

Q

Loss

Long run Economic Profit• If short run has economic profit

• Firms enter the industry• Output increases• Price decreases• Profit in long run disappears

• If short run economic loss• Firms exit the industry• Output decreases• Price increases• Loss disappears

Long run

No economicNo economic

Profits orProfits or

LossesLosses

Oligopoly• Market structure characterized by

a few firms whose behavior is interdependent

Characteristics• A few large producers• Homogeneous or differentiated

products• Control over Price• Mutual interdependence and

strategic behavior• Barriers to entry• Mergers

Mergers• Oligopolists have a tendency to

merge and become monopolists• Increases market share• Greater economies of scale• Caused by desire for monopoly

power

Measures of Industry Concentration

• oligopolistic industries are concentrated in the hands of their largest firms

• Concentration ratios• Reveals the percentage of total output

produced and sold by an industry’s largest firms.

• When largest four firms control over 40% then it is oligopoly

• Automotive 81%• Sugar cane 99%• Shortcomings• Localized markets• Interindustry competition• World trade

• Herfindahl Index• The index is the sum of squared percentage

market shares of all firms in the industry.• Larger the index, the more market power

within the industry

Oligopoly• Models of Oligopoly

• There is no general theory but rather a set of theories

• Each based on the diversity of observed behavior in an interdependent market

• Collusion• an agreement among firms to

increase economic profit by dividing the market or fixing the price

• CARTELS are created

Oligopoly• Collusion

• Cartel• A group of firms that agree to

coordinate their production and pricing decisions to act like a monopolist

• Problems with Collusion and Cartels

• Differences in Average Cost• Number of firms in the cartel• New entry into the industry

Oligopoly• Price Leadership

• A firm whose price is adopted by other firms in the industry

• Tacit form of collusion• Typically a dominant firm in the

industry• Set prices and others follow

avoiding competition• Violates antitrust laws

Oligopoly• Game Theory

• An approach that analyzes ologopolistic behavior as a series of strategic moves and countermoves by rival firms

• Outcome is achieved when each player’s choice does not depend on what the other player does