1. Monopolistic Competition and Oligopoly
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Monopolistic Competition and Oligopoly 1

2. Topics to be Discussed Monopolistic Competition Oligopoly
Price Competition
Competition Versus Collusion: The Prisoners’ Dilemma
Implications of the Prisoners’ Dilemma for Oligopolistic Pricing
Cartels
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3. Monopolistic Competition
Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product
The amount of monopoly power depends on the degree of differentiation.
Examples of this very common market structure include:
Toothpaste
Soap
The Makings of Monopolistic Competition
Two important characteristics
Differentiated but highly substitutable products
Free entry and exit
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4. A Monopolistically Competitive Firm in the Short and Long Run
$/Q
Short Run
$/Q
Long Run MC AC MC AC
DSR
MRSR
QSR
PSR
DLR
MRLR
QLR
PLR
Quantity
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5. A Monopolistically Competitive Firm in the Short and Long Run
Observations (short-run)
Downward sloping demand--differentiated product
Demand is relatively elastic--good substitutes
MR < P
Profits are maximized when MR = MC
This firm is making economic profits
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6. A Monopolistically Competitive Firm in the Short and Long Run
Observations (long-run)
Profits will attract new firms to the industry (no barriers to entry)
The old firm’s demand will decrease to DLR
Firm’s output and price will fall
Industry output will rise
No economic profit (P = AC)
P > MC -- some monopoly power
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7. Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium
Perfect Competition
Monopolistic Competition
$/Q
$/Q
Deadweight
loss MC AC MC AC
DLR
MRLR
QMC P QC PC
D = MR
Quantity
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8. Monopolistic Competition
Monopolistic Competition and Economic Efficiency
The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle.
With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists.
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9. Oligopoly Characteristics Examples Small number of firms
Product differentiation may or may not exist
Barriers to entry
Examples
Automobiles, Steel, Aluminum, Petrochemicals, Electrical equipment, Computers
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10. Oligopoly The barriers to entry are: Natural Scale economies Patents
Technology
Name recognition
Strategic action
Flooding the market
Controlling an essential input
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11. Price Competition Price Competition with Differentiated Products
Market shares are now determined not just by prices, but by differences in the design, performance, and durability of each firm’s product.
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12. Oligopolistic Pricing
The Dominant Firm Model
In some oligopolistic markets, one large firm has a major share of total sales, and a group of smaller firms supplies the remainder of the market.
The large firm might then act as the dominant firm, setting a price that maximized its own profits.
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13. Cartels Characteristics 1) Explicit agreements to set output and price
2) May not include all firms
3) Most often international
Examples of successful cartels : OPEC
Examples of unsuccessful cartels : Copper,Tin,Tea
4) Conditions for success
Competitive alternative sufficiently deters cheating
Potential of monopoly power--inelastic demand
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14. Cartels Observations To be successful:
Total demand must not be very price elastic
Either the cartel must control nearly all of the world’s supply or the supply of noncartel producers must not be price elastic
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15. The Cartelization of Intercollegiate Athletics
Observations
1) Large number of firms (colleges)
2) Large number of consumers (fans)
3) Very high profits
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16. Summary
In a monopolistically competitive market, firms compete by selling differentiated products, which are highly substitutable.
In an oligopolistic market, only a few firms account for most or all of production.
Firms would earn higher profits by collusively agreeing to raise prices, but the antitrust laws usually prohibit this.
In a cartel, producers explicitly collude in setting prices and output levels.
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