1. Monopolistic Competition & Oligopoly ECO 2023 Chapter 11 Fall 2007

2. 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

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

4. 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

5. 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 costMarginal revenue = marginal cost

6. Monopolistic Competition – Short run Demand Price Average Total Cost Marginal CostProfit Marginal Revenue Price Cost Q Profit

7. Monopolistic Competition – Short run Demand Price Average Total Cost Marginal Cost Loss Marginal Revenue Cost Price Q Loss

8. 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

9. Long run No economic Profits or Losses

10. Oligopoly Market structure characterized by a few firms whose behavior is interdependent

11. Characteristics A few large producers Homogeneous or differentiated products Control over Price Mutual interdependence and strategic behavior Barriers to entry Mergers

12. Oligopolists have a tendency to merge and become monopolists Increases market share Greater economies of scale Caused by desire for monopoly power

13. 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

14. 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

15. 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

16. 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

17. 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