1. MICROECONOMICS: Theory & Applications Chapter 13 Monopolistic Competition and Oligopoly
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
9th Edition, copyright 2006
PowerPoint prepared by Della L. Sue, Marist College

2. Learning Objectives
Explain how price and output are determined under monopolistic competition.
Understand the characteristics of oligopoly.
Explore several key non-cooperative oligopoly models: Cournot, Stackelberg, and dominant firm.
Show how price and output are determined under the cooperative oligopoly model of cartels.
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3. Price and Output Under Monopolistic Competition
Monopolistic competition – a market characterized by:
unrestricted entry and exit
a large number of independent sellers producing differentiated products
Differentiated product – a product that consumers view as different from other similar products.
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4. Determination of Market Equilibrium
The demand curve facing each firm is downward-sloping but fairly elastic.
Long-run equilibrium is attained as a result of firms entering (or leaving) the industry in response to profit incentives.
Figure 13.1
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5. Monopolistic Competition and Efficiency
Excess capacity – the result of firms failing to produce at lowest possible average cost
Figure 13.2
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6. Is Government Intervention Warranted?
3 reasons why government intervention is probably not warranted:
Any deadweight loss is likely to be small, due to the presence of competing firms and free entry.
Any possible inefficiency cost must be weighed against the product variety produced and the benefits of such variety to consumers.
The costs of intervention must be balanced against the potential gain from expanding output.
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7. Oligopoly Oligopoly – an industry structure characterized by:
a few firms producing all or most of the output of some good that may or many not be differentiated
mutual interdependence: a firm’s actions have an effect on its rivals and induce a react by the rivals
barriers to entry which can influence pricing behavior
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8. The Cournot Model Duopoly – an industry with two firms
Cournot Model – a model of oligopoly that assumes each firm determines its output based on the assumption that any other firms will not change their outputs.
Figure 13.3
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9. Reaction Curves
Reaction Curve – a relationship showing one firm’s most profitable output as a function of the output chosen by other firms
Figure 13.4
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10. Evaluation of the Cournot Model
The assumption that each firm takes the output of a rival firm as constant is implausible if the market is adjusting toward equilibrium.
The assumption is more plausible the larger the number of firms in the market.
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11. Other Oligopoly Models
The Stackelberg Model – a model of oligopoly in which a leader firm selects its output first, taking the reactions of follower firms into account
Dominant Firm Model – a model of oligopoly in which the leader or dominant firm assumes its rivals behave like competitive firms in determining their output
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12. The Stackelberg Model
Residual demand curve – a firm’s demand curve based on the assumption that the firm knows how much output rivals will produce for each output the firm may choose
Figure 13.5
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13. The Dominant Firm Model
Also known as “the dominant firm with a competitive fringe” model
At any price, the dominant firm can sell an amount equal to the total quantity demanded at that price minus the quantity the fringe firms produce.
Figure 13.6
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14. Comparison Between Oligopoly Models
Different assumption about rival behavior
In the Stackelberg model, the leader firm assumes Cournot behavior on the part of rivals.
In the dominant firm model, the leader firm assumes competitive behavior.
The dominant firm model is more appropriate when there are a sufficiently large number of fringe firms.
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15. The Elasticity of the Dominant Firm’s Demand Curve
ηD = ηM (1/MS) + εSF((1/MS) – 1)
where:
ηD = elasticity of the dominant firm’s demand
ηM = elasticity of the market demand
MS = the dominant firm’s market share
εSF = elasticity of supply of the fringe firms
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16. Cartels and Collusion
Cartel – an agreement among independent producers to coordinate their decisions so each of them will earn monopoly profit
Collusion – coordinated decisions among independent producers in an industry
Cartels are illegal under antitrust laws in the United States.
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17. Cartelization of a Competitive Industry [Figure 13.7]
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18. Why Cartels Fail
Each firm has a strong incentive to cheat on the cartel agreement.
Members of the cartel will disagree over appropriate cartel policy regarding pricing, output, allowable market shares, and profit sharing.
Profits of the cartel members will encourage entry into the industry.
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19. Oligopolies and Collusion
Firms in an oligopolistic industry can increase their profits by colluding.
The limited number of firms makes it easier to reach agreements.
When few firms are involved, it is easier to detect cheaters.
Factors that inhibit the formation and maintenance of cartels:
Incentive to cheat
Higher price achieved by collusion prompts entry by new firms
It is not necessary for all firms in the industry to participate in the cartel for it to be worthwhile.
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