3. Perfect competition, with an infinite number of firms, and monopoly, with a single firm, are polar opposites. Monopolistic competition and oligopoly lie between these two extremes. Perfect Monopolistic competition competition Oligopoly Monopoly

5. Monopolistic competition is a mixture of monopoly and perfect competition. A monopolistically competitive industry has the following characteristics: - A large number of firms - - No barriers to entry - - Product differentiation -

6. product differentiation A strategy that firms use to achieve market power. Accomplished by producing products that have distinct positive identities in consumers’ minds.

7. The advocates of spirited competition believe that differentiated products and advertising give the market system its vitality and are the basis of its power. They are the only ways to begin to satisfy the enormous range of tastes and preferences in a modern economy. Product differentiation also helps to ensure high quality and efficient production. Advertising provides consumers with the valuable information on product availability, quality, and price that they need to make efficient choices in the marketplace.

8. Critics of product differentiation and advertising argue that they amount to nothing more than waste and inefficiency. Enormous sums are spent to create minute, meaningless, and possibly nonexistent differences among products.

9. There are strong arguments on both sides of the advertising debate, and even the empirical evidence yields to conflicting conclusions. Some studies show that advertising leads to concentration and positive profits; others, that advertising improves the functioning of the market.

10. Although the demand curve faced by a monopolistic competitor is likely to be less elastic than the demand curve faced by a perfectly competitive firm, it is likely to be more elastic than the demand curve faced by a monopoly.

11. To maximize profit, the monopolistically competitive firm will increase production until the marginal revenue from increasing output and selling it no longer exceeds the marginal cost of producing it. This occurs at the point at which marginal revenue equals marginal cost: MR = MC.

12. The firm’s demand curve must end up tangent to its average total cost curve for profits to equal zero. This is the condition for long-run equilibrium in a monopolistically competitive industry.

13. Because entry is easy and economic profits are eliminated in the long run, we might conclude that the result of monopolistic competition is efficient. There are two problems, however. First, once a firm achieves any degree of market power by differentiating its product (as is the case in monopolistic competition), its profit-maximizing strategy is to hold down production and charge a price above marginal cost. Second, the final equilibrium in a monopolistically competitive firm is necessarily to the left of the low point on its average total cost curve.

14. An oligopoly is a form of industry (market) structure characterized by a few dominant firms. Products may be homogeneous or differentiated. The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others.

15. Because many different types of oligopolies exist, a number of different oligopoly models have been developed. All kinds of oligopoly have one thing in common: The behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry comprising the oligopoly.

16. collusion model The collusion model argues that when there are few firms in the industry, it is possible for the firms to get together and acts like a monopolist.cartel A group of firms that gets together and makes joint price and output decisions to maximize joint profits. Collusion occurs when price- and quantity-fixing agreements are explicit. tacit collusion occurs when firms end up fixing price without a specific agreement, or when agreements are implicit.

17. Cournot model A model of a two-firm industry (duopoly) in which a series of output adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly. duopoly A two-firm oligopoly.

18. price leadership A form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.

19. game theory Analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. In game theory, firms are assumed to anticipate rival reactions.

20. The strategy that firm A will actually choose depends on the information available concerning B’s likely strategy. Regardless of what B does, it pays A to advertise. This is the dominant strategy, or the strategy that is best no matter what the opposition does.

21. dominant strategy In game theory, a strategy that is best no matter what the opposition does. prisoners’ dilemma A game in which the players are prevented from cooperating and in which each has a dominant strategy that leaves them both worse off than if they could cooperate.

22. The Prisoners’ Dilemma Both Ginger and Rocky have dominant strategies: to confess. Both will confess, even though they would be better off if they both kept their mouths shut.

23. tit-for-tat strategy A company’s strategy that lets a competitor know the company will follow the competitor’s lead. Payoff Matrix for Airline Game

24. Nash equilibrium In game theory, the result of all players’ playing their best strategy given what their competitors are doing. maximin strategy In game theory, a strategy chosen to maximize the minimum gain that can be earned.

25. A market is perfectly contestable if entry to it and exit from it are costless. In contestable markets, even large oligopolistic firms end up behaving like perfectly competitive firms. Prices are pushed to long-run average cost by competition, and positive profits do not persist.

26. Oligopolies, or concentrated industries, are likely to be inefficient for the following reasons: They are likely to price above marginal cost. This means that there would be underproduction from society’s point of view. Strategic behavior can force firms into deadlocks that waste resources. Product differentiation and advertising may pose a real danger of waste and inefficiency.