Monopolistic Competition and Oligopoly

Vocabulary flashcards covering key concepts from the lecture notes on Monopolistic Competition and Oligopoly.

Monopolistic Competition

Market structure with relatively many sellers, differentiated products, easy entry/exit, and some pricing power gained through advertising.

Oligopoly

Market structure dominated by a few large firms with interdependence, strategic behavior, barriers to entry, and potential for collusion.

Four-Firm Concentration Ratio (4-FCR)

The share of industry output accounted for by the four largest firms.

Herfindahl Index (HI)

A measure of market concentration calculated by summing the squares of the market shares of all firms.

Productive inefficiency

A situation where price exceeds the minimum average total cost (P > min ATC).

Allocative inefficiency

A situation where price exceeds marginal cost (P > MC), indicating resources are not allocated efficiently.

Excess capacity

In monopolistic competition, output is below the level that minimizes ATC.

Short-run profit maximization (Monopolistic Competition)

Produce where MR = MC; firms may earn profits or incur losses in the short run.

Long-run normal profit (Monopolistic Competition)

In the long run, entry and exit drive economic profits to zero, so firms earn only normal profit.

Demand is highly elastic (Monopolistic Competition)

The demand faced by an individual monopolistically competitive firm is relatively elastic due to many close substitutes.

Oligopoly models

Theoretical frameworks to analyze oligopolies: game theory, collusive pricing, price leadership, and kinked demand curves.

Game Theory

Study of strategic interactions where each firm’s payoff depends on the actions of others.

Prisoners’ Dilemma

A game showing why cooperation is difficult: pursuing self-interest leads to a worse outcome for all.

Dominant strategy

The best action for a player regardless of others’ actions.

Cartel

A formal agreement among firms to collude on price/output; often illegal in the U.S.; example: OPEC.

Obstacles to collusion

Differences in costs/demand, number of firms, cheating incentives, recession, new entrants, and legal barriers.

Price leadership model

A dominant firm sets price and others follow; may use limit pricing to deter entry.

Kinked-Demand Theory

Noncollusive oligopoly theory where rivals’ responses create a kink in the demand curve, leading to price rigidity.

Kinked Demand Curve

A price–quantity relationship with a sudden change in MR, producing price rigidity because rivals either match price decreases or ignore price increases.

Advertising in oligopoly

Firms rely on product development and advertising to gain competitive advantage; price changes are harder to copy.

Positive effects of advertising

Provides information, fosters competition, accelerates technological progress, and can improve economies of scale.

Negative effects of advertising

Can be manipulative or misleading, leading to higher prices for consumers.

Oligopoly and Efficiency

Oligopolies tend to be inefficient: P > min ATC (productive inefficiency) and P > MC (allocative inefficiency).

P > min ATC

Price exceeds the minimum average total cost.

P > MC

Price exceeds marginal cost, signaling allocative inefficiency.

OPEC

Organization of the Petroleum Exporting Countries; a real-world cartel coordinating oil production and pricing.

Limit pricing

Setting a price low enough to deter entry by potential competitors.

Interdependence (Mutual interdependence)

Firms consider rivals’ likely reactions when making pricing/output decisions.

Cheating in cartels

Members of a cartel may secretly increase output to gain more profit, undermining the agreement.

Oligopoly in the U.S. Beer Industry

An example of oligopoly where a few large firms influence price and advertising, illustrating interdependence.