Chapter 12: Monopolistic Competition and Oligopoly

Monopolistic competition

Market in which firms can enter freely, each producing its own brand or version of a differentiated led product

Oligopoly

Market in which only a few firms compete with one another, and entry by new firms is impeded

Cartel

Market in which some or all firms explicitly collide, coordinating prices and output levels to maximize joint profits

Key characteristics of a monopolistically competitive market

1. Firms compete by selling differentiated products that are highly substitutable

2. Cross-price elasticities of demand are large but not infinite.

3. Free entry and exit

Demand Curve of a Monopolistically Competitive Market

Downward-sloping

In a monopolistically competitive firm, price…

exceeds marginal cost

In the long run, In a monopolistically competitive firm, price…

equals average cost, so that the firm earns zero profit even though it has monopoly power.

Under perfect competitive, price…

equals marginal cost

Under perfect competition, the demand curve facing the firm is…

horizontals, so the zero-profit point occurs at the point of minimum average cost

Is the monopolistic competition then a socially undesirable market structure that should be regulated?

no

In most monopolistically competitive markets…

monopoly power is small

Any inefficiency must be balanced against an important benefit from monopolistic competition…

product diversity

Product diversity

most consumers value the ability to choose among a wide variety of competing products and brands that differ in various ways.

The gains from product diversity can be ___ and may easily outweigh the ____ resulting from downward-sloping firm demand curve.

large; inefficiency costs

In oligopolistic markets, the products may or may not be ___

differentiated

What matters most in an oligopoly?

only a few firms account for most or all of total production

In some oligopoly markets, some or all firms earn substantial profits over the ___ because barriers to entry make it difficult or impossible to new firms to enter.

long run

Examples of oligopolistic industries

automobiles, steel, aluminum, petrochemicals, electrical equipment, and computers.

Reasons we might see an oligopoly:

1. Scale economies may make it unprofitable for more than a few firms to coexist in the market

2. Patents or access to a technology may exclude potential competitors

3. The need to spend money for name recognition and market reputation
   may discourage entry by new firms

Incumbent firms may take ___ to deter entry

strategic actions

In an oligopolistic market, a firm sets price or output based partly on strategic considerations regarding the ____ of its competitors

behavior

When a market is in equilibrium…

firms are doing the best they can and have no reason to change their price or output.

Nash equilibrium

1. Set of strategies or actions in which each firm does
   the best it can given its competitors’ actions.

2. Each firm is doing the best it can given what its
   competitors are doing

Duopoly

Market in which two firms compete with each other

Cournot Model

Oligopoly model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms
decide simultaneously how much to produce.

Reaction curve

Relationship between a firm’s profit maximizing output and the amount it thinks its competitor will produce

Cournot equilibrium

Equilibrium in the Cournot model in which each
firm correctly assumes how much its competitor will produce and sets its own production level accordingly.

Cournot equilibrium is an example of a…

Nash equilibrium

Stackleberg Model

Oligopoly model in which one firm sets its output before other firms do

If enough producers adhere to the cartel’s agreements, and if market demand is sufficiently ___, the cartel may drive prices well above competitive levels.

inelastic

Cartels are often

international

Conditions for cartel success

1. members agree on price and production levels and then adhere
   to that agreement.

2. potential for monopoly power.

Success cartelization requires two things:

1. the total demand for the good must not be very price
   elastic.

2. either the cartel must control nearly all the world’s supply or, if it does not, the supply of noncartel producers must not be price elastic.