Econ 101 M8

Econ 101: Microeconomics - Monopolistic Competition and Oligopoly

Module Overview

• Topics Covered: Monopolistic competition, oligopoly, firm characteristics, profit maximization, efficiency, government intervention.

• Learning Outcomes:

  • Define monopolistic competition and identify its characteristics.

  • Understand profit maximization in both short-run (SR) and long-run (LR).

  • Analyze efficiency and the need for government regulation.

  • Explore the roles of advertising in monopolistic competitive firms.

  • Understand oligopoly structures and behaviors.

Market Review

• Characteristics of Competitive Firms:

  • Many firms exist, none can influence market outcomes (price-takers).

  • Products are largely identical (homogeneous).

  • Free entry and exit are present.

• Characteristics of Monopoly Firms:

  • There is a single firm controlling the market with no close substitutes.

  • High barriers to entry prevent other firms from entering the market.

Definitions of Market Models

1. Monopolistic Competition: Many sellers, differentiated products.

   • Example: Brands of toothpaste.

2. Oligopoly: A few sellers acting strategically in production and pricing.

   • Example: Airlines, car manufacturers.

Characteristics of Monopolistic Competition

• Firms in Industry: Many, each with some market influence.

• Types of Goods: Differentiated.

• Entry and Exit: Free, similar to perfect competition.

• Demand Curve: Downward-sloping, steeper than perfect competition but not as steep as monopoly.

Profit Maximization in Monopolistic Competition

Short Run (SR)

• Decision Rule: Produce where marginal revenue (MR) equals marginal cost (MC).

• Can experience profits, losses, or break-even.

Long Run (LR)

• Equilibrium: Entry of firms drives economic profits to zero (P = AC).

  • When existing firms profit, new firms enter and increase market supply, leading to lower prices.

• Profits: Firms can earn accounting profits but not economic profits in the long run.

Economic Efficiency of Monopolistic Competitive Firms

• Inefficiency:

  • Produce less than ideal output level, charge higher prices.

  • Create deadweight loss (DWL).

  • Exhibit excess capacity as they do not minimize average costs (AC).

Government Intervention

• Interventions are generally not justified due to minor magnitude of monopolistic power and the benefits of product variety and differentiation.

Advertising in Monopolistic Competition

• Advertising drives brand identification and differentiates products.

• Firms invest significantly in marketing to gain market share, sometimes misinforming consumers.

Oligopoly Characteristics

1. Number of Firms: Few.

2. Types of Goods: Can either be homogeneous or differentiated.

3. Behavior: Strategic behavior; firms consider competitors’ actions when making production decisions.

Principal Behavior of Oligopoly Firms

• Oligopolists may collude to maximize joint profits but face incentives to cheat.

• Example: Pricing strategies among airline companies.

Related Terminology

• Collusion: Firms agree to limit production or raise prices but is illegal.

• Cartel: A group of firms coordinating production/pricing like a monopoly.

• Duopoly: A specific case of oligopoly with two firms.

Game Theory in Oligopoly

• Firms must strategize based on competitors’ likely responses.

• Prisoners’ Dilemma: Illustrates challenges in cooperation among oligopolists.

Government Policy on Oligopoly

• Regulated under acts like the Competition Act in Canada to monitor and prohibit anti-competitive behavior.

Comparing Market Models

Review Questions

1. Define a monopolistic competitive firm and list its characteristics.

2. Explain differentiated products.

3. Compare monopolistic competition and monopoly.

4. Discuss monopolistic competition versus perfect competition.

5. Outline production and pricing decisions in SR and LR.

Sample Multiple-choice Questions

1. In a monopolistically competitive industry, price is:

   • a. Equal to marginal cost since each firm is a price taker

   • c. Above marginal cost, since each firm is a price setter

2. Monopolistic competition differs from perfect competition because:

   • c. Each of the sellers offers a somewhat different product

3. A similarity between Monopoly and monopolistic Competition is:

   • c. Sellers are price makers rather than price takers

...and continue with relevant questions.