Part 9

Monopolistic Competition Market Structure

• Characteristics:

  • Many small sellers.

  • Differentiated products (products that are not homogeneous).

  • Easy entry and exit from the market.

Pricing and Revenue in Monopolistic Competition

• Price Maker:

  • Because of limited control over price firm experiences a downward-sloping demand curve and marginal revenue curve.

  • Demand curve elasticity: Less elastic than perfect competition, more elastic than monopoly.

  • engages in non-price competition, such as advertising.

Advertising: Pros and Cons

• Pros:

  • Infuses products with distinguishing characteristics and informs consumers about products.

  • Enhances awareness regarding product availability.

• Cons:

  • Can promote unhealthy products (e.g., junk food).

  • May mislead consumers into purchasing decisions.

  • Resources used could be allocated to the production of more desirable goods.

Demand and Marginal Revenue Curves

• When demand is downward sloping, for monopolistically competitive firms:

  • Price must be lowered to sell additional units, affecting all units sold.

  • Marginal revenue (MR) is always less than price (P).

  • MR intersects the quantity axis halfway between the origin and the demand curve.

Short-Run Outcomes

• Profit Maximization: Occurs at MR = MC (Marginal Revenue = Marginal Cost).

• Possible scenarios:

  • Economic profit: P > ATC (Average Total Cost)

  • Normal profit: P = ATC

  • Loss: AVC < P < ATC

  • Shutdown condition: P < AVC (Average Variable Cost).

Long-Run Outcomes

• Over time, firms can earn only normal profits in monopolistic competition due to:

  • Easy entry and exit.

  • Market adjustments lead to normalization of profits (P = LRAC at MR = MC).

Comparisons to Perfect Competition

• Monopolistically competitive firms typically:

  • Charge higher prices.

  • Produce less output than in perfect competition.

  • May provide more consumer choice and product variety

Oligopoly Market Structure

• Characteristics:

  • Few sellers in the market.

  • Can offer either homogeneous or differentiated products.

  • Significant barriers to entry affecting market dynamics.

Price-Output Decisions in Oligopoly

• Mutual Interdependence: Decisions made by one firm affect others; requires consideration of reactions from competitors.

• Analyzing price and output decisions requires strategic foresight and the appraisal of competitor behaviors.

Game Theory

• Key Concepts:

  • Analyzes strategic decision-making considering interdependencies between firms.

  • Dominant Strategy: Best response regardless of competitors’ actions.

  • Nash Equilibrium: Stable state where no firm benefits from changing its strategy while others keep theirs unchanged.

Collusion and Price Leadership

• Collusion: Firms may engage in non-direct agreements to set prices due to legal constraints on price fixing.

  • Tacit Collusion: Informal price-fixing arrangements.

  • Price Leadership: A leading firm sets an industry price, which is followed by others.

The Cartel

• Definition: A group of firms with a formal agreement to control price and output.

  • Example: OPEC (Organization of the Petroleum Exporting Countries).

  • Cartels act like monopolies to maximize profits by reducing output and raising prices.

  • High incentives exist for individual members to cheat on cartel agreements.

Long-Term Implications in Oligopoly

• Prices in oligopoly markets tend to be higher than in perfect competition.

• Oligopoly firms engage in advertising and product differentiation.

• Barriers to entry allow firms to charge higher prices and earn economic profits over the long term, resulting in resource misallocation.