1. Monopolistic
Competition &
Oligopoly

2. Outline
I. Introduction
A. Where Does Monopolistic Competition
“fit in”?
B. Assumptions of Monopolistic
Competition
II. Monopolistic Competition
A. Short Run
B. Long Run

3. Outline (Cont.)
III. Long Run Conditions
A. Excess Capacity
B. Product Differentiation
C. Allocative and Productive Efficiency
IV. Oligopoly
A. Where Oligopoly “fits in”
B. Assumptions
C. Concentration Ratios

4. Outline (Cont.)
V. Models of Oligopoly
A. Cartel Theory
B. Game Theory

5. Where Does Monopolistic
Competition “fit in?”
Perfect Competition Monopoly

6. Where Does Monopolistic
Competition “fit in?”
Perfect Competition Monopoly
Monopolistic
Competition

7. Assumptions of Monopolistic
Competition
• Many buyers and sellers (as opposed to
monopoly)
• Firms produces a similar, yet unique
product (gives us downward sloping
demand)
• Ease of entry and exit

8. Examples of Monopolistically
Competitive Markets
• Pizza Places (Pizza Hut, Dominos)
• Hairdressers
• Grocery Stores (IGA, Kroger, Meijer)

9. Monopolistic Competition in the
Short Run
• Looks and Acts Like Monopoly
• Faces Downward Sloping Demand and MR
• Produces where MR=MC and may make a
profit.

10. Monopolistic Competition in the
Short Run
P
$10 MC
8 ATC
p*
AVC
6
atc*
4
2 MR D
0 1 2 3 4 5 Q

11. Monopolistic Competition in the
Long Run
• Firm Demand Shifts Back and Gets More
Elastic.
• Demand Shifts Back Because More Firms Enter
the Industry, So There is Less Demand Per
Firm.
• Demand Gets More Elastic Because More
Firms Means More Substitutes and More
Substitutes Means More Elastic

12. Monopolistic Competition in the
Long Run
• Like Perfect Competition, Firms Will
Continue to Enter Until There are No More
Profits to Attract Them.

13. Monopolistic Competition in the
Long Run
P
$10 MC
8 ATC
AVC
6
p*= atc*
4
2 MR D
0 1 2 3 4 5 Q

14. Long Run Conditions of
Monopolistic Competition
• Excess Capacity
• Product Differentiation
• Efficiency

15. Excess Capacity
• Excess Capacity is the Difference Between
The Long Run Perfectly Competitive
Quantity Produced and the Long Run
Monopolistically Competitive Quantity
Produced.
• Generally Speaking, There Will be Excess
Capacity in the Long Run of Monop.
Competition.

16. Excess Capacity
P
MC
ATC
AVC
P*
D
MR
0 Q Q Q
Excess Capacity

17. Product Differentiation
• The More That a Firm Can Differentiate
Their Product, The More Inelastic The
Demand Becomes.
• Thus, Profits Can Be Sustained.
• This is the Role of Advertising.

18. Efficiency
• Productive Efficiency
– Generally, A Monopolistically Competitive
Firm is not Productively Efficient, since it is
not producing at the bottom of it’s ATC curve
• Allocative Efficiency
– Generally, A Monopolistically Competitive
Firm is not Allocatively Efficient, since there is
excess capacity.

19. Oligopoly
• For a Market to be Described as
Oligopolistic, it must satisfy the following
conditions:
– Few Sellers, Many Buyers (more like
Monopoly).
– The Firm’s products may be identical or unique
– The are Barriers to Entry (like monopoly)

20. Where Does Oligopoly “fit in?”
Perfect Competition Monopoly
Monopolistic Oligopoly
Competition

21. Concentration Ratios
• One Way to Determine Whether a Market is
Oligopolistic is to look at a Concentration
Ratio
• A Concentration Ratio Let’s Us Know if the
Whole Industry’s Sales are Dominated by
the Sales of a Few Firms.

22. The X-Firm Concentration Ratio
• The X-Firm Concentration Ratio is the
Percentage of Industry Sales Accounted for
by the Sales of the Top X Firms in the
Industry:
• Sales of the Top X Firms
Total Industry Sales

23. Models of Oligopoly
• Cartel Theory: The Oligopolists Get
Together (Since There are So Few of Them)
and Act As If They Were One Monopolist
and Collectively Produce the Monopolistic
Quantity - Thus Maximizing Profit
• Example: OPEC

24. Problems With Cartels
• Generally, They Are Not Legal (Price
Fixing)
• They Are Difficult to Organize and Monitor
• Can’t Force New Firms to Join
• Cheating

25. The Incentive to Cheat On A
Cartel
• If the Cartel Maintains the Monopoly Price,
The Individual Member of the Cartel Can
Act Like a Price Taker (They Can Sell All
They Want at the Market Price)
• As a Price Taker, They Maximize Profit
Where MC=MR.

26. The Incentive to Cheat On A
Cartel (Cont.)
• This Quantity is Greater Than the Cartel
Wants the Individual Firm to Produce.
• All Firms in the Cartel Do This and the
Cartel Falls Apart

27. The Incentive to Cheat On A
Cartel
$ $
MR
MC MC ATC
P
MR D
Q Market Q Q Firm Qcheater

28. Game Theory
• Game Theory is a Technique That Allows
Us to Examine The Strategies of
Oligopolists
• This Technique Allows Us to Determine the
Best Strategy for a Oligopolist if the Other
Oligopolists are Aware of the All of
Avaliable Strategies

29. Example - The Prisoner’s
Dilemma
Consider the Following Story:
• Bill and Jill Have Cheated on an Exam
• They are Both Caught
• Bill in Prof. Platt’s Office and Jill is Prof.
Lage’s Office
• Each Are Told That Their Punishment Will
Be Somewhat Lighter if They Confess

30. Example - The Prisoner’s
Dilemma (Cont.)
• They Both Know That if They BOTH
Admit Nothing, it Will Be Tough to Prove
That They Cheated
• They Can’t Communicate With Each Other
• What Do They Do?

31. Example - The Prisoner’s
Dilemma
Jill is Silent Jill Confesses
Bill is They Fail The Class
Jill Fails,
Silent and Their Transcript
Bill is Expelled
is Noted
They Are Both
Bill Bill Fails, Suspended For a Year,
Confesses Jill is Expelled Fail the Class and
Transcipts are Noted.

32. How Does The Prisoner’s
Dilemma Apply to Oligopoly?
• A Cartel Can only Hold Together if
Everyone Sticks to Producing the
Monopoly Quantity
• But a Cheater Benefits More Than the
Others - Much Like Confession By Bill or
Jill Alone, Benefits One More Than the
Other.
• But if They All Know This -- They All
Cheat and the Cartel Falls Apart.