1. Chapter 10
Monopolistic Competition &
Oligopoly

2. The Monopolistic Competition Market
Structure
• A market structure characterized by:
▫ Many small sellers
▫ A differentiated product
▫ Easy market entry & exit
• This market structure fits many real-world
industries

3. Many Small Sellers
• The exact number cannot be stated.
• This structure is one where the seller can set
prices slightly higher or improve services
independently without fear that competitors will
react by changing their prices or giving better
service.

4. Differentiated Product
• This is the key difference between perfect
competition and monopolistic competition
▫ Def: Production differentiation is the process
creating real or apparent differences between
goods and services

5. Examples of Differentiated Products
• Design
• Reliability
• Location
• Costly information

6. How do they compete
• They often compete on non-price competition
▫ Advertising
▫ Packaging
▫ Product development
▫ Better quality
▫ Better services

7. Easy Entry & Exit
• They face low barriers to entry, but it is not as
easy to enter as perfect competition.
• Because there are differentiated products it is
hard for firms to get established in these
markets.
▫ Example: new restaurants in town

9. Monopolistically Competitive Firms are
Price Makers
• They are not price takers, meaning they let the
market set the price.
• Thus the demand curve is less elastic than the
perfectly competitive firm, but more elastic than
the monopolist.

10. What do the Demand and Marginal
Revenue Curve look like
• Demand and marginal revenue are negatively-
sloped
▫ Negatively-sloped demand curve⇒marginal
revenue is less than price at each quantity.
▫ Marginal revenue curve is negatively-sloped and
lies below the demand curve.

11. Short-Run
• The monopolistically competitive firm will
maximize profit at MR=MC.
• If short-run economic losses occur, then the firm
will exit the market.

12. Long-Run
• The firms will not earn a profit, like perfect
competition.
▫ Long-run equilibrium: Sellers earn zero
economic profit (or a normal accounting profit).

13. 13 Monopolistic
Competition and
Oligopoly
Short-Run Equilibrium
The profit-maximizing quantity
where marginal revenue equals
marginal cost . . .
is 150 pairs of jeans per day.
The maximum price consumers
are willing to pay for 150 pairs is
$70 per pair.
The average total cost to produce
150 pairs is $20 per pair, . . .
so economic profit is $50 per
pair or $7,500 a day.

14. 14 Monopolistic
Competition and
Oligopoly
Adjustment from Short Run to
Long Run
Short-run economic profit
creates an incentive for entry of
new resources.
With increased competition,
demand decreases to D' and
marginal revenue decreases to
MR'.

15. How does it Compare to Perfect
Competition
• The monopolistically competitive firm also fails
the efficiency test, P>MC.
• The value to consumers is greater than the cost
of producing it.
• The L-R equilibrium output is lower than the
perfect competitive firm and the price is higher.
• What does this mean?

16. The Oligopoly Market Structure
• An imperfectly competitive market structure in
which a few large firms dominate the market
• How to define an oligopoly?
▫ Few sellers
▫ Either a homogenous or a differentiated product
▫ Difficult market entry

17. Few Sellers
• Again, there is no specific number that must
dominate an industry before it is an oligopoly.
• The components of an oligopoly are the mutual
interdependence .
▫ Def: Mutual interdependence in which an action
by one firm may cause a reaction from other firms.
• Being there are only a few firms in the market, it
is easy to collude in the market

18. Homogenous or Differentiated
Product
• The goods produced may be identical or may not
be identical.

19. Difficult Entry
• Some barriers:
▫ Exclusive financial requirements
▫ Control over an essential resource
▫ Patent rights
▫ Other legal barriers
▫ Economies of Scale- this is the major one

20. Examples of Oligopolies
• Characteristics of Oligopoly
▫ Examples
• Do sellers in these markets behave competitively or
monopolistically?
• Beverages (soft drinks)
• Music (CD’s)
• Tobacco
• Automobiles

21. • Characteristics of Oligopoly
• In 2007 (after 2008, “the Big Three” went
from 70% of the market to 50%):
U.S. Market Share of Largest Sellers in Market
Beverages Tobacco Cars
Seller Share Seller Share Seller Share
Phillip
Coke 44.5% Morris 49.4% GM 29.3%
R.J.
Pepsi 31.4% 24.0% Ford 24.9%
Reynolds
Brown and
Cadbury 14.4% Williamson 15.0% Chrysler 16.1%
Total 90.3% Total 88.4% Total 70.3%

22. Price and Output for an Oligopolist
• The maximize price is not as simple at MR=MC.
One player’s move depends on the anticipated
reactions of the opposing player.
• The oligopoly can compete on several different
levels.
▫ Non-price competition
▫ Price Leadership
▫ The Cartel
▫ Game Theory

23. Non-price Competition
• They often compete using advertising & product
differentiation
• This is why research & development is so
important in these type of firms.

24. Price Leadership
• They play a game of follow the leader.
▫ Def: Price leadership is a pricing strategy in which
a dominant firm sets the price for an industry and
the other firms follow

25. Collusion
• An agreement among firms in the industry to
divide the market and fix the prices

26. The Cartel
• Firms may decide to avoid price wars and they
may openly or secretly conspire to form a
monopoly called a “cartel.”
▫ Def: A cartel is a group of firms that formally
agree to control the price and the output of a
product

28. CARTELS
Anatomy of a Cartel:
OPEC
In the 1970’s, OPEC succeeded
in limiting the supply of crude
oil produced by member
countries so as to increase the
price.
After 1980, however, the market
imploded. Price fell almost as
much as it had risen.
What happened? Why was the
cartel’s success so short-lived?
Monopolistic Competition and Oligopoly
28

29. Monopolistic
Competition and
29 Oligopoly
CARTELS
• Anatomy of a Cartel: OPEC
▫ Reaching agreement

30. Monopolistic
Competition and
30 Oligopoly
CARTELS
• Anatomy of a Cartel: OPEC
▫ New sources of supply

31. Monopolistic
Competition and
• Anatomy of a Cartel: OPEC
31 Oligopoly
▫ Greater energy efficiency and consumer
substitution

32. Monopolistic
Competition and
• Anatomy of a Cartel: OPEC
32 Oligopoly
▫ Detecting and preventing cheating

33. Monopolistic
Competition and
33 Oligopoly
CARTELS
• Anatomy of a Cartel: OPEC
▫ Enforcing the agreement

34. Game Theory
• Def: Game theory is a model of strategic moves
and countermoves of rivals
▫ They are mutually interdependence because an
action by one firm may cause a reaction from the
other firm.

35. Game Theory
• In an oligopoly structure, a few firms compete
for their customers. One firm may gain
customers by decreasing the price at the expense
of the other firms or they may increase
advertising.
• In an oligopoly, the important element is those
firms that do not follow suit will lose customers.
However, if the other firms react competitively
by doing the same, then all the firms lose. Thus,
each firm finds itself on the horns of a dilemma-
this example is known as the classic “prisoner’s
dilemma.”

36. Game Theory
• Economists have increasingly used game theory
(like the example of the prisoner’s dilemma) to
analyze strategic choices made by competitors.

37. Example of Game Theory

38. Example of Game Theory
• To see how this works, think about two touring
Americans who just met at a train station in a
small foreign country : Joe and William.
• The two are taken into the local police station
under the suspicion of being involved in a local
robbery of the bakery.
• The two are told that it will make the polices’ job
easier if they confess immediately, giving them 6
months of jail time each. But they are also told
that if one confesses and the other does not, then
the one who confesses will get 6 months of jail
time, but the one who does not confess will get
12 months.

39. Example of Game Theory
• If neither confesses, both will be held for three
months while the investigation continues.
William and Joe are not allowed to communicate
with each other. Will they confess?
▫ In order to figure this out, we must lay out the
alternative outcomes and show how they would
relate to the choices made by the players of the
game. This is done in a matrix form.

40. Example of Game Theory
Joe’s
Choice
Confess Not Confess
Confess 6 months each Joe: 12 months
William’s William: 6 months
Choice
Not Confess Joe: 6 months 3 months each
William: 12 months

41. Example of Game Theory
• For both Joe and William, the best choice
depends on what the other does. If Joe
confesses, then William can save 6 months of jail
time by also confessing. The same will hold for
William if he thinks that Joe is going to confess.
But if neither confesses then they both will only
receive 3 months of jail time. Joe and William
must each decide, without communicating with
each other, whether to confess.

42. Example of Game Theory
• Joe knows that if William does not confess, then
he can either confess and spend 6 months in jail,
or not confess and spend 3 months. But if
William does confess, then Joe’s failure to
confess will cost him an additional 6 months in
jail. The story for William is the same… Thus,
each man has an incentive to confess if he thinks
the other one will, but an incentive not to
confess if he thinks the other will also remain
silent.

44. How does this apply to Oligopoly?
• The firms must make decisions in this same way,
they are dependent on what the other firm is
going to do. For instance, if one firm cuts its
price, then how do the other firms react? Do
they choice to advertise or not?
▫ There is always a trade-off for the individual
firms.