ECON Chapter 10: Monopolistic Competition & Oligopoly

Tit-for-tat game

A game theory strategy where each participant mimics the action of their opponent after cooperating in the first round of collusion.

Cartel

A group of firms acting in unison. They collude on their prices and quantities produced.

Prisoner's Dilemma

A paradox in decision analysis where two individuals acting in their own self-interests do not produce the optimal outcome. They are prisoners to their own self-interest.

Nash Equilibrium

A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen.

Dominate Strategy

A strategy that gives a player the best outcome regardless of the strategy chosen by their opponent.

Firms in the short run in a monopolistically competitive market...

Can have both profits and losses, but in the long run cannot escape zero economic profit.

How can an oligopoly become monopolistic competition or perfect competition?

If a firm in an oligopoly produce slightly differentiated products and enough firms enter the market, it becomes monopolistic competition. If they produce identical products and enough firms enter, it becomes perfect competition.

Describe how a firm in monopolistic competition may set prices.

Firms know that consumers may buy less if they raise their prices, but if demand is inelastic and their profits overall increase, they are ok with that and will increase prices.

Describe monopolistic competition.

In a monopolistically competitive market structure, there are many companies selling slightly differentiated products. Firms in monopolistic competition have the power to set prices. However, unlike in a monopoly, for monopolistically competitive firms, this power does not come from being the only game in town, instead it comes from brand loyalty. This is why advertising is so important in this market structure.

Anti-trust Laws

In place to deal with firms coordinating prices and quantities to stop cooperation from occurring.

What happens if a firm has positive economic profit in the short run?

In the long run, potential firms enter the market if there are profits, leading to zero economic profits.

What happens if the demand curve is below the Average Total Cost curve?

The best the firm can do is minimize a loss.

What happens if the firm is producing at a point at which the demand curve is above the average total cost curve?

The firm could make positive profit

Graphically, what is the difference between perfect competition and monopolistic competition?

The firm in monopolistic competition is facing a downward sloping demand curve that is below the marginal revenue curve, while the other firm in a perfectly competitive market is a price taker with a horizontal demand curve.

How are firms entering the market shown on a graph of a firm in a monopolistically competitive market?

The marginal revenue (MR) and demand curves shift to the left because there is less demand for that specific firm because other firms have entered the market and now offer similar products.

What is the difference between finding the "right" price when regulating prices for a monopolistic competition firm vs. a monopoly?

The most efficient price is always equal to MC. However, firms in monopolistic competition are earning zero economic profit in the long run, then the MC is below the ATC, and the policy maker would force firms into losses. Even if they set the price above MC, it is still a problematic situation, leaving the firm with no incentive to innovate for efficiency's sake. If the price always changes commensurate with costs, there is no incentive to be cost efficient.

What is the only real difference between the different market structures?

The number of firms

Where is a downward sloping demand curve tangent to the ATC?

To the left of the efficient scale.

What do we know creates efficiency from perfect competition?

We know that the most efficient price is equal to the marginal cost.

How does cooperation affect the market?

When it comes to the market for goods, cooperation is a bad thing as it leads to higher prices and lower quantity produced.

How do firms in an oligopoly act when they compete?

When they compete, an oligopoly falls in between a monopoly and perfect competition in terms of its rank of competitiveness, meaning it charges a lower price and produces more than a monopoly but charges a higher price and produces less than a firm in perfect competition.

When the best a firm can do is zero economic profit, where does that production take place?

Where the demand curve is tangent to the ATC curve.

Where do firms in monopolistic competition and perfect competition maximize profits in the long run?

Where the demand curve is tangent to the ATC. Therefore producing zero economic profits.

How is can the prisoner's dilemma be illustrated?

With two criminals accomplices who confess and give each other up for leniency, causing them both to serve more time than if they had both stuck to the plan and stayed quiet.

Duopoly

an oligopoly that consists of two firms.

If two firms are colluding, they...

maximize profits as if they were a monopoly and together, they would split a market quantity and would also split the profit.

In what two ways is monopolistic competition less efficient than perfect competition?

- Excess capacity that exists only in monopolistic competition. There is no excess capacity in perfect competition. The downward sloping demand curve (monopolistic competition) is tangent to the ATC curve to the left of the efficient scale. - There is no DWL in perfect competition while there is in monopolistic competition.

Collusion

An agreement between firms about quantities to produce and prices to charge.

In terms of competitiveness, where does an oligopoly fall?

An oligopoly is more competitive than a monopoly but less competitive than perfect competition.

Where is a horizontal demand curve tangent to the ATC?

At the efficient scale

Why is dealing with the inefficiency of monopolistic competition so complicated?

Because it is difficult to ascertain the "appropriate" number of firms in a monopolistically competitive market.

Where does the competitive price and quantity for an oligopoly fall?

Between that of a monopolist and a firm in perfect competition.

What does monopolistic competition have in common with a monopoly?

Firms have power over the price and therefore the demand curve is downward sloping.

Why is there DWL in perfect competition but not in monopolistic competition?

Due to firms being price takers in perfection competition, the AR is equal to the MR, and the demand curve for the firm is the same as the MR curve. The result of this is that in perfect competition, production always takes place where the value to the buyer (represented by the demand curve) is equal to the cost to the seller (represented by the MC curve). However, in monopolistic competition, the demand curve is downward sloping and the MR curve is below the demand curve because the firm needs to lower the price to sell more units. Since firms maximize profits where MR=MC, the price set by the monopolistic competitive firm is marked up above the MC. This results in some buyers who value the product above or equal to the cost of producing not being able to enter the market. This price creates deadweight loss.

Excess Capacity

Exists in monopolistic competition not in perfect competition. It means that the firm could decrease its ATC by increasing production.

What is an example of a market that straddles the world between monopolistic competition and an oligopoly?

Fast food. Firms are primarily considered a part of the monopolistic competition market, but we see strategic interaction among firms.

Do markets have to either be an oligopoly or monopolistic competition?

No, there are markets that straddle the world between monopolistic competition and an oligopoly.

What is danger to firms colluding?

One firm could give in to the short-term temptation of increasing profits and could therefore cheat on their agreement, setting off a tit-for-tat game.

Although both monopolistic competition and perfect competition produce where price=ATC, and therefore earn zero economic profit, which is more efficient?

Perfect Competition

When a firm is making zero economic profit, graphically at what point are they producing at?

The optimal quantity is where MR=MC. We follow this quantity up to the demand curve to find our price. In the long run at zero economic profit, the demand curve at this point is tangent to the Average Total Cost (ATC) curve.

What is another course of action that a policy maker could take to eliminate DWL?

The policy maker could try to regulate prices like they would for natural monopolies. however, they would run into the same difficulties.

In the cases of both price regulation and increasing competition, what is the policy maker really doing?

The policy maker is more likely to end up just picking winners and losers as opposed to making the market more efficient. Sometimes accepting markets may not always be perfect and taking a hands-off approach can be the right thing to do.

What is a problem that policy makers could run into when trying to regulate prices?

The policy maker needs to determine the "right" price.

Game Theory

The study of how people or firms behave in strategic situations.

Oligopoly

There are a few sellers offering similar or identical products.

What is the defining characteristic of an oligopoly?

There are few enough firms that strategic interaction becomes possible. The firm shouldn't just concentrate on their own production, but should also concentrate on how the production of their competitors affects them.

What does monopolistic competition have in common with perfect competition?

There are many firms with free entry and exit into the market, resulting in zero economic profits in the long run.

What is the second reason that perfect competition is more efficient than monopolistic competition?

There is no DWL in perfect competition, but there is DWL in monopolistic competition.

Even though firms in monopolistic competition have slighter differentiated products...

There is still only room for so many firms in the market.

When there is collusion in an oligopoly, how do firms act?

They act like a cartel, they charge a price and produce a quantity equal to that of a monopoly.

Beyond forming an oligopoly to compete, what does the policy maker run into when trying to increase competition or regulate prices for an oligopoly?

They run into many of the same issues they face when trying to increase competition or regulate prices for a monopoly or for monopolistic competition.

How would a firm give into the short-term temptation of increasing profits and cheat on their agreement?

They would produce more than the agreed upon quantity and would pocket the extra profits.

In monopolistic competition, what would happen if a policy maker were to force new firms into the market?

This course of action may force existing firms into losses causing exit from the market. Policy makers may also have a difficult time enticing new firms into a market if firms think that the market will be oversaturated.

How are prices determined for an oligopoly?

Through strategic interaction in an oligopoly.

Even though a firm has to lower their price to sell an increased quantity, if the _________ dominates the ________ , their profits will increase

output effect, price effect