Ch. 11: Monopolistic Competition and Oligopoly

How does the demand curve that a monopolistic competitive firm faces differ from the one that a perfectly competitive firm faces?

perfect competition — *perfectly elastic demand* — marginal revenue is the market price — zero price-setting power monopolistic competition — *downward-sloping demand curve*

Understand the four market models summary (in other words make sure to understand the characteristics of each of the types of markets covered, similarities and differences, etc.).

perfect competition — P = MC, average costs at minimum, no economic profits in the long run monopolistic competition — P > MC, MR = MC, average costs not at minimum, no economic profits in the long run oligopoly — MR = MC, average costs not at minimum, profits in the long run if acting as monopoly monopoly — MR = MC, average costs not at minimum, profits in the long run

What are the four characteristics of monopolistically competitive markets?

(1) many producers (2) variety of types of products, each slightly different (3) easy entry and exit (4) lots of information about buyers and other sellers

What happens in the long run? Does the monopolistic competitive firm earn zero economic profits, like a competitive firm in the long run or not? Why or why not?

(1) new firms will enter the market (2) demand for existing firms' product falls (3) existing firms reduce prices and output (4) economic profits fall, but as long as there's still profit, firms join until *profits are competed away* (5) monopolistically competitive firm earns *zero economic profit* — MC still < P, firm still not produce at lowest AC, producing at less than capacity

What is the cost curve that an oligopoly faces?

*U-shaped cost curve* BUT exhibits economies of scale that allow for more efficient productions

Recall the characteristics of a perfectly competitive market and a monopoly. How do imperfectly competitive firms compare with these two extremes in terms of their influence over price in the market?

*perfect competition* — many firms sell identical products; no power over price *monopolistic competition* — large number of firms with slightly differentiated products; some control over price *oligopoly* — small number of firms with identical or differentiated markets; have more control over price; choose price based on other firms decisions *monopoly* — one firm sells a product with no close substitutes; complete control over price

What happens to a monopolistically competitive firm in the short run?

AC not at minimum MC < P economic profits can be earned AC will be as low as possible at every level of output due to competition, with exception of advertising costs, which makes AC not at minimum

What is collusion?

agreement among firms in an oligopoly *setting quantities to produce or prices to charge* and made at the expense of buyers formal agreements are illegal in the U.S. informally setting prices and not actively competing is a legal workaround

What happens in a Prisoner's Dilemma game in which the players have to move at the same time and there is no cooperation allowed? How does the outcome compare with other potential outcomes that could have been obtained if cooperation was possible?

both players will use their dominant strategy and act in self interest, because they do not know what the other player is doing outcome will be the equilibrium outcome, rather than the cooperative outcome that would lead to them both being better off

What is a cartel? What is always the downfall of a cartel?

cartel — formal agreement to collude, to act in concert with one another, to act like a monopoly perfect cartel occurs when firms share the market and choose to charge the monopoly price, maximizing industry profits

What are some examples of an oligopoly?

commercial aircraft (Boeing and Airbus), soft drink industry (Coke and Pepsi), automobile sellers (Ford, Toyota, General Motors)

What is a dominant strategy? What does it mean that a player (firm) has a dominant strategy?

dominant strategy — strategy a player is choosing regardless of what the other player in the situation is doing means they have incentive to do one action no matter what

How might firms in an oligopoly work together to act like a monopolist in that market?

firms in an oligopoly can work together to *maximize industry profits* rather than individual firm profits

How do the cost functions for a monopolistically competitive firm contrast with the cost functions of perfectly competitive firms?

for monopolistic competition, *costs may be higher* because of use of advertising to distinguish themselves this adds to costs of production and average costs are higher

What is game theory? What does game theory illustrate?

game theory — branch of mathematics that analyzes situations in which players make decisions and receive payoffs based on their decisions illustrates *strategic behavior* that firms in an oligopoly exhibit oligopolists always take their competitors' strategies into account

What is the demand curve that an oligopoly faces?

if differentiated products, downward-sloping if similar products, much more elastic

What are the differences between a monopolistically competitive market and a market with a monopoly?

monopolistic competition — many firms monopoly — one firm

What is an oligopoly? What are the characteristics of an oligopolistic market?

oligopoly — *few firms* with differentiated or identical products in a market with some barriers to entry (1) *small number of dominant firms* (2) similar or differentiated products (3) experiencing significant barriers to entry

Understand the outcome in terms of output and price for a monopolistically competitive firm (graph).

output set where MR = MC price set at highest price where firm can sell at MR = MC — found on demand curve

How does a monopolistically competitive firm maximize its profits Where does it produce? Is the profit maximizing condition (MR = MC) for a monopolistically competitive firm different than for any other profit-maximizing firm?

produces where MR = MC produces where MR < P so less than allocatively efficient amount will be produced same rule as for monopolies

How do the cost functions for a monopolistically competitive firm compare to the cost functions of perfectly competitive firms?

quite similar to cost function of perfect competition average cost curve: *U shaped* marginal cost curve: declines as variable input increases, inclines as diminishing marginal returns kick in average cost at minimum where AC = MC

What is the Prisoner's Dilemma?

situation in which *gains from cooperation are larger than the gains from pursuing self-interest* acting in self-interest leaves everyone worse-off usually illustrated by the situation of two prisoners who will both be better off not confessing to a crime, but who each have individually beneficial reasons to confess

What are some examples of monopolistically competitive markets?

stores in a shopping mall all selling slightly different products, restaurants all making slightly different food, mystery novels all with slightly different stories

What is a payoff matrix?

table that shows each player's set of possible actions and their different payoffs, dependent on both players' courses of action

Why would a firm cheat on a cartel agreement?

to *gain more economic profit for itself* by lowering price and attracting new customers greater MR to individually lower price than if all firms were to lower their price, since customers are being taken away from the other firms in a cartel, there is always an incentive to cheat

How does an oligopoly maximize profits?

whole industry (all firms) operates where MR = MC agree on total level of output, which is difficult, as most firms want a larger share of the market rather than to split output between each other if all firms lower prices, they will not maximize industry profits and will all earn lower profits

Does the monopolistically competitive firm have power over setting price?

yes, *some market power* because it sells a slightly differentiated product so, if price is changed, demand will not fall to zero because some consumers like the differentiated product and will continue to purchase it at the higher price