ECO 101 (Module 10 - Monopolistic Competition and Oligopoly)

Cartel

A group of firms that collude to produce the monopoly output and sell at the monopoly price

Kinked Demand Curve

A perceived demand curve that arises when competing oligopoly firms commit to match price cuts, but not price increases

If the oligopoly decides to produce more and cut its price,

the other members of the cartel will immediately match any price cuts—and therefore, a lower price brings very little increase in quantity sold.

Figure 1 offers a reminder that the demand curve as faced by a perfectly competitive firm is

perfectly elastic or flat, because the perfectly competitive firm can sell any quantity it wishes at the prevailing market price.

A firm can try to make its products different from those of its competitors in several ways:

physical characteristics of the product, location from which the product is sold, intangible aspects of the product, and perceptions of the product.

While oligopoly is defined as an industry consisting of, or dominated by a small number of firms,

the key characteristic is interdependence among firms.

In contrast, the demand curve, as faced by a monopolist, is

the market demand curve, since a monopolist is the only firm in the market, and hence is downward sloping.

Note also that if the firm was making a loss,

the negative profit (i.e. loss) would be the rectangle on top of total revenue.

However, if the airline seeks to raise prices,

the other oligopolists will not raise their prices, and so the firm that raised prices will lose a considerable share of sales.

Moreover, they argue that consumers benefit substantially

when firms seek short-term profits by providing differentiated products.

However, each firm in an oligopoly has an incentive to produce more and grab a bigger share of the overall market;

when firms start behaving in this way, the market outcome in terms of prices and quantity can be similar to that of a highly competitive market.

Monopolistic competition is ________ and a good example would be ________.

when many firms compete with distinctive products; toothpaste (Monopolistic competition is what economists call industries that consist of many firms competing against each other, but selling products that are distinctive in some way. When products are distinctive such as various forms of toothpastes with a large breadth and depth, each firm has a mini-monopoly on its particular style or flavor or brand name.)

A Nash equilibrium occurs

when no player has an incentive to change their decision, taking into account what the players have decided and assuming the other players don't change their decisions.

Oligopolies can be characterized by collusion,

where firms act jointly like a monopolist to share industry profits,

Oligopolies can be characterized by competition,

where firms compete aggressively for individual profits, or something in between.

We start by identifying the profit-maximizing level of output,

where marginal revenue equals marginal cost.

Game Theory

A branch of mathematics that economists use to analyze situations in which players must make decisions and then receive payoffs based on what decisions the other players make

Prisoner's Dilemma

A game in which the gains from cooperation are larger than the rewards from pursuing self-interest

advertising causes demand for the firm's product to increase

(that is, it causes the firm's perceived demand curve to shift to the right).

advertising causes a firm's perceived demand curve to become more inelastic

(that is, it causes the perceived demand curve to become steeper);

For example, many people could not tell the difference in taste between common varieties of beer or cigarettes if they were blindfolded but, because of past habits and advertising, they have strong preferences for certain brands.

Advertising can play a role in shaping these intangible preferences.

________ is displayed with perfect competition because the social benefits of additional production (measured by the price that people are willing to pay) are in balance with the ________ to society of that production.

Allocative efficiency; marginal costs (When Price is equal to marginal cost, the value of the product to society represented by the price matches the economic cost of the product which shows that the proper amount of resources is allocated to this product to satisfy society's wants. This defines allocative efficiency.)

Duopoly:

An oligopoly with only two firms

The final columns of Table 1 show total cost, marginal cost, and average cost.

As always, marginal cost is calculated by dividing the change in total cost by the change in quantity, while average cost is calculated by dividing total cost by quantity.

Which of the following is NOT a correct step in computing profits or losses for a monopolistically competitive firm?

Calculate the area where MR>MC. (Calculating the area where marginal revenue is greater than marginal cost does NOT help compute profits for a monopolistically competitive firms. Instead, identify the marginal principle where MR=MC, then use a chart or graph to identify the profit-maximizing level of output where MR=MC, then look for the profit margin (the difference between price and average cost) and multiply it by the quantity.

In the context of a monopolistic competitive market, which of these actions would lead to creating the best product differentiation?

Creating a unique concept for a good or service. (The goal is to differentiate products.)

Why does cut-throat competition happen between oligopolistic firms?

Each firm is tempted to increase production to raise their revenue and profit which leads to lower prices and profits for all firms. (Competition hardly leads to higher profit; Firms always have the incentive to produce more and raise revenue but if they all behave the same way, it will lead to cut throat competition as prices fall as well as profit.)

Which of the following is the most accurate statement about collusion by oligopolies?

Each oligopolies' revenue, cost, and demand curves can influence the others. (It complicates matters within oligopolistic industries that one firm's demand and marginal revenue curves can be influenced by what the other oligopolistic firms are doing.)

Why did fast food restaurants start offering salads?

Fast food restaurants added salads to their menus to differentiate their product by appealing to health conscious diners.

What does the demand curve look like for a perfectly competitive firm?

Flat and perfectly elastic (The demand curve for a perfectly competitive firm is horizontal and perfectly elastic because each firm is a price taker.)

Since there is not a generally-accepted theory of how oligopolies behave (in the same way that we have theories for all the other market structures), game theory is often used by economist because it models different situations. Which is a truer statement regarding the use of game theory due to the complexity of oligopolies?

Game theory is the study of conflict and cooperation within a competitive environment. (It is a branch of mathematics that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do. It is used extensively in the study of oligopolies as a result of mutual interdependence among firms and has found widespread applications in the social sciences, as well as in business, law, and military strategy.)

Which of the following is most accurate regarding monopolistic competition?

Has no perfect substitutes, incur large expenditures on advertising of its product, and relies heavily on product variation to drive sales (Because there are no perfect substitutes for monopolistically competitive products, efforts must be made for firms to distinguish between variations in similar products, at least in the minds of buyers. The concept of differentiated products is closely related to the degree of variety that is available to consumers. Variety can include different of styles, flavors, locations, and characteristics to creates products differentiation and monopolistic competition.)

Which of the following reasons is the biggest incentive to create an oligopoly?

In order to earn higher profits. (An oligopoly has more market power than a competitive firm and greater chances to earn an economic profit.)

What benefits would businesses gain if they worked with each other like they were a monopoly?

Industry output could be depressed by the firms. (It is likely that firms would produce less if they are able to collude and behave as a monopoly in the market. Monopolies tend to produce less to charge a higher price.)

A perfectly competitive firm has a perfectly elastic demand curve while a monopolistically competitive firm has a downward sloping demand curve because ________.

It can sell any quantity it wishes at the prevailing market price (This is true because perfect information exists for a perfectly competitive firm but not for a monopolistically competitive firm that can convince consumers that products are different or have more appealing features.)

Which of the following statements accurately describes a monopolistically competitive firm?

It competes against a large number of firms selling slightly different products. (Monopolistically competitive markets are characterized by a large number of firms.)

What does the demand curve look like for a monopoly?

It is downward-sloping. (A monopoly has a downward sloping demand curve because it is a price maker.)

When analyzing a monopolistically competitive business, how would you say it is inefficient?

Its production is not at the minimum of its average cost curve. (Average cost are not being minimized and productive efficiency is not achieved.)

Why did McDonalds come up with the Big Mac sandwich?

McDonalds invented the Big Mac because its competitors offered similar enough regular burgers that McDonalds lost its monopoly profits. The Big Mac restored those profits, at least until Burger King came up with the Whopper and other fast food restaurants developed their own special burgers.

The new profit-maximizing output is Q1, because the intersection of the MR1 and MC now occurs at point U.

Moving vertically up from that quantity on the new demand curve, the optimal price is at P1.

Why do economists use game theory to explain oligopolies?

Oligopolies are complex and varied and game theory allows economists to model different variations of competition and cooperation. (Correct. Oligopolies are complex and varied and game theory allows economists to model different scenarios.)

Cut-throat Competition

Oligopolistic outcome when firms decide to cut prices to capture market share; in the limit, this leads to zero economic profits

What does it mean in a monopolistically competitive market, when the rule for maximizing profit is to set MR = MC?

Price is higher than marginal revenue. (For a monopolistically competitive firm, price is not equal to marginal cost.)

What happens if either formally or informally, oligopoly firms work together and hold to their agreements?

Profits can be maximized by decreasing output and increasing the price of goods and services. (Decreasing output would lead to higher prices and profit.)

Many purchases that individuals make at the retail level are produced in markets that are neither perfectly competitive, monopolies, nor monopolistically competitive.

Rather, they are oligopolies.

Nash Equilibrium

Solution to a game-theoretic scenario when no player has an incentive to change their decision, taking into account what the players have decided and assuming the other players don't change their decisions.

Why do gas stations charge different prices for a gallon of gasoline?

Some gasoline companies use different additives to make their products at least appear different. This allows them to charge higher prices than companies that don't make as good a case for their product. Location also matters. A gas station just off the highway can charge higher prices than stations further away, because travelers perceive and are willing to pay for the convenience of the former.

What determines how far apart the prices of Colgate and Crest toothpaste can be?

The answer is brand name loyalty. To the extent that Colgate users believe Colgate is superior to Crest, they will be willing to pay more for Colgate than for Crest. By contrast, if the two products are perceived to be close substitutes, the prices should be similar.

After determining its profit-maximizing quantity of output, how does a monopolistic competitor choose its price?

The firm will look at the demand curve to find out what it could charge for that quantity of output. (The demand curve will provide the profit maximizing quantity and price combination.)

Take what you've learned from game theory and apply it to the framework of an oligopoly. Which of these strategies can work like a silent form of cooperation?

The firms always match other cartel firms' price cuts, but don't match price increases. (The dominant strategy for firms is to maintain or gain market share and so they will match price cuts and not match price increases,)

What are the typical results from a successful advertising campaign?

The perceived demand curve becomes more inelastic or it increases. (Advertising is designed to emphasize product differentiation and increase firms' market power and would cause the demand curve to be more inelastic. Advertising can also result in a greater demand for the advertised product.)

What is the effect of advertising when it comes to a business's product?

The product is more clearly differentiated. (Advertising is designed to emphasize product differentiation.)

As a firm's perceived demand curve shifts to the left, its marginal revenue curve will shift to the left, too.

The shift in marginal revenue will change the profit-maximizing quantity that the firm chooses to produce, since marginal revenue will then equal marginal cost at a lower quantity.

Which of the following do firms in an oligopoly tend to operate more like?

They can operate like competitors or monopolies. (In some cases, they do operate like monopolies, in others, more like competitors.)

Which of the following is not true about oligopolies?

They exist as a large number of firms that have all or most of the market share. (This is not true. An oligopoly arises when a small number of large firms have all or most of the sales in an industry.)

What characterizes oligopolistic markets?

They have a small number of sellers. (A market where a small number of large firms to dominate most or all of the sales would be known as an oligopoly market.)

If you recall, price takers are firms that have no market power.

They simply have to take the market price as given.

The game theory (Prisoners Dilemma)

Two co-conspiratorial criminals are arrested. When they are taken to the police station, they refuse to say anything and are put in separate interrogation rooms. Eventually, a police officer enters the room where Prisoner A is being held and says: "You know what? Your partner in the other room is confessing. So your partner is going to get a light prison sentence of just one year, and because you're remaining silent, the judge is going to stick you with eight years in prison. Why don't you get smart? If you confess, too, we'll cut your jail time down to five years, and your partner will get five years, also." Over in the next room, another police officer is giving exactly the same speech to Prisoner B. What the police officers do not say is that if both prisoners remain silent, the evidence against them is not especially strong, and the prisoners will end up with only two years in jail each.

Collusion

When firms act together to reduce output and keep prices high

Select the statement that is most accurate.

When marginal revenue is greater than marginal cost profit is not maximized. (When marginal revenue is greater than marginal cost, profit is not maximized, the firms should produce more output and will increase profit as long as marginal revenue is higher than marginal cost.)

Consider the following questions:

Why do gas stations charge different prices for a gallon of gasoline? What determines how far apart the prices of Colgate and Crest toothpaste can be? Why did fast food restaurants start offering salads? Why are fast food chicken sandwich prices different from burger prices? Why did McDonalds come up with the Big Mac sandwich?

Instead, many economists use game theory,

a branch of mathematics that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do.

Another way of interpreting this shift in demand is to notice that, for each quantity sold,

a lower price will be charged.

But the underlying economic meaning of these perceived demand curves is different, because

a monopolist faces the market demand curve and a monopolistic competitor does not.

Second, a monopolist is surrounded by barriers to entry and need not fear entry, but

a monopolistic competitor who earns profits must expect the entry of firms with similar, but differentiated, products.

differentiated product:

a product that its consumers perceive as distinctive in some way

Oligopoly arises when

a small number of large firms have all or most of the sales in an industry.

A monopolistically competitive firm perceives a demand for its goods that is

an intermediate case between monopoly and competition. Figure

A monopolistic competitor, like a monopolist, faces a downward-sloping demand curve,

and so it will choose some combination of price and quantity along its perceived demand curve.

If the firm is producing at a quantity where marginal costs exceed marginal revenue, then each marginal unit is costing more than the revenue it brings in,

and the firm will increase its profits by reducing the quantity of output until MR = MC.

As more firms enter the market, the quantity demanded at a given price for any particular firm will decline,

and the firm's perceived demand curve will shift to the left.

product differentiation:

any action that firms do to make consumers think their products are different from their competitors'

A small handful of oligopoly firms may end up competing so fiercely that they all find themselves earning zero economic profits—

as if they were perfect competitors.

The fourth column, marginal revenue, is calculated

as the change in total revenue divided by the change in quantity.

Unlike a monopoly, with its high barriers to entry, a monopolistically competitive firm with positive economic profits will

attract competition.

Examples of oligopoly abound and include the

auto industry, cable television, and commercial air travel.

Total cost is

average cost times quantity (This is the area of the rectangle that starts at the origin, goes up the vertical axis to an average cost of $14.50, goes over to the average cost curve, down to the quantity of 40 and back to the origin.)

Thus, when entry occurs in a monopolistically competitive industry, the perceived demand curve for each firm will shift to the left,

because a smaller quantity will be demanded at any given price.

If the firm is producing at a quantity of output where marginal revenue exceeds marginal cost, then the firm should keep expanding production,

because each marginal unit is adding to profit by bringing in more revenue than its cost. In this way, the firm will produce up to the quantity where MR = MC.

In such a setting, the market has room for only one firm,

because no smaller firm can operate at a low enough average cost to compete, and no larger firm could sell what it produced given the quantity demanded in the market.

Thus, if oligopolists always match price cuts by other firms in the cartel,

but do not match price increases, then none of the oligopolists will have a strong incentive to change prices, since the potential gains are minimal.

Monopolistic competitors can make an economic profit or loss in the short run,

but in the long run, entry and exit will drive these firms toward a zero economic profit outcome.

Monopolistically competitive markets feature a large number of competing firms,

but the products that they sell are not identical.

If a monopolist raises its price, some consumers will choose not to purchase its product—

but they will then need to buy a completely different product.

The long-term result of entry and exit in a perfectly competitive market is that all firms end up selling at the price level determined

by the lowest point on the average cost curve.

In 2007, five or six major pharmaceutical companies formed a group in order to control the price of vitamins and adjust their production. Such an arrangement is called a ________.

cartel (A dominant strategy would not require control of price and production by the firms in the market.)

In the framework of monopolistic competition, the way advertising works can be perceived as

causing a firm's perceived demand curve to become more inelastic. (Advertising is designed to emphasize product differentiation and increase a firm's market power which would be a move away from the perfect competition model.)

If the firms decide to collude, they

choose to produce the monopoly output, Qc, and charge a corresponding price, Pc, which can be read off the market demand curve.

Cut-throat competition happens when oligopolistic firms ________.

compete hard and end up acting very much like perfect competitors, driving down costs and leading to zero profits in the long run (This oligopolistic outcome is when firms decide to cut prices to capture market share; in the limit, this leads to zero economic profits.)

Analyzing the choices of oligopolistic firms about pricing and quantity produced involves

considering the pros and cons of competition versus collusion at a given point in time.

Monopolistic competition is what economists call industries that

consist of many firms competing against each other, but selling products that are distinctive in some way.

The location of a firm can also create a

difference between producers.

Intangible aspects can

differentiate a product, too.

Oligopolistic markets are those

dominated by a small number of firms.

In a monopolistically competitive industry, when a business faces a ________ demand curve, it will choose a combination of quantity and ________ to maximize its profit.

downward-sloping; price (If the demand curve is downward sloping, the firm has some control over the price and can choose the quantity it will produce as well as the price.)

A monopolistically competitive firm and a monopoly both have a ________ demand curve and can therefore charge ________.

downwardly sloping demand curves; a price that is greater than the marginal cost (Since there are substitutes, the demand curve facing a monopolistically competitive firm is more elastic than that of a monopoly where there are no close substitutes. However, a monopolist faces the market demand curve and a monopolistic competitor does not, The marginal revenue always less than the prices of the good because they both must lower the price in order to sell additional ones.)

If oligopolists compete hard, they may end up acting very much like perfect competitors,

driving down costs and leading to zero profits for all.

When products are distinctive,

each firm has a mini-monopoly on its particular style or flavor or brand name.

Monopolistically competitive industries are those that contain more than a few firms,

each of which offers a similar but not identical product.

When price is equal to average cost,

economic profits are zero.

In the framework of monopolistic competition, there are two ways to conceive of how advertising works:

either advertising causes a firm's perceived demand curve to become more inelastic (that is, it causes the perceived demand curve to become steeper); or advertising causes demand for the firm's product to increase (that is, it causes the firm's perceived demand curve to shift to the right).

The task of public policy with regard to competition is to sort through these multiple realities, attempting to

encourage behavior that is beneficial to the broader society and to discourage behavior that only adds to the profits of a few large companies, with no corresponding benefit to consumers.

A zero economic profit means the firm's accounting profit is

equal to what its resources could earn in their next best use

When P > MC, which is the outcome in a monopolistically competitive market, the benefits to society of providing additional quantity, as measured by the price that people are willing to pay,

exceed the marginal costs to society of producing those units.

imperfectly competitive:

firms and organizations that fall between the extremes of monopoly and perfect competition

Most of the firms that get talked about as "monopolies" today or that regulatory authorities pursue antitrust activities against are actually oligopolies,

firms that have only a limited number of competitors.

Firms exit up to the point where there are no more losses in this market,

for example when the demand curve touches the average cost curve,

Cartels are

formal agreements to collude.

Thus, all players have made an optimal decision,

given the decisions of the other players.

This outcome is why perfect competition displays productive efficiency:

goods are being produced at the lowest possible average cost.

We characterize oligopolies by

high barriers to entry with firms choosing output, pricing, and other decisions strategically based on the decisions of the other firms in the market.

Oligopolies are characterized by

high barriers to entry with firms strategically choosing output, pricing, and other decisions based on the decisions of the other firms in the market.

By acting together, oligopolistic firms can

hold down industry output, charge a higher price, and divide the profit among themselves.

The reason that the firm faces a kink in its demand curve is because of

how the other oligopolists react to changes in the firm's price.

Which is the correct calculation for total cost?

implicit cost + explicit cost (Total cost would be equal to fixed cost + variable cost or average cost x quantity.)

Oligopolies are inefficient for the same reasons that monopolies are—

in order to reap economic profits, they produce too little output so they create deadweight losses to society.

Within a monopolistically competitive industry, it would be expected that

in the short-run, an innovative firm's price can be greater than their average cost. (In the short run, a firm can earn economic profit when price is greater than average cost.)

One example of the pressure these firms can exert on one another is the kinked demand curve,

in which competing oligopoly firms commit to match price cuts, but not price increases.

This strategy can work like a silent form of cooperation,

in which the cartel successfully manages to hold down output, increase price, and share a monopoly level of profits even without any legally enforceable agreement.

A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the monopoly price

is called a cartel.

The other type of imperfectly competitive market

is oligopoly.

A monopolistically competitive firm is considered inefficient in the short and long run because ________.

it has deadweight loss. (A monopolistically competitive firm does not produce more, which means that society loses the net benefit of those extra units and therefore deadweight loss. This is the same argument we made about monopoly, but in this case to a lesser degree. Thus, a monopolistically competitive industry will produce a lower quantity of a good and charge a higher price for it than would a perfectly competitive industry.)

When firms act together in this way to reduce output and keep prices high,

it is called collusion.

In many parts of the world, including the European Union and the United States,

it is illegal for firms to divide up markets and set prices collaboratively.

If a monopolistic competitor raises its price, it will not lose as many customers as would a perfectly competitive firm, but

it will lose more customers than would a monopoly that raised its prices.

Like firms in any market structure, if a monopolistically competitive firm wishes to maximize profits,

it will supply the quantity of output where marginal revenue equals marginal cost.

When another competitor enters the market, the original firm's perceived demand curve shifts to the

left, from D0 to D1, and the associated marginal revenue curve shifts from MR0 to MR1

Firms in an oligopoly often

make decisions based on the behavior or expected behavior of their competitors. (Firms in oligopoly markets are mutually interdependent and make decisions based on the behavior or expected behavior of their competitors.)

monopolistic competition:

many firms competing to sell similar but differentiated products

For a monopolistically competitive firm, ________ is calculated by dividing the change in total cost by the change in quantity.

marginal cost (Marginal cost = Change in total cost / change in quantity)

Advertising spent on differentiated products for monopolistically competitive firms is considered controversial in ________.

market-oriented economies (Economists have struggled, with only partial success, to address the question of whether a market-oriented economy produces the optimal amount of variety. Critics of market-oriented economies argue that society does not really need dozens of different athletic shoe or breakfast cereals or automobiles. they argue that much of the costs of creating such a high degree of product differentiation, is societally wasteful. defenders of a market-oriented economy response that if people do not want to buy differentiated products or highly advertised brand names, no one is forcing them to do so, Moreover, they argue that consumers benefit substantially when firms seek short-term profits by providing differentiated products.)

By agreeing to work together, either formally or informally, oligopolies in a market can ________ profits by reducing output and charging a ________ price which is much like a monopoly.

maximize; higher (Economists have understood for a long time the desire of businesses to avoid competing so that they can instead raise the prices that they charge and earn higher profits. If oligopolists collude with each other, they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit. Oligopolies are typically characterized by mutual interdependence where various decision such as output, price, advertising, and so on, depend on the decision of the other firm(s). Analyzing the choices of oligopolistic firms about pricing and quantity produced involves considering the pros and cons of competition versus collusion at a given point in time.)

A clothing store has a wide selection of clothing for women. Within the clothing racks are shirts, pants, dresses, skirts, blouses, etc. Clothing manufacturers such as Guess, Donna Karan, Levi, Calvin Klein, etc. have build up their brand names through marketing and advertising to differentiate their clothes in the mind of the consumer. This group of clothing manufacturers competes to sell similar but not identical products, they are engaging in ________.

monopolistic competition (Monopolistically competitive markets are characterized by a large number of firms with differentiated products.)

A monopolistically competitive firm will profit maximize using the marginal principle much like a(n) ________.

monopoly (The monopolistically competitive firm decides on its profit-maximizing quantity and price in much the same was as a monopolist. To maximize profits, it will choose a quantity and price based on the marginal principle where MR=MC.)

Since there are substitutes, the demand curve facing a monopolistically competitive firm is

more elastic than that of a monopoly where there are no close substitutes.

The combinations of price and quantity at each point on the demand curve can be

multiplied to calculate the total revenue that the firm would receive, which is shown in the third column of Table 1.

In comparison with perfect competition that spawns allocative and productive efficiencies, monopolistic competition creates ________.

neither productive efficiency nor allocative efficiency. (Monopolistic competition does not minimize average cost and price is greater than marginal cost and therefore achieves neither productive efficiency nor allocative efficiency.)

As long as the firm is earning positive economic profits,

new competitors will continue to enter the market, reducing the original firm's demand and marginal revenue curves.

However, in monopolistic competition, the end result of entry and exit is that firms end up with a price that lies on the downward-sloping portion of the average cost curve,

not at the very bottom of the AC curve. (Thus, monopolistic competition will not be productively efficient.)

Many people would prefer to live in an economy with many kinds of clothes, foods, and car styles;

not in a world of perfect competition where everyone will always wear blue jeans and white shirts, eat only spaghetti with plain red sauce, and drive an identical model of car.

Critics of market-oriented economies argue that society does

not really need dozens of different athletic shoes or breakfast cereals or automobiles.

However, when a monopolistic competitor raises its price, some consumers will choose

not to purchase the product at all, but others will choose to buy a similar product from another firm.

In principle, one can calculate and graph an

oligopoly's cost and revenue curves, and determine its profit maximizing level of output and price in the same way as we did with monopoly.

A combination of the barriers to entry that create monopolies and the product differentiation that characterizes monopolistic competition can create the setting for an

oligopoly.

In monopolistic competition, the result of entry and exit in the long run is that firms end up with a price that lies

on the downward-sloping portion of the average cost curve. (In the long run, economic profit is zero for monopolistic competition and the price is equal to the average cost. The point where price is equal to average cost happens to be on the downward-sloping portion of the average cost curve.)

If one monopolistic competitor earns positive economic profits,

other firms will be tempted to enter the market.

Assuming economies of scale exist, within a monopolistically competitive industry in the long-run, it would be expected that

price is greater than marginal cost. (Price is greater than marginal cost in the long run in monopolistically competitive industries because at profit maximizing output, marginal cost is equal to marginal revenue but price is greater than marginal revenue, therefore price will be greater than marginal cost.)

In a perfectly competitive market, each firm produces at a quantity where

price is set equal to marginal cost, both in the short run and in the long run.

A perfectly competitive market has many firms selling identical products, who all act as

price takers in the face of the competition.

Total revenue is

price times quantity (This is the area of the rectangle that starts at the origin, goes up to a price of $16, goes over to the demand curve, down to the quantity of 40 and back to the origin.)

Many real-world oligopolies,

prodded by economic changes, legal and political pressures, and the egos of their top executives, go through episodes of cooperation and competition.

Unlike in the simple example in Figure 1, oligopolists also do not typically

produce at the minimum of their average cost curves, so they are not productively efficient.

What does a monopolistically competitive industry fail to display in either the short-run making profits/losses or in the long-run when earning zero economic profit?

productive efficiency and allocative efficiency (Average cost is not minimized so productive efficiency is not achieved. Price is greater than marginal cost and so allocative efficiency is not achieved either.)

Some intangible aspects may be

promises like a guarantee of satisfaction or money back, a reputation for high quality, services like free delivery, or offering a loan to purchase the product.

If oligopolists collude with each other, they may effectively act like a monopoly and succeed in

pushing up prices and earning consistently high levels of profit.

However, the zero economic profit outcome in monopolistic competition looks different from the zero economic profit outcome in perfect competition in several ways

relating both to efficiency and to variety in the market.

Both the Antitrust Division of the Justice Department and the Federal Trade Commission have

responsibilities for preventing collusion in the United States.

In either case, a successful advertising campaign may allow a firm to

sell either a greater quantity or to charge a higher price, or both, and thus increase its profits.

Consequently, the marginal revenue will be lower for each quantity sold—and the marginal revenue curve will

shift to the left as well.

Conversely, exit causes the perceived demand curve for a monopolistically competitive firm to

shift to the right and the corresponding marginal revenue curve to shift right, too.

The entry of other firms into the same general market (like gas, restaurants, or detergent)

shifts the demand curve faced by a monopolistically competitive firm.

A monopolistically competitive industry does not display productive and allocative efficiency in either the

short run, when firms are making economic profits and losses, nor in the long run, when firms are earning zero profits.

Firms may earn profits in the ________ run while in the ________ run equilibrium profits will equal zero.

short; long (The entry of other firms into the same general market shifts the demand curve faced by a monopolistically competitive firm. As more firms enter the market, the quantity demanded at a given price for any particular firm will decline, and the firm's perceived demand curve will shift to the left. AS a firm's perceived demand curve shifts to the left, its marginal revenue curve will shift to the left, too. This shift in marginal revenue will change the profit-maximizing quantity that the firm choose to produce, since marginal revenue will then equal marginal cost at a lower quantity)

The more like a monopoly a given oligopoly is,

the higher their profits and the greater the deadweight loss.

Oligopolistic markets are those which a

small number of firms dominate.

Foreign cartels with a ________ number of firms have a higher chance of monopolistic power than those with a ________ number of firms.

small; large (Economists have understood for a long time the desire of businesses to avoid competing so that they can instead raise the prices that they charge and earn higher profits. Cartels are illegal in the U.S. under antitrust laws so exists primarily in Europe. These foreign cartels have a greater probability of reaching monopoly power where there are fewer it is easier to act in unison, decision can be made quicker, and less self-interest to consider.)

They typically operate at a level of output where price is greater than marginal cost,

so oligopolistic industries are not allocatively efficient.

Alternatively, oligopolists may choose to act in a way that generates pressure on each firm to

stick to its agreed quantity of output.

Examples include

stores that sell different styles of clothing; restaurants or grocery stores that sell different kinds of food; and even products like golf balls or beer that may be at least somewhat similar but differ in public perception because of advertising and brand names.

Many people would prefer to live in an economy where firms are

struggling to figure out ways of attracting customers by methods like friendlier service, free delivery, guarantees of quality, variations on existing products, and a better shopping experience.

Thus, a monopolistically competitive industry will produce a lower quantity of a good and charge a higher price for it

than would a perfectly competitive industry.

They argue that much of the cost of creating such a high degree of product differentiation, and then of advertising and marketing this differentiation, is socially wasteful—

that is, most people would be just as happy with a smaller range of differentiated products produced and sold at a lower price.

Advertising is all about explaining to people, or making people believe,

that the products of one firm are differentiated from the products of another firm.

The break-even point occurs where

the demand curve intersects with average cost, so P = AC.

In a monopolistically competitive market, the rule for maximizing profit is to set MR = MC—and price is higher than marginal revenue, not equal to it because

the demand curve is downward sloping.

Similarly, a natural monopoly will arise when

the demand in a market is only large enough for a single firm to operate at the minimum of the long-run average cost curve.

Next, look for the profit margin,

the difference between price and average cost.

Profit is

the difference between the two areas, (This is shown graphically as the area of the rectangle on top of total cost, or the price minus average cost, times quantity.)

Considering Figure 1 above, if the average cost curve is above the demand curve then that means ________.

the firm has no profit (To show economic loss or no profit, the average total cost (ATC) curve will be above the demand curve at the price point and the per unit loss will be ATC minus the price.)

If the firm is producing at a quantity of output where marginal cost exceeds marginal revenue, then ________.

the firm should reduce production (If marginal revenue is less than marginal cost, each additional unit will add more cost than revenue and will reduce profit. Because at lower output levels, marginal revenue tends to be higher than marginal cost, reducing production can help the firm reach output levels where marginal cost is no longer greater than marginal revenue.)

Because oligopolists cannot sign a legally enforceable contract to act like a monopoly,

the firms may instead keep close tabs on what other firms are producing and charging.

The prisoner's dilemma is a scenario in which

the gains from cooperation are larger than the rewards from pursuing self-interest. It applies well to oligopoly.

Thus, although a monopolistically competitive firm may earn positive economic profits in the short term,

the process of new entry will drive down economic profits to zero in the long run.

Total profit is

the profit margin times the quantity

Note that if the firm was earning zero economic profits,

the rectangles of total revenue and total cost would be the same—there would be no profit rectangle

This outcome is why perfect competition displays allocative efficiency:

the social benefits of additional production, as measured by the marginal benefit, which is the same as the price, equal the marginal costs to society of that production

Confess is considered the dominant strategy or

the strategy an individual (or firm) will pursue regardless of the other individual's (or firm's) decision.

The result of this prisoner's dilemma is often that even though A and B could make the highest combined profits by cooperating in producing a lower level of output and acting like a monopolist,

the two firms may well end up in a situation where they each increase output and earn only $400 each in profits.

If each of the oligopolists cooperates in holding down output,

then high monopoly profits are possible.

If at least some oligopolists give in to this temptation and start producing more,

then the market price will fall.

For example, firms may need to reach a certain minimum size before

they are able to spend enough on advertising and marketing to create a recognizable brand name.

Because cartel agreements provide evidence of collusion,

they are rare in the United States.

When they lack vibrant competition,

they may lack incentives to provide innovative products and high-quality service.

When oligopolies result from patented innovations or from taking advantage of economies of scale to produce at low average cost,

they may provide considerable benefit to consumers.

Oligopolists are allocatively and productively inefficient in the markets because ________.

they typically operate at a level of output where price is greater than marginal cost and do not produce at the minimum point on their average cost curves (Oligopoly is probably the second most common market structure (monopolistic competition being the first). Oligopolies are often protected by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. They typically operate at a level of output where price is greater than marginal cost, so oligopolistic industries are not allocatively efficient. Further, oligopolists also do not typically produce at the minimum of their average cost curves, so they are not productively efficient. When they lack vibrant competition, they may lack incentives to provide innovative products and high-quality service.)

Since they produce together where MR = MC,

they will maximize industry profits, just like an actual monopoly would.

Again, smaller firms would have higher average costs and be unable to compete, while additional large firms would produce such a high quantity that

they would not be able to sell it at a profitable price.

When the government grants patents to, for example, three different pharmaceutical companies that each has its own drug for reducing high blood pressure,

those three firms may become an oligopoly

We will then discuss oligopolistic firms, which face two conflicting temptations:

to collaborate as if they were a single monopoly, or to individually compete to gain profits by expanding output levels and cutting prices.

Alternatively, we can compute profit as

total revenue minus total cost.

Physical characteristics of a product include all the phrases you hear in advertisements:

unbreakable bottle, nonstick surface, freezer-to-microwave, non-shrink, extra spicy, newly redesigned for your comfort.

Like perfectly competitive firms, competition prevents monopolistically competitive firms from earning positive economic profits in the long run,

unless those firms create innovative new products and/or use advertising to convince customers they have done so.

Product differentiation is based on

variety and innovation.

Oligopolies are typically characterized by mutual interdependence where

various decisions such as output, price, advertising, and so on, depend on the decisions of the other firm(s).

What complicates matters with oligopolistic industries is that any one firm's demand and marginal revenue curves are influenced by

what the other oligopolistic firms are doing.

In order for a monopolistic competitor to produce at the level of output which maximizes profits, it will select an output level

where marginal revenue equals marginal cost. (Profit is maximized at the output where marginal revenue equals marginal cost.)

Monopolistically competitive industries consist of a significant number of firms,

which each produce a differentiated (or heterogeneous) production.

Oligopolies are often protected by significant barriers to entry,

which enable the oligopolists to earn sustained profits over long periods of time.

In the United States, as well as many other countries, it is illegal for firms to collude since collusion is anti-competitive behavior,

which is a violation of antitrust law.

Because of the complexity of oligopoly,

which is the result of mutual interdependence among firms, there is no single, generally-accepted theory of how oligopolies behave, in the same way that we have theories for all the other market structures.

A monopolistically competitive firm does not produce more,

which means that society loses the net benefit of those extra units.

The demand may also only be limited to two or three times the quantity needed to produce at the minimum of the average cost curve—

which means that the market would have room for only two or three oligopoly firms (and they need not produce differentiated products).

The demand curve as faced by a monopolistic competitor is not flat, but rather downward-sloping,

which means that the monopolistic competitor can raise its price without losing all of its customers or lower the price and gain more customers.

In the long run, however, firms will enter the industry and cause the demand curve to shift to the left,

which results in no economic profit.

The combination of price P0 and quantity Q0 lies above the average cost curve,

which shows that the firm is earning positive economic profits.

Monopoly arises when a single firm sells a product for

which there are no close substitutes.

The economic losses lead to firms exiting,

which will result in increased demand for this particular firm, and consequently lower losses.

Even when oligopolists recognize that they would benefit as a group by acting like a monopoly, each individual oligopoly faces a private temptation to produce just a slightly higher quantity and earn slightly higher profit—

while still counting on the other oligopolists to hold down their production and keep prices high.

First, although both a monopolist and a monopolistic competitor face downward-sloping demand curves, the monopolist's perceived demand curve is the market demand curve,

while the perceived demand curve for a monopolistic competitor is based on the extent of its product differentiation and how many competitors it faces.

In the short run, the graph looks like just like the graph for a monopoly,

with the firm making an economic profit.

Each oligopolist, however, must

worry that while it is holding down output, other firms are taking advantage of the high price by raising output and earning higher profits.

Perhaps the easiest approach for colluding oligopolists, as you might imagine,

would be to sign a contract with each other that they will hold output low and keep prices high.

At a glance, the demand curves faced by a monopoly and by a monopolistic competitor look similar

—that is, they both slope down.