Monopolistic Competition and Oligopoly © 2003 South-Western/Thomson Learning

The Concept of Imperfect Competition Imperfect competition: market structures between perfect competition and monopoly more than one seller, but too few to create a perfectly competitive market often violate other conditions of perfect competition, such as the requirement of a standardized product or free entry and exit

Monopolistic Competition Monopolistic Competition in the Short Run Monopolistic Competition in the Long Run Excess Capacity Under Monopolistic Competition Nonprice Competition

Monopolistic Competition A monopolistically competitive market has three fundamental characteristics: 1. Many buyers and sellers 2. No significant barriers to entry/exit 3. Differentiated products

Monopolistic Competition Because it produces a differentiated product, a monopolistic competitor faces a downward-sloping demand curve when it raises its price a modest amount, quantity demanded will decline but not all the way to zero

Monopolistic Competition in the Short Run Under monopolistic competition, firms can earn positive or negative economic profit in the short run.

Monopolistic Competition in the Short Run MR 1 $70 30 Dollars 250 Homes Serviced per Month d A MC ATC

Monopolistic Competition in the Long Run But in the long run, free entry and exit will ensure that each firm earns zero economic profit, just as under perfect competition.

Monopolistic Competition in the Long Run In long run, a monopolistic competitor will operate with excess capacity - that is, it will produce too little output to achieve minimum cost per unit.

Monopolistic Competition in the Long Run Dollars d MC ATC d 2 MR 2 E $40 100 200 Homes Serviced per Month a a a

Excess Capacity Under Monopolistic Competition In the long run, a monopolistic competitor will operate with excess capacity; it will produce too little output to achieve minimum cost per unit.

Non-price Competition Any action a firm takes to increase the demand for its product, other than cutting its price.

Oligopoly Oligopoly in the Real World Why Oligopolies Exist Oligopoly Behavior Cooperative Behavior in Oligopoly The Limits of Oligopoly

Oligopoly Oligopoly A market structure in which a small number of firms are strategically interdependent.

Why Oligopolies Exist Economies of scale: natural oligopolies Reputation as a barrier Strategic barriers Government-created barriers

Minimum Efficient Scale (MES) Why Oligopolies Exist Minimum Efficient Scale (MES) The level of output at which economies of scale are exhausted and minimum LRATC is achieved.

Why Oligopolies Exist

Oligopoly Behavior Game Theory An approach to modeling the strategic interaction of oligopolists in terms of moves and countermoves

Oligopoly Behavior Payoff Matrix A table showing the payoffs to each of two players for each pair of strategies they choose

Oligopoly Behavior Confess Don’t Confess Don’t Rose’s Actions Colin gets 20 years 30 years 3 years 5 years Rose Colin’s Actions

Oligopoly Behavior Dominant Strategy A strategy that is best for a firm no matter what strategy its competitor chooses

An oligopoly market with only two sellers Oligopoly Behavior Duopoly An oligopoly market with only two sellers

Oligopoly Behavior Low Price High Price Low Price High Filip’s Gus’s profit = $25,000 $75,000 Gus’s Actions –$10,000 $50,000

Oligopoly Behavior Repeated Play A situation in which strategically interdependent sellers compete over many time periods

Cooperative Behavior in Oligopoly Explicit Collusion Cooperation involving direct communication between competing firms about setting prices

Cooperative Behavior in Oligopoly Cartel A group of firms that selects a common price that maximizes total industry profits

Cooperative Behavior in Oligopoly Tacit Collusion Any form of oligopolistic cooperation that does not involve an explicit agreement

Cooperative Behavior in Oligopoly Price Leadership A form of tacit collusion in which one firm sets a price that other firms copy

Cooperative Behavior in Oligopoly Tit for Tat A game-theoretic strategy of doing to another player this period what he has done to you in the previous period

When Is Cheating Likely? Cheating will be likely, and collusion least successful, under the following conditions: Difficulty observing other firms’ prices Unstable market demand Large number of sellers