Chapter 11: Between Competition & Monopoly

Monopolistic Competition & Oligopolistic Competition

What is Monopolistic Competition?

A market with many competitors all producing slightly different products.

  • Many producers.
  • A variety of types of products, each one slightly different.
  • Freedom of entry & exit.
  • Lots of information about buyers & other sellers.

We assume that firms have a lot of knowledge about to how to produce its product effectively. This means that similar firms will face similar cost functions.

Short-Run Equilibrium in Monopolistic

Monopolistically Competitive Costs

It has incredibly similar cost curves to perfect competition. Only difference may be that it has a higher cost due to advertising.

In short run, average cost curve will be u-shaped for the same reasons as in perfect competition.

Monopolistic Competition Demand Curves

An individual firm’s demand curve is downward sloping in monopolistic competition. This is because there is enough product differentiation between firms to cause them to not lose all customers if they change prices.

Monopolistic Competition Profit Maximization

They maximize profits by producing a quantity where Marginal Revenue = Marginal Cost. However, price will be determined by the highest price they can charge on the demand curve.

Summary of Final Outcome of a Monopolistic Firm in Short Run

​Average cost will not be at a minimum. Marginal cost will be less than price. Economic profits can be earned (in the short run). Average costs at each level of output (with one exception) will be low as possible, as firms are forced through competition to use the best technology and least expensive inputs. The exception is that firms may advertise or devote resources to differentiate their products in other ways. This increases cost to a level above the perfectly competitive costs.

Long-Run Equilibrium in Monopolistic

Entry & Exist

In the long run, firms will enter if there are economic profits. As they do, demand goes down (for each individual firm), overall prices will fall & firms will reduce output. This will happen until economic profits are 0. Prices will be higher than marginal cost, and the firms will still not be producing at the lowest average cost (meaning they will be less than their capacity).

What Does Capacity of a Firm Refer To?

Capacity refers to the amount of quantity production that could be produced if the firm producing where average cost are a minimum.

What Will Happen to a Firm’s Demand Curve in the Long Run?

The demand curve will become tangent to the average cost curve.

Will Firms Be Allocatively Efficient in Monopolistic Markets?

As long as price is higher than marginal cost, they will not be allocatively efficient.

Oligopolies

What is an Oligopolistic Market?

An oligopolistic market is one where there are few firms & there is a significant barrier to entry (usually due to economies of scale, as new firms will not be able to compete with big firms). They can sell differentiated products or they could even sell identical products (ex: crude oil).

What Do Cost Curves Look Like in Oligopolistic Markets?

Exactly the same as other cost curves we’ve seen. The only difference is that they may experience significant economies of scale.

What Do Demand Curves Look Like in Oligopolistic Markets?

If the products are differentiated, the demand curve will be downward sloping. If the product is identical, the demand curve may even be perfectly elastic.

This means that oligopolies can set a price equal to or less than a monopoly price!

How Do Oligopolies Maximize (Industry) Profit?

By colluding with each other, oligopolies may be able to maximize the entire industry’s profits. This is known as forming a cartel (a group of producers agree to act together with one another). They will produce at the quantity where Marginal Cost = Marginal Revenue.

What Happens if a Firm Cheats a Cartel’s Agreement?

If one of the firms lowers its price, it will be sell a lot more due to new customers who are now willing to the pay the lower price offered. They will also take away customers away from others. This means that a firm’s single demand curve is more elastic than a whole market’s demand curve.

What’s a Payoff Matrix?

A payoff matrix is an m x m table with 2 players. Each player will have a set of actions that will result in different payoffs. Each player’s payoff is dependent on both players’ actions.

It’s difficult for both firms not to change prices since they both have incentives to lower price. Eventually, they will both cheat & the entire industry will lose profits as production increases.

What About Economic Profits in the Long-Run?

Just like monopolies, it is possible for an oligopolistic market to always experience economic profits since there are no entries or exits.


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