Reading 20 - Monopolistic Competition and Oligolpoly

Friday, August 29, 2008

4:42 PM
Monopolistic Competition
o Large # of competing firms
o Differentiated products
• This causes inefficiency sinec its costly. If the benefit from having product
variety > apparent deadweight loss due to price markup then
monopolistic competition is efficient
o Competition is based on quantity, price and marketing
• Advertising can increase total fixed cost but may lower ATC if quantity
sold increases enough.
• Advertising can also increase demand but could also decrease it by
increasing competition
o Freedom to enter and exit the market
• This results in LR economic profit of 0
 Demand curve shifts down to point where Price = ATC
• Excess capacity also
o Firms can achieve a monopoly like profit in the SR by setting Price > MR = MC

Firms in monopolistic competition face downward sloping demand curves and

produce where MR = MC

Overall this type tends to

• Raise prices
• Lower output
• Increase consumer choices

Oligopoly
o Small # of firms compete
• Natural or legal barriers(required licenses)
• Economies of scale could also be so big that output of only a few large
firms is needed to satisfy total market demand.
o Actions taken by any one firm can impact the profitability of its competitors
o Follow general principle that profit is maximized by producing up to the point
where MC = MR
o Independent action by the same firms increase competition, thus reducing
prices and increasing output
o Firms are sometimes tempted to form a cartel and achieve monopolistic profits
• Some firms within a cartel try to cheat and obtain windfall profits
o Can also price discriminate

2 Oligopoly Models
i. Kinked Demand Curve("Sticky Prices")
 If rivals match price cuts but not price hikes
 Change prices only when large cost changes occur.

ii. Dominant Firm

 1. One firm is viewed as price searcher and acts like monopolist
2. Other firms follow its pricing strategy and are price takers(like PC)

Game Theory
• Used to understand the strategic decision making process where firms
need to account for the behavior of their rivals.

Prisoner's Dilemma
• Two firms acting in their own interest harm their joint interest.

Nash Equilibrium
• Both firms cheat and output and price are the same as in PC

Quiz Notes
• If many firms face downward sloping demand curve it's monopolistic
competition and profits are maximized where MR=MC
• Demand curves for oligopolies lie above MR curve