Between Competition and Monopoly

● Monopolistic Competition

● Oligopoly

● Monopolistic Competition, Oligopoly, and Public Welfare

● A Glance Backward: Comparing the Four Market Forms

● Monopolistic Competition

● Oligopoly

● Monopolistic Competition, Oligopoly, and Public Welfare

● A Glance Backward: Comparing the Four Market Forms

OutlineOutline

Three Real World PuzzlesThree Real World Puzzles

1. Why are there so many retailers? ● E.g., intersections with 4 gas stations which is more than #

of cars warrants. Why and how do they all stay open?

2. Why do oligopolists advertise more than competitive firms?

● E.g., many big Co. use ads to battle for customers and ad budgets account for a huge portion of TC. Vs. farmers where few if any farms spend $ on ads.

3. Why do oligopolists seem to ∆P so infrequently?● E.g., ∆P commodities hourly but ∆P cars or refrigerators

only a few times a year.

1. Why are there so many retailers? ● E.g., intersections with 4 gas stations which is more than #

of cars warrants. Why and how do they all stay open?

2. Why do oligopolists advertise more than competitive firms?

● E.g., many big Co. use ads to battle for customers and ad budgets account for a huge portion of TC. Vs. farmers where few if any farms spend $ on ads.

3. Why do oligopolists seem to ∆P so infrequently?● E.g., ∆P commodities hourly but ∆P cars or refrigerators

only a few times a year.

Characteristics of Monopolistic CompetitionCharacteristics of Monopolistic Competition

1. Many small buyers and sellers

2. Freedom of entry and exit

3. Perfect information

4. Heterogeneous products: each seller’s product differs somewhat from every other seller’s product.

♦ E.g., Diff. in packaging, services, or consumers’ perceptions.

♦ Only characteristic that differs from perfect competition.

1. Many small buyers and sellers

2. Freedom of entry and exit

3. Perfect information

4. Heterogeneous products: each seller’s product differs somewhat from every other seller’s product.

♦ E.g., Diff. in packaging, services, or consumers’ perceptions.

♦ Only characteristic that differs from perfect competition.

Monopolistic CompetitionMonopolistic Competition

● D curve facing firm has (-) slope. ♦ Each seller’s product is different –they are not perfect

substitutes.

♦ ↑P will drive away some but not all of firm’s customers. Or ↓P will attract some but not all customers from rival firms.

● Freedom of entry and exit → firms cannot earn econ Π in LR. ♦ SR Π > 0 → new firms enter and ↓P until P = AC.

● Most U.S. firms are in this market structure.

● D curve facing firm has (-) slope. ♦ Each seller’s product is different –they are not perfect

substitutes.

♦ ↑P will drive away some but not all of firm’s customers. Or ↓P will attract some but not all customers from rival firms.

● Freedom of entry and exit → firms cannot earn econ Π in LR. ♦ SR Π > 0 → new firms enter and ↓P until P = AC.

● Most U.S. firms are in this market structure.

Determination of Price and Output under Monopolistic CompetitionDetermination of Price and Output under Monopolistic Competition

● Recall when D has (-) slope → P > MR.● Profit-max Q is where MR = MC.● Analysis looks like pure monopoly, but monop. comp.

firm (with rivals producing close substitutes) has a much flatter D curve.

● LR: Π = 0 → each firm produces where P = AC. So firm’s D curve must be tangent to its AC curve.

● Zero econ. Π in LR is seen in real world. ♦ E.g., Gas station owners do not earn higher Π than small

farmers under perfect competition.

● Recall when D has (-) slope → P > MR.● Profit-max Q is where MR = MC.● Analysis looks like pure monopoly, but monop. comp.

firm (with rivals producing close substitutes) has a much flatter D curve.

● LR: Π = 0 → each firm produces where P = AC. So firm’s D curve must be tangent to its AC curve.

● Zero econ. Π in LR is seen in real world. ♦ E.g., Gas station owners do not earn higher Π than small

farmers under perfect competition.

FIGURE 1. Short-Run Equilibrium Under Monopolistic Competition

Gallons of Gasoline per Week

12,000

Π-max Q =12,000 and P = $3.50

Per unit Π = $0.10 → total Π = $1,200.

FIGURE 2. Long-Run Equilibrium Under Monopolistic Competition

15,000

Gallons of Gasoline per Week

10,000

SR profits in Fig. 1 → new firms enter which shifts each firm’s D curve down until P = AC.

Compared with SR profits in Fig. 1:

a. P is lower in LR

b. more firms in industry; each produces a smaller Q with higher AC.

The Excess Capacity TheoremThe Excess Capacity Theorem

● In Fig. 2, AC at LR Q of firm (pt P) > min AC (pt M).● Pt M is where LR Q of a perf. comp. firm would be.● In LR, monop. comp. firm is producing where ↓AC but

has not yet reached its min.● Monopolistic competition leads to firms that have

unused or wasted capacity.● Resolve puzzle 1 –abundance of retailers: intersection

with 4 gas stations where 2 would suffice and operate at lower AC is real world ex. of excess capacity.

● In Fig. 2, AC at LR Q of firm (pt P) > min AC (pt M).● Pt M is where LR Q of a perf. comp. firm would be.● In LR, monop. comp. firm is producing where ↓AC but

has not yet reached its min.● Monopolistic competition leads to firms that have

unused or wasted capacity.● Resolve puzzle 1 –abundance of retailers: intersection

with 4 gas stations where 2 would suffice and operate at lower AC is real world ex. of excess capacity.

The Excess Capacity TheoremThe Excess Capacity Theorem

● Fewer firms in a monop. comp. market → each firm could ↑Q and ↓AC.

● Yet, fewer firms with larger quantities means there is less variety of product.

● Greater efficiency would be achieved at the cost of greater standardization.

● Not clear society would be better off with fewer firms.

● Fewer firms in a monop. comp. market → each firm could ↑Q and ↓AC.

● Yet, fewer firms with larger quantities means there is less variety of product.

● Greater efficiency would be achieved at the cost of greater standardization.

● Not clear society would be better off with fewer firms.

Oligopoly DefinedOligopoly Defined

● Oligopoly = market dominated by a few sellers, where several are large enough to affect market P.

● Great rivalry among firms with new product intros, free samples, and agro marketing campaigns.

● Degree of product differentiation varies by industry: none in steel plates but lots in cars.

● Some industries also contain large # of smaller firms (e.g., soft drinks) but they are dominated by a few large firms that get bulk of industry sales.

● Oligopoly = market dominated by a few sellers, where several are large enough to affect market P.

● Great rivalry among firms with new product intros, free samples, and agro marketing campaigns.

● Degree of product differentiation varies by industry: none in steel plates but lots in cars.

● Some industries also contain large # of smaller firms (e.g., soft drinks) but they are dominated by a few large firms that get bulk of industry sales.

● Firms strive to create unique products (in terms of features, location, or appeal) to shield themselves from competition that ↓P and ↓sales.

● More intense competition than pure competition. ♦ E.g., A corn farmer doesn’t make tough P decisions. He

accepts market P and reacts by picking Q.

♦ A farmer doesn’t need to advertise. He can sell as much as he likes at current market P.

♦ A farmer doesn’t worry about P policies his rivals are planning.

● Firms strive to create unique products (in terms of features, location, or appeal) to shield themselves from competition that ↓P and ↓sales.

● More intense competition than pure competition. ♦ E.g., A corn farmer doesn’t make tough P decisions. He

accepts market P and reacts by picking Q.

♦ A farmer doesn’t need to advertise. He can sell as much as he likes at current market P.

♦ A farmer doesn’t worry about P policies his rivals are planning.

● Oligopolists have some influence over market P, so they must consider rivals’ P; spend a fortune on ads; and try to predict their rivals’ actions.

● Resolve puzzle 2 –why oligopolists advertise and perfectly competitive firms do not.

1. Comp. firms can sell as much as they want at current P, so why advertise? Vs. Toyota faces a (-) sloped D curve, so it must ↓P or ↑ads (try to shift D out) to sell more cars.

2. Products are identical, so farm A’s ads might ↑ sales of farm B. Vs. Toyota’s ads may ↑ its sales and ↓ sales of rival carmakers.

● Oligopolists have some influence over market P, so they must consider rivals’ P; spend a fortune on ads; and try to predict their rivals’ actions.

● Resolve puzzle 2 –why oligopolists advertise and perfectly competitive firms do not.

1. Comp. firms can sell as much as they want at current P, so why advertise? Vs. Toyota faces a (-) sloped D curve, so it must ↓P or ↑ads (try to shift D out) to sell more cars.

2. Products are identical, so farm A’s ads might ↑ sales of farm B. Vs. Toyota’s ads may ↑ its sales and ↓ sales of rival carmakers.

Why Oligopolistic Behavior is So Difficult to AnalyzeWhy Oligopolistic Behavior is So Difficult to Analyze

● Largest firms can impact P and all firms must watch rivals’ actions.

● Analysis is difficult as firms’ decisions are inter-dependent and oligopolists know that outcomes of their decisions depend on rivals’ responses.♦ E.g., Toyota’s managers know that their actions will cause

reactions by Honda which may require Toyota to adjust its plans.

● Oligopolies have a variety of behavior patterns which requires different models to understand their behavior.

● Largest firms can impact P and all firms must watch rivals’ actions.

● Analysis is difficult as firms’ decisions are inter-dependent and oligopolists know that outcomes of their decisions depend on rivals’ responses.♦ E.g., Toyota’s managers know that their actions will cause

reactions by Honda which may require Toyota to adjust its plans.

● Oligopolies have a variety of behavior patterns which requires different models to understand their behavior.

Models of OligopolyModels of Oligopoly

● Different models to understand Oligopoly behavior:♦ Ignore interdependence

♦ Strategic interaction

♦ Cartels

♦ Price leadership and tacit collusion

♦ Sales maximization

♦ Kinked demand curve

♦ Game theory

● Different models to understand Oligopoly behavior:♦ Ignore interdependence

♦ Strategic interaction

♦ Cartels

♦ Price leadership and tacit collusion

♦ Sales maximization

♦ Kinked demand curve

♦ Game theory

Ignoring Interdependence Ignoring Interdependence

● Simplest model● Firms behave as if their actions will not spark reactions

from rivals.● Each firm seeks to max profits and assumes its P-Q

decision will not affect its rivals’ strategy.● Analyze oligopoly in the same way as pure monopoly.● This doesn’t explain most oligopoly behavior!

● Simplest model● Firms behave as if their actions will not spark reactions

from rivals.● Each firm seeks to max profits and assumes its P-Q

decision will not affect its rivals’ strategy.● Analyze oligopoly in the same way as pure monopoly.● This doesn’t explain most oligopoly behavior!

Strategic InteractionStrategic Interaction

● Consider 2 soap makers: X and Y.● X ↓P to $4.05 and assumes Y will continue its P = $4.12● Say Qx = 5m and X spends $1m on ads.● X may be surprised when Y cuts P to $4.00; ↑Qy to 8m

and sponsors the Super Bowl.● This ↓Πx and X wishes it didn’t cut P in first place.● X cannot afford to ignore how Y will react.

● Consider 2 soap makers: X and Y.● X ↓P to $4.05 and assumes Y will continue its P = $4.12● Say Qx = 5m and X spends $1m on ads.● X may be surprised when Y cuts P to $4.00; ↑Qy to 8m

and sponsors the Super Bowl.● This ↓Πx and X wishes it didn’t cut P in first place.● X cannot afford to ignore how Y will react.

CartelsCartels

● All firms agree to set P and Q → act as pure monopolist.● OPEC began making joint decisions in 1970’s and has

been successful over time at ↓Q oil and ↑P oil.● Cartels are difficult to organize and hard to enforce.

♦ Each member must produce small Q assigned by group. But once high P is established, every firm is tempted to cheat by ↑Qs. When cheating is suspected, cartel quickly falls apart as others ↑Qs which ↓P.

● Considered worse than monopoly. Cartel charges monopoly P without the cost savings from large scale production.

● All firms agree to set P and Q → act as pure monopolist.● OPEC began making joint decisions in 1970’s and has

been successful over time at ↓Q oil and ↑P oil.● Cartels are difficult to organize and hard to enforce.

♦ Each member must produce small Q assigned by group. But once high P is established, every firm is tempted to cheat by ↑Qs. When cheating is suspected, cartel quickly falls apart as others ↑Qs which ↓P.

● Considered worse than monopoly. Cartel charges monopoly P without the cost savings from large scale production.

Price Leadership and Tacit CollusionPrice Leadership and Tacit Collusion

● Overt collusion (where firms meet to pick P-Q) is illegal in the U.S. and rare. But tacit collusion is common.

● Each tacitly colluding firm hopes that if it does not rock the boat (via ↓P or ↑ads), then rivals will do same.

● Price leadership = 1 firm makes P decisions for group.♦ Other firms are expected to adopt P of leader without any

explicit agreement.

♦ P leader is often largest firm in industry.

● Overt collusion (where firms meet to pick P-Q) is illegal in the U.S. and rare. But tacit collusion is common.

● Each tacitly colluding firm hopes that if it does not rock the boat (via ↓P or ↑ads), then rivals will do same.

● Price leadership = 1 firm makes P decisions for group.♦ Other firms are expected to adopt P of leader without any

explicit agreement.

♦ P leader is often largest firm in industry.

Sales Maximization: Model with Interdependence IgnoredSales Maximization: Model with Interdependence Ignored

● Firms may attempt to max revenue rather than profit if:♦ control is separated from ownership

♦ compensation of managers is related to size of the firm

● Q set where MR = 0 (rather than MR = MC)♦ Recall: MR is slope of TR curve. So TR is max when MR = 0.

If MR > 0 → ↑Q to ↑TR and if MR < 0 → ↓Q to ↑TR.

● Compared to profit-max firm:♦ Higher Q

♦ Lower P

● Firms may attempt to max revenue rather than profit if:♦ control is separated from ownership

♦ compensation of managers is related to size of the firm

● Q set where MR = 0 (rather than MR = MC)♦ Recall: MR is slope of TR curve. So TR is max when MR = 0.

If MR > 0 → ↑Q to ↑TR and if MR < 0 → ↓Q to ↑TR.

● Compared to profit-max firm:♦ Higher Q

♦ Lower P

FIGURE 3. Sales-Max EquilibriumFIGURE 3. Sales-Max Equilibrium

3.69 3.75 3.80

Millions of Boxes per Year

Π-max Q = 2.5m where MR =

MC. P = $4.00 and total Π = $0.20 x 2.5 m = $500,000.

Sales-max Q = 3.75m where

MR = 0. P = $3.75 and total Π = $0.06 x 3.75 m = $225,000.

Total Π (TR) is lower (higher) at point F than point E.

The Kinked Demand Curve ModelThe Kinked Demand Curve Model

● Resolve puzzle 3 –why do P in oligopolistic markets (cars or appliances) change less often than P of commodities (wheat or gold)?

● Firms think that other firms will match any P cut, but not any P increase. If true, firms face an inelastic D curve with P cuts and an elastic curve with P increases.

● Resolve puzzle 3 –why do P in oligopolistic markets (cars or appliances) change less often than P of commodities (wheat or gold)?

● Firms think that other firms will match any P cut, but not any P increase. If true, firms face an inelastic D curve with P cuts and an elastic curve with P increases.

● In Fig. 4, pt A is firm’s initial P = $8. ● 2 D curves pass through pt A.

♦ DD is more elastic → rivals’ P are fixed

♦ dd is less elastic → rivals match ∆P

● If firm ↓P to $7 (and rivals don’t match ↓P) → large ↑customers, so new Qd = 1,400.

● If rivals match ↓P → ↑Qd is small, so new Qd = 1,100.● If firm ↑P (and rivals don’t match ↑P) → large ↓Qd.

● In Fig. 4, pt A is firm’s initial P = $8. ● 2 D curves pass through pt A.

♦ DD is more elastic → rivals’ P are fixed

♦ dd is less elastic → rivals match ∆P

● If firm ↓P to $7 (and rivals don’t match ↓P) → large ↑customers, so new Qd = 1,400.

● If rivals match ↓P → ↑Qd is small, so new Qd = 1,100.● If firm ↑P (and rivals don’t match ↑P) → large ↓Qd.

● The firm’s true demand curve in Fig. 4 is DAd –a kinked demand curve.

● P tend to “stick” to their original level because ↑P → lose many customers and ↓P → gain very few customers.

● Firm will only ∆P if costs change enormously.

● The firm’s true demand curve in Fig. 4 is DAd –a kinked demand curve.

● P tend to “stick” to their original level because ↑P → lose many customers and ↓P → gain very few customers.

● Firm will only ∆P if costs change enormously.

FIGURE 4. The Kinked Demand Curve

Quantity per Year

D (Competitors’ prices are fixed)

1,400 1,100 1,000

(Competitors respond to price changes)

Typical oligopoly fears the worst. If firm cuts P then rivals will match P cut → relevant demand curve is dd. But if firm raises P then rival will not match the P increase → relevant demand curve is DD. Thus, the firm’s true demand curve is the red line “DAd.”

● MR is associated with DD and mr is associated with dd.● Overall marginal revenue curve is DBCmr.● MC = MR at pt E which shows Π-max Q for oligopolist.● Since relevant MR curve is kinked, even a moderate shift

in MC will leave Q and thereby P unchanged.● Oligopoly prices are “sticky” and do not respond to

minor cost changes.

● MR is associated with DD and mr is associated with dd.● Overall marginal revenue curve is DBCmr.● MC = MR at pt E which shows Π-max Q for oligopolist.● Since relevant MR curve is kinked, even a moderate shift

in MC will leave Q and thereby P unchanged.● Oligopoly prices are “sticky” and do not respond to

minor cost changes.

FIGURE 5. The Kinked Demand Curve and Sticky Prices

Quantity Supplied per Year

The Game-Theory ApproachThe Game-Theory Approach

● Most widely used approach to analyze oligopoly behavior.

● Each oligopolist is seen as a competing player in a game of strategy.

● Optimal strategies are determined by examining a payoff matrix showing Π of each firm depending on P strategy that each firm follows.

● Most widely used approach to analyze oligopoly behavior.

● Each oligopolist is seen as a competing player in a game of strategy.

● Optimal strategies are determined by examining a payoff matrix showing Π of each firm depending on P strategy that each firm follows.

Games with Dominant StrategiesGames with Dominant Strategies

● Dominant strategy = one that gives the bigger payoff to the firm that selects it, no matter which of the two strategies the competitor selects.♦ E.g., Table 1., both firms have an incentive to pick low P

strategy regardless of what other firm does. If B picks high P, then A receives largest payoff choosing low P. Or if B picks low P, then A receives the largest payoff by choosing low P.

♦ “Low Price” is the dominant strategy for both firms, so both charge a low P and each earns $3m.

● Dominant strategy = one that gives the bigger payoff to the firm that selects it, no matter which of the two strategies the competitor selects.♦ E.g., Table 1., both firms have an incentive to pick low P

strategy regardless of what other firm does. If B picks high P, then A receives largest payoff choosing low P. Or if B picks low P, then A receives the largest payoff by choosing low P.

♦ “Low Price” is the dominant strategy for both firms, so both charge a low P and each earns $3m.

TABLE 1. Payoff Matrix with Dominant Strategies

A gets $10m

B gets $10m

A gets -$2m

B gets $12m

A gets $12m

B gets -$2m

A gets $3m

B gets $3m

Firm B Strategy

High Price Low Price

Firm A Strategy

High Price

Low Price

Games with Dominant StrategiesGames with Dominant Strategies

● A market with a duopoly serves public interest better than a monopoly because of the competition created between two firms.♦ Both firms would be better off if they could charge high P. But

the presence of a competitor, forces each firm to protect itself by charging low P.

● It is damaging to the public to allow rival firms to collude on what prices to charge for their products.♦ E.g., if two firms collude in Table 1, then we end up with high

P and each earning $10m.

● A market with a duopoly serves public interest better than a monopoly because of the competition created between two firms.♦ Both firms would be better off if they could charge high P. But

the presence of a competitor, forces each firm to protect itself by charging low P.

● It is damaging to the public to allow rival firms to collude on what prices to charge for their products.♦ E.g., if two firms collude in Table 1, then we end up with high

P and each earning $10m.

Games without Dominant StrategiesGames without Dominant Strategies

● Maximin = select the strategy that yields the max payoff assuming your rival does as much damage to you as he can.

● In Table 2, A’s maximin strategy is to pick low P and earn $5m. ♦ Firm A thinks: if I chose a high P → worst outcome is B picks

a low P and I get $3m. If I chose a low P → worst outcome is B picks a low P and I get $5m.

♦ Firm A picks the strategy that offers the best of those bad outcomes.

● Maximin = select the strategy that yields the max payoff assuming your rival does as much damage to you as he can.

● In Table 2, A’s maximin strategy is to pick low P and earn $5m. ♦ Firm A thinks: if I chose a high P → worst outcome is B picks

a low P and I get $3m. If I chose a low P → worst outcome is B picks a low P and I get $5m.

♦ Firm A picks the strategy that offers the best of those bad outcomes.

TABLE 2. A Payoff Matrix without a Dominant Strategy

A gets $10m A gets $3m

A gets $8m A gets $5m

High Price Low Price

High Price

Low Price

Firm B Strategy

Firm A Strategy

Repeated GamesRepeated Games

● Repeated games give players the opportunity to learn something about each other’s behavior patterns and, perhaps, to arrive at mutually beneficial arrangements.

● Table 1 shows a single round of the game. Each firm picked low P. But if games are repeated, players can escape this trap. ♦ E.g., Firm A could cultivate a reputation of “tit for tat.” Each

time B charges a high P → A would charge a high P. After a few repetitions, B learns that A always matches its P decisions. So B will see that it’s better to stick with a high P.

● Repeated games give players the opportunity to learn something about each other’s behavior patterns and, perhaps, to arrive at mutually beneficial arrangements.

● Table 1 shows a single round of the game. Each firm picked low P. But if games are repeated, players can escape this trap. ♦ E.g., Firm A could cultivate a reputation of “tit for tat.” Each

time B charges a high P → A would charge a high P. After a few repetitions, B learns that A always matches its P decisions. So B will see that it’s better to stick with a high P.

Threats and CredibilityThreats and Credibility

● Use threats to induce rivals to change their behavior.♦ E.g., retailer could threaten to double Q and ↓P to $0 if a rival

imitates its product. But this is not credible, because it hurts the retailer who is making the threat.

● A credible threat is a threat that does not harm the threatener if it is carried out.

● Old firms often use credible threats to prevent new firms from entering the industry.♦ E.g., old firm will build a larger factory than it would

otherwise want. Large factory lowers cost of ↑Q –even at low P.

● Use threats to induce rivals to change their behavior.♦ E.g., retailer could threaten to double Q and ↓P to $0 if a rival

imitates its product. But this is not credible, because it hurts the retailer who is making the threat.

● A credible threat is a threat that does not harm the threatener if it is carried out.

● Old firms often use credible threats to prevent new firms from entering the industry.♦ E.g., old firm will build a larger factory than it would

otherwise want. Large factory lowers cost of ↑Q –even at low P.

FIGURE 6. Entry and Entry-Blocking Strategy

–2 –2

Profits (millions $) Old Firm New Firm

Possible Reactions of New Firm

Possible Choices of Old Firm

Don’t Enter

Small Factory

Big Factory

Threats and CredibilityThreats and Credibility

● In Fig. 6, best outcome for old firm is to have a small factory and no rivals.♦ But if old firm builds a small factory, it can count on new firm

entering to earn $2m. So old firm’s ↓Π to $2m.

● If old firm builds a big factory, its ↑Q will ↓P and ↓Π. Old firm now earns $4m if new firm stays out.♦ Clearly, new firm will stay out to avoid loses of $2m.

● Thus, old firm should build big factory to keep rivals out.

● In Fig. 6, best outcome for old firm is to have a small factory and no rivals.♦ But if old firm builds a small factory, it can count on new firm

entering to earn $2m. So old firm’s ↓Π to $2m.

● If old firm builds a big factory, its ↑Q will ↓P and ↓Π. Old firm now earns $4m if new firm stays out.♦ Clearly, new firm will stay out to avoid loses of $2m.

● Thus, old firm should build big factory to keep rivals out.

Monopolistic Competition, Oligopoly, & Public WelfareMonopolistic Competition, Oligopoly, & Public Welfare

● Oligopolistic behavior is so varied that it is hard to come to a simple conclusion about welfare implications.

● In many circumstances, the behavior of monopolistic competitors and oligopolists falls short of the social optimum.

● Excess capacity theorem suggests monopolistic competition can lead to inefficiently high production costs.

● Oligopolists may organize into successful cartels to ↓Q and ↑P.

● Oligopolistic behavior is so varied that it is hard to come to a simple conclusion about welfare implications.

● In many circumstances, the behavior of monopolistic competitors and oligopolists falls short of the social optimum.

● Excess capacity theorem suggests monopolistic competition can lead to inefficiently high production costs.

● Oligopolists may organize into successful cartels to ↓Q and ↑P.

Monopolistic Competition, Oligopoly, & Public WelfareMonopolistic Competition, Oligopoly, & Public Welfare

● When an oligopolistic market is perfectly contestable –if firms can enter and exit without losing $ they invested –then (P,Q) of firms is likely to be socially efficient.

♦ E.g., airplanes, trucks, and barges can easily be moved.

● Constant threat of entry forces oligopolists to keep their prices down and their costs low.

● When an oligopolistic market is perfectly contestable –if firms can enter and exit without losing $ they invested –then (P,Q) of firms is likely to be socially efficient.

♦ E.g., airplanes, trucks, and barges can easily be moved.

● Constant threat of entry forces oligopolists to keep their prices down and their costs low.

Comparing the Four Market FormsComparing the Four Market Forms

● Perfect competition and pure monopoly are rare.● Most firms are monopolistically competitive, but

oligopoly firms account for largest share of economy’s output.

● Π = 0 in LR under perfect competition and monopolistic competition because of free entry and exit.♦ Thus, P = AC in LR under these 2 market forms.

● Π-max firm under any market form selects Q by setting MR = MC. ♦ However, oligopolists may not set MC = MR when choosing Q

–e.g., if firm max sales.

● Perfect competition and pure monopoly are rare.● Most firms are monopolistically competitive, but

oligopoly firms account for largest share of economy’s output.

● Π = 0 in LR under perfect competition and monopolistic competition because of free entry and exit.♦ Thus, P = AC in LR under these 2 market forms.

● Π-max firm under any market form selects Q by setting MR = MC. ♦ However, oligopolists may not set MC = MR when choosing Q

–e.g., if firm max sales.

Comparing the Four Market FormsComparing the Four Market Forms

● Perfectly competitive firm and industry efficient allocation of resources.

● Monopoly inefficient allocation of resources by ↓Q and ↑P.

● Monopolistic competition inefficient allocation of resources through excess capacity.

● Under oligopoly, almost anything can happen, impossible to generalize about its vices or virtues.

● Perfectly competitive firm and industry efficient allocation of resources.

● Monopoly inefficient allocation of resources by ↓Q and ↑P.

● Monopolistic competition inefficient allocation of resources through excess capacity.

● Under oligopoly, almost anything can happen, impossible to generalize about its vices or virtues.

TABLE 3. Attributes of the Four Market Forms

Between Competition and Monopoly

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UNIT III: MONOPOLY & OLIGOPOLY Monopoly Oligopoly Strategic Competition 7/30.

Monopoly and Competition

11 Between Competition and Monopoly... Neither fish nor fowl. JOHN HEYWOOD (CIRCA 1565) Between Competition and Monopoly... Neither fish nor fowl. JOHN.

Competition and Monopoly

Monopoly & Perfect Competition

Imperfect competition and monopoly