By: Adrian Morales and Angelica Morgan

Characterized by • (1) Relatively large number of sellers; competitive aspect• (2) Differentiated products; monopolistic aspect• (3) Easy entry/exit to industry; competitive aspect

In general, monopolistically competitive industries are more competitive than they are monopolistic

Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

Fairly large number of firms but less then pure competition. Therefore,

1. Small market shares

2. No collusion

3. Independent action

• Product differentiation- Monopolistic competitive firms turn out variations of a particular product. Product differentiation may occur through:

• Product Attributes• Service

• Location• Brand Names and Packaging

• Easy entry and exit is easy.

• Financial barriers such as copyrights trademarks makes it difficult/costly to imitate their products.

• Nothing keeps monopolistic competitor from shutting down.

• Advertising- goal of product differentiation and advertising is non-price competition

• Monopolistic Competitive Industries- Retail establishments: grocery stores, gas stations, barbershops, clothing stores, and restaurants. Professional services: medical care, legal assistance, and real estate sales.

• Assumptions: each firm in an industry is producing a specific differentiated product and engaging in a particular amount of advertising.

• The Firms Demand Curve- monopolistic competitor’s demand is more elastic than demand faced by a pure monopolists

• Not perfectly elastic for two reasons:

1) Monopolistic competitor has fewer rivals,

2) Product differentiation

D

MR

P1

Pri

ce a

nd

Cos

ts

Q1

Short-RunEconomic

Profits

Quantity

A1

MC

ATC

D

MR

MC

P2

ATC

Pri

ce a

nd

Cos

ts

Q2

Short-RunEconomic

Losses

Quantity

A2

D

MR

MC

P3 = A3

Pri

ce a

nd

Cos

ts

Q3

Quantity

NormalProfitOnly

ATC

• Some firms may have sufficient product differentiation such that firms cannot duplicate them even in the long run. Example: Well known brand names.

• Product differentiation can lead to financial barriers making entry more difficult than if the product where standardized. This suggests some monopoly power with small economic profits continuing even in the long run.

D

MR

MC

P3 = A3

Pri

ce a

nd

Cos

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Q3

Long-Run EquilibriumPrice is ≠ Minimum

ATC

Price MC

ATC

D

MR

MC

P3 = A3

Pri

ce a

nd

Cos

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Q3

ATC

Q4

Excess Capacity

(1) In the eyes of monopolistic competitors:• A firm can attempt to stay ahead of competitors and keep profits

through further product differentiation and better advertising.• Rivals must imitate/improve on the product or lose business• If demand ↑ by more than enough cover advertising costs, then the firm

has improved financial position.(2) In the eyes of consumers:• Consumers are offered a wide range of types, styles brands and quality

gradations of a product. • Product differentiation creates a tradeoff between consumer choice and

product efficiency. • Stronger product differentiation = greater excess capacity (product

inefficiency) = greater satisfaction of diverse consumer tastes.

• Assumptions: a constant given product and given level of advertising expenditures.

• However, monopolistic competitors must determine what variety of a product, at what price, and what level of advertising will result in the greatest profit.

• Moreover, this optimal combo can only be found through trial and error.

Characterized by:• A market demanded by a few large producers• Selling either a homogenous or differentiated product• Considerable control over prices• Strategic behavior or self interested behavior that takes into

account the reactions of other firms• Mutual interdependence or a situation where a firm’s profit

depends on not only their own price and sales strategies but also that of other firms.

Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

Entry Barriers:

• New firms tend to be high-cost producers

• Large expenditures for capital

• Ownership of raw materials

• Patents, copyrights, and trademarks

• Retaliatory pricing and advertising strategies

Mergers:

• Increase market share

• Greater economies of scale, greater control over market supply and thus the price of it product.

Concentration Ratio

• Percentage total output produced and sold by an industry’s largest firms

• Example: Four largest U.S. producers of breakfast cereal account for 83% of cereals made in the U.S.

• If the four largest firms control 40% of the market than the industry is considered oligopolistic.

Shortcomings:

1. Localized Markets

2. Interindustry Competition

3. World Trade

Herfindahl Index

• The sum of the squared percentage market shares of all the firms in industry.

• Formula: (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2

• Problem: Suppose you have industry X and Y. X is pure monopoly with a 100% concentration ratio. Y is an oligopoly with 100% as well but each firm has a 25% market share.

• Which has a a greater market share?

• Herfindahl Index is the solution:

Industry X → 1002 = 100,000

Industry Y → 252+252+252+252 = 25,000

• The Game Theory is the study of how people behave in strategic situations

• Game Theory model assumptions: (1) Duopoly; (2) Price high or Price low

High Low

Nike’s Price Strategy

High

Low

Ree

bo

k’s

Pri

ce S

trat

egy

GreatestCombined

Profit

High Low

Nike’s Price Strategy

High

Low

Ree

bo

k’s

Pri

ce S

trat

egy Independent

Actions increases the profits at the expense of the

other

IndependentActions increases the profits at the expense of the

other

High Low

Nike’s Price Strategy

High

Low

Ree

bo

k’s

Pri

ce S

trat

egy

Collusion increases the profits of both

firms

High Low

Nike’s Price Strategy

High

Low

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k’s

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trat

egy

The incentive to cheat

becomes very tempting

Three distinct models for oligopolistic pricing and output behavior:

1. The Kinked Demand Curve

2. Collusive Pricing

3. Price Leadership

Why not a single model, as in our discussions of the other market structures?

• Diversity of oligopolies

• Complications of Interdependence

The diversity of oligopolies and the presence of mutual interdependence are reflected in the models that follow…

D1

MR1Quantity

The Anheuser’s demand andmarginal revenue curveswhen rivals match price

changes

Pri

ce

Q0

P0

MR2D1

D2

MR1Quantity

The Anheuser’s demand andmarginal revenue curveswhen rivals ignore price

changes

Pri

ce

Q0

P0

MR2D1

D2

MR1Quantity

Pri

ceRivals

Follow any price cuts

Q0

P0

MR2D1

D2

MR1Quantity

Pri

ce

Rivals ignoreprice any increase

Q0

P0

MR2D1

D2

MR1Quantity

Pri

ce

Behold!The Kinked Demand Curve

Q0

P0

D

Pri

ce

Anheuser Busch’s Demand Curve

Q0

P0

D

MR1Quantity

Pri

ce

MC2

MC1

MR2

Prices are generally stable in noncollusive oligopolies for

both demand and cost reasons

Q0

P0

D

Quantity

Profit maximizationat the kink

Pri

ce

MC2

MC1

MR2

MR1

Q0

P0

D

Quantity

This behavior can setoff a price war.P

rice

MC2

MC1

MR2

MR1

Q0

P0

Colluding Oligopolists Will

Split the Monopoly

Profits.

D

MC

ATC

MR

EconomicProfit

MR = MC

Pri

ce a

nd

cos

ts

Q0

P0

A0

Price ≠ Minimum ATC

Price ≠MC

• Demand and Cost Differences• Number of Firms

• Cheating• Recession

• Potential Entry• Legal Obstacles

• An understanding by which oligopolists can coordinate prices without outright collusion

• Most efficient firm initiates price changes and all the other firms follow the leader

Leadership tactics include:

• Infrequent Price Changes

• Communications

• Limit Pricing

• Increased foreign competition

• Limit Pricing

• Advances in Technology

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