CHAPTER TEN
10
Monopolistic Competition
and Oligopoly
Content
◼ Monopolistic Competition
◼ Oligopoly
Monopolistic Competition
◼ Characteristics:
➢ There are many firms in the industry
➢ Free entry and exit
➢ Differentiated products but not perfect
substitutes
➢ There are different multiple prices.
Monopolistic Competition
◼ Monopolistic competition power depends on
the degree of product differentiation.
◼ Examples
➢ Taxi service
➢ Toothpaste
➢ Shampoo…
Equilibrium
Short Run P
Long Run
P MC MC
AC
AC
PSR PLR
DSR DLR
MRSR MRLR
Q QLR Q
QSR
Equilibrium
◼ Short Run
➢ The demand curve is downward sloping
➢ Demand is relatively elastic
➢ MR <P
➢ Maximum profit when MR = MC
➢ The firm has economic profit
Equilibrium
◼ Long run
➢ The profit induces entry by other firms.
➢ Each firm’s demand decreases.
➢ Firm’s sales and prices decrease.
➢ Output of the whole industry increases.
➢ No economic profit (P = AC).
➢ P> MC.
Monopolistic Competition
◼ Monopolistic competition creates higher prices
and lower output than perfect competition.
◼ There exists deadweight loss.
Oligopoly
◼ Characteristics:
➢ Few firms in the industry
➢ Barriers to entry
➢ The products may or may not be
differentiated
◼ Examples:
➢ Automotive industry, telecommunications
Oligopoly
◼ Barriers to entry:
➢ Nature: Scale economies, patents or
access to a technology, brands…
➢ Strategic actions: flood the market, drive
prices down if entry occurs…
Oligopoly
◼ Challenges in management:
➢ Strategic action
➢ Competitors’ reactions
◼ How will the opponent react if a business
drops its price?
Oligopoly
◼ Firms in oligopoly must take into account the
competitor's response when making decisions
to choose output levels and selling prices.
◼ What about perfect competition and
monopoly?
Oligopoly
◼ Equilibrium in an Oligopolistic Market:
➢ Firms are doing the best they can and have
no reason to change their price or output
➢ Firms must predict the opponents’ reaction
➢ MR = MC
Oligopoly
◼ Nash equilibrium :
➢ Set of strategies or actions in which each
firm does the best it can given its
competitors’ actions.
Oligopoly – Cournot model
Assumptions:
◼ Two firms produce a homogeneous good
◼ Firms know the market demand curve and
costs of each other
◼ Each firm treats the output of its competitors
as fixed
◼ All firms decide simultaneously how much to
produce.
Cournot model
P1
Firm 1’s profit-maximizing
output depends on how
D1(0)
much it thinks that Firm 2
MR1(0) will produce.
MC1
D1(50)
MR1(75) D1(75)
MR1(50)
12.5 25 50 Q1
Firm 1’s output decision
Reaction curves
Reaction curves
◼ Reaction curve shows the relationship
between a firm’s profit-maximizing output
and the amount it thinks its competitor will
produce.
◼ Q1 = f(Q2) and vice versa.
Oligopoly – Cournot model
◼ The two firms may collude and choose their
output levels cooperatively
◼ The collusion curve shows combinations of
outputs to maximize profits
◼ Output decreases but profit increases
compared to competition
Oligopoly – Stackelberg model
◼ Assumptions:
➢ One of the firms can set its output first
➢ Two firms determine the market demand
➢ Firm 1 sets its output first and then Firm 2, after
observing Firm 1’s output, makes its output
decision.
Oligopoly – Stackelberg model
◼ Firm 1 must consider how Firm 2 will react
◼ Firm 2 takes Firm 1’s output as fixed and then
determine its output according to the Cournot
reaction curve
Price Competition – The Bertrand
Model
◼ Homogeneous Products
◼ Competition occurs along price dimensions
instead of quantities
◼ Bertrand model is an oligopoly model in which
firms produce a homogeneous good, each firm
treats the price of its competitors as fixed, and
all firms decide simultaneously what price to
charge.
Price Competition – The Bertrand
Model
◼ Price Competition with Differentiated Products
◼ For example: design, performance, and
durability of each firm’s product.