MCD2020 Microeconomics
Tutorial 10: Monopolistic Competition and Oligopoly
(Chapters 16 &17)
Learning objectives:
1. Understand the models of competition that lie between monopoly and perfect
competition
2. Compare the outcome under monopolistic competition and under perfect
competition
3. Compare the outcome under monopolistic competition and monopoly
4. Examine the market outcomes in an oligopoly market
5. Discuss the prisoners’ dilemma and how it applies to the strategic behaviour of
oligopoly
Exercises marked with ★ are core content, and should be prioritised during class time.
pg. 1
Two market types between perfect competition and monopoly are:
1. Monopolistic competition
Example: Coffee shops (e.g., Starbucks, local cafés).
2. Oligopoly
Example: Soft drink market (e.g., Coca-Cola, Pepsi).
Learning Objective 1
★Question 1 – Characteristics of monopolistic competition
The table below lists several market characteristics. For each one:
Indicate whether it applies to monopolistic competition by writing “Yes” or “No” in the second
column.
The third column provides a brief explanation of the characteristic in the context of monopolistic
Characteristic Monopolistic
Competition Explanation
Yes / No
Many sellers Many small firms compete in the market.
Identical or similar products Firms sell the same or almost the same products
Differentiated products Each firm’s product is slightly different.
Easy entry and exit for firms Low barriers to entry and exit
Few firms dominate the market Market power is concentrated in a few firms
Firms have significant control over
Firms can strongly influence market prices
price
Few or no close substitutes Few, if any, alternative goods meet the same need
Strong focus on marketing and building brand
Heavy use of adverting and branding
identity
Strong price competition Firms mainly compete by charging lower prices
Large start-up costs Significant costs to enter the market
competition to help you decide.
pg. 2
Learning Objective 2
★Question 2 - Monopolistic competition and perfect competition long-run
equilibrium compared
a) Draw diagrams in the space provided below to illustrate the long-run equilibrium in a
monopolistically competitive firm and perfectly competitive firm.
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b) Explain how the long-run equilibrium in a monopolistically competitive firm differs from
that in a perfectly competitive firm.
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pg. 3
★Question 3 - Monopolistic competition and consumer surplus (loss of consumer welfare)
The following figure illustrates the market for Sparkle toothpaste in long-run equilibrium.
The profit-maximising level of output is QM and the price is PM.
Based on the diagram, circle or fill in the correct word to complete the following paragraph:
Sparkle’s profit is …………., since at quantity QM, …………………. equals ……………………. The
consumer surplus from the purchase of Sparkle toothpaste is area ………….. The efficient level of
output occurs where the ……………. curve intersects the …………………. curve, at …………. So, the
deadweight loss is area …………, the area above ……….. and below …………, from …………
to ………. .
pg. 4
Learning Objective 3
★Question 4 - Monopolistic competition and monopoly compared
Firms in monopolistic competition and monopoly both face downward-sloping demand curves, but
their market outcomes differ.
a) Using separate diagrams for each market structure, draw and label the long-run equilibrium
for:
• A monopolistically competitive firm
• A monopoly
pg. 5
b) Compare the two market structures in terms of:
• Price charged
• Quantity produced
• Efficiency (productive and allocative)
• Profit in the long run.
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pg. 6
Learning Objective 4
★Question 5 – Characteristics of oligopoly market
The table below lists several market characteristics. For each one:
Indicate whether it applies to oligopoly by writing “Yes” or “No” in the second column.
The third column provides a brief explanation of the characteristic in the context of oligopoly to help
you decide.
Oligopoly
Characteristic Explanation
Yes / No
Many sellers
Only a few firms dominate.
Identical or similar products
Some oligopolies sell similar products (e.g., petrol).
Differentiated products
Many oligopolies differentiate through branding and features
Easy entry and exit for firms
High costs and strong barriers block new entrants.
Few firms dominate the
A small number of large firms control most of the market.
market
Firms have significant control
Few competitors allow more influence on price
over price
Few or no close substitutes Depends - Substitutes exist (e.g. tea or coffee for soft drinks). No
close substitutes (e.g. air tickets)
Heavy use of adverting and
Used to strengthen brand loyalty and market share.
branding
Strong price competition Price wars can occur, especially in similar-product oligopolies.
(e.g. air lines)
Large start-up costs Large investments needed for production, marketing, or
distribution.
pg. 7
Learning Objective 5
★Question 6 – Prisoners’ dilemma
A pair of bank robbers, Bonnie and Clyde, have been caught. The police have enough evidence to
convict them both on an unlicensed gun charge (which carries a sentence of one year) but suspect that
they have been involved in a bank robbery (which carries a sentence of 20 years).
The police need at least one of the two to confess to the bank robbery, so they interview the two in
separate rooms. The decision whether to confess or not to confess for both Bonnie and Clyde can be
described using the following matrix:
a) Explain why Bonnie’s dominant strategy is to confess? Why Clyde’s dominant strategy
is to confess?
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b) If they would both cooperate and stay silent how many years would they sentenced to
stay in prison?
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pg. 8
c) What do you think is the most likely outcome for them, cooperative or non-
cooperative? How many years they will spend in prison?
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d) What does the prisoners’ dilemma teach us about oligopolies?
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e) Why is game theory helpful for understanding markets with a few firms but not
markets with many firms?
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pg. 9
Q.7 Prisoners’ dilemma and oligopoly strategy
Assume that Coca Cola and Pepsi Cola are the only companies supplying soft drinks in Australia, and
they are considering whether to advertise on television or not. Successful advertising could attract
more customers away from the other company, but at the same time advertising will lower profit
because it is very expensive.
a) What is the dominant strategy for each of them? Explain your answer.
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b) The Australian Government is very concerned with the obesity level caused by the
consumption of soft drink and is considering a new law banning soft drink advertising on television.
How would this policy affect the profit of both companies?
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c) Could this ban still be good public policy? Explain your answer.
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pg. 10
Independent Learning
Question 1
Fill in the table to compare market structures
Perfect Monopolistic
Do firms: Oligopoly Monopoly
Competition Competition
Have higher average costs?
Pick Q so that MR = MC?
Pick Q so that P = MC?
Earn economic profits in the
long-run
Face a downward-sloping demand
curve
Have MR less than price?
Exit in the long run if profits are less
than zero
pg. 11
Question 2
A large share of the world’s supply of diamonds comes from Russia and South Africa. Suppose that
the marginal cost of mining is $1000 per diamond, and the demand for diamonds is described by
the following table. Calculate the Total revenue and Marginal revenue, and use your values to
complete the last two columns of the table:
Price Quantity Total Marginal
($000) (000s) revenue($m) revenue ($m)
8 5 40
7 6 42 2
6 7 42 0
5 8 40 -2
4 9 36 -4
3 10 30 -6
2 11 22 -8
1 12 12 -10
a) If there were many suppliers of diamonds in Russia and South Africa, the price and
quantity of diamonds would be:
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b) If there was only one supplier of diamonds in both Russia and South Africa, the price
and quantity of diamond would be:
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c) If there was one supplier in Russia and one in South Africa and they formed a cartel,
the price and quantity would be:
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d) If the countries split the market evenly, South Africa’s production and profit would be
equal to
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e) What would happen to South Africa’s profit if it increased its production by 1000 while
Russia stuck to the cartel agreement?
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pg. 12
f) Use your answer to part (e) to explain why cartel agreements are often not successful.
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g) Calculating non- cooperative equilibrium using the Nash equilibrium formula, the j
joint output will be equal to of the competitive output and equal to diamonds.
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pg. 13