Intermediate Cases: Monopolistic Competition and Oligopoly

1. Characteristics of Monopolistic Competition
   1. Firms in the industry face a downward sloping demand for their product: they are price searchers.
   2. Monopolistic Competitors are able to differentiate their products.
   3. Low barriers to entry
   4. Large number of firms in the industry.

      Examples: Gasoline (retail), retail soft-drinks, fast food.

2. Price and Output
   1. Monopolistic Competitor will lower price and expand output until marginal revenue equals marginal cost.
   2. In the long-run, firms are just able to cover per unit production costs. Economic profits will be zero.
      1. If the firm earns economic profit, other firms will enter the industry. Overall market share falls and demand for the firm's product shrinks.
      2. If the firms earns economic losses, some of the firms will leave the industry. Supply falls and prices begin to rise. Overall market share increases as demand for the firms product rises.
3. Pure Competition vs. Monopolistic Competition
   1. Similarities
      1. Zero long-run profit
      2. Responsive to consumer desires
      3. Low barriers to Entry
   2. Differences
      1. Equilibrium does not occur at minimum LRATC
      2. Price is above short-run Marginal Cost

4. Characteristics of Oligopoly
   1. Recognized interdependence among firms--the policies of one firm are taken in to account by its competitors.
   2. Large-scale production, relative to the size of the market, is required to achieve minimum per unit costs.
   3. Substantial barriers to entry
   4. Output may be homogeneous or heterogeneous
5. Price and Output under Oligopoly

   Unlike monopolists and pure competitors, an oligopolist cannot determine price and quantity by simply estimating market demand and costs. It must also take into account how its rivals will react to changes in its own price and quantity. This makes precise predictions about price and quantity in oligopoly markets difficult. We can, however, derive a range of possible prices and quantities for the oligopoly markets.

   1. If the oligopolists collude, acting as a single firm, then we would expect the monopoly price and quantity in the market. There is always an incentive to collude since industry profits will be higher when firms collude.
   2. If the oligopolists compete, then we would expect P=ATC (which is the competitive solution).
   3. Depending on how the rival oligopolists react to one another's price and output decision(s), the oligopoly price is likely to fall somewhere between these two extremes.
   4. Obstacles to collusion
      1. Collusion is usually illegal
      2. The more firms in the industry, the more difficult it will be to maintain the collusive agreement.
      3. The relative ease of detecting cheating will affect the ability to successfully collude.
      4. Low entry barriers
      5. Rapidly changing market conditions

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   This page was last modified Wednesday, March 19, 1997.