Monopolistic Competition and Oligopoly

Study Notes

Students will describe the characteristics of a monopolistically competitive market.
Students will determine the profit-maximizing quantity and price for a monopolistically competitive firm.
Students will describe the characteristics of an oligopoly.
Students will explain how collusion impacts production decisions in an oligopolistic market.
Students will identify the dominant strategy (where applicable) foreach player, given a payoff matrix.
Students will describe how firms with market power respond to changes in demand and costs.
Students will compare market decisions by competitive firms and firms with market power.
Students will describe the efficiency outcomes in markets where firms have market power.

Firm market share is the percentage of total market output or revenue a firm controls.
Market share can be measured in terms of output or sales.

The Four Firm Concentration Ratio calculates the market share of the top four firms.
A 40% or higher ratio suggests an oligopolistic market.

Many producers with a small market share
Low barriers to entry and exit.
Slightly different products, but they are close substitutes
Firms raise prices, losing customers to rivals.
Firms have some price control, so the firms are price makers.
Firms face downward-sloping demand curves.
Firms often engage in non-price competition (like product differentiation).
Examples include local restaurants, gas stations, hair stylists, local breweries, breakfast cereals, beer, and highway motels.

Demand curve (D) slopes downward.
Firms have market power.
Demand curve is more elastic than a monopolist's, but less elastic than a perfect competitor's.
Marginal revenue curve (MR) is below the demand curve and also slopes downward.
Cost curves: average total cost (ATC), average variable cost (AVC), and marginal cost (MC).

Short-run economic profit leads new firms to enter the market.
Entering firms take customers away from existing firms; reduces demand and lowers individual firm’s demand curve (becomes flatter, more elastic)
Profit disappears.
Price = Average Cost = Zero economic profit
Short-run economic loss causes some firms to exit.
Customers switch, increasing demand for remaining firms and making their demand curve steeper or less elastic.
Loss is erased, and economic profit returns to zero.

The MC firm in the short run faces a demand curve (DSR), produces QSR and charges price PSR.
If Q= QSR, the AC = CSR < P*SR, firm earns profit.
Profit encourages new firms to enter, causing demand to shift downward to DLR, and the new firm seeks Q=Q*LR for which, AC=CLR=PLR, resulting in Zero economic profit in the Long-run.

In the short run, a firm in monopolistic competition can earn positive economic profit, economic loss or normal profit.
New firms entering the market increases competition and affects demand elasticities.
In the long run, firms earn normal profit.

The demand curve for MC firms is more responsive/elastic than for monopolies, due to availability of close substitutes.
Monopolistically competitive firms face downward-sloping demand curves because they offer differentiated products
Firms are not price takers, but instead, price makers/searchers

Provides graphs comparing demand curves for pure monopoly, monopolistic competition, and perfect competition.

Monopolistically competitive firms are not resource-allocative efficient (price > MC).
Nor are they productive efficient (price does not equal the lowest possible ATC, and operates at excess capacity)