Oligopoly and Monopolistic Competition

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Questions and Answers

What characterizes a market that is classified as monopolistic competition?

Firms engage in collusion to set prices.

Firms have significant barriers to entry.

Firms sell differentiated products that are substitutes. (correct)

Firms produce identical products without any differentiation.

In a monopolistically competitive market, what happens in the long run with respect to firm profits?

Firms will engage in illegal price fixing.

Firms make continuous profits indefinitely.

Firms will experience increasing profits over time.

Firms will eventually earn zero profit. (correct)

What effect does firm entry have on the demand curve of an existing firm in monopolistic competition?

The demand curve shifts downward. (correct)

The demand curve remains unchanged.

The demand curve becomes perfectly elastic.

The demand curve shifts inward to the left.

How does the price set by a monopolistically competitive firm compare to its marginal cost in the short run?

Price exceeds marginal cost. Signup and view all the answers

Which of the following markets is an example of monopolistic competition?

Local gym services. Signup and view all the answers

What is one key feature that distinguishes oligopoly from monopolistic competition?

A few firms dominate, and entry is difficult. Signup and view all the answers

What is the condition for achieving Cournot equilibrium?

Each firm correctly predicts the output of its competitor Signup and view all the answers

What is the implication of differentiated products in a monopolistic competition market?

Firms can exercise some degree of pricing power. Signup and view all the answers

What happens to a firm’s market share in monopolistic competition as new competitors enter the market?

The firm’s market share decreases. Signup and view all the answers

What does Firm 1's reaction curve indicate?

The firm's production level based on Firm 2's output Signup and view all the answers

What is the total quantity produced at Cournot equilibrium based on the given example?

$20$ Signup and view all the answers

In the case of collusion, what is the total quantity profit-maximized for both firms?

$15$ Signup and view all the answers

In the reaction curve equations, what does the term 15 represent?

The intercept of the demand curve when Q is zero Signup and view all the answers

If Firm 1's marginal revenue is expressed as $MR_1 = 30 - 2Q_1 - Q_2$, what happens at equilibrium?

MR becomes equal to total cost Signup and view all the answers

What is the marginal cost for both firms in this Cournot model?

$0$ Signup and view all the answers

When two firms collude and share profits equally, how much will each produce?

$7.5$ Signup and view all the answers

What typically characterizes the price behavior in monopolistic competition compared to perfect competition?

Price exceeds marginal cost under monopolistic competition. Signup and view all the answers

Which of the following best describes the efficiency of markets characterized by monopolistic competition?

Monopolistic competition can maintain small inefficiencies due to product diversity. Signup and view all the answers

What effect does the presence of many firms in a monopolistically competitive market have on individual firms' monopoly power?

It diminishes the monopoly power of each firm. Signup and view all the answers

Why might monopolistic competition not be deemed socially undesirable?

It offers significant product diversity that consumers value. Signup and view all the answers

How do demand curves in monopolistic competition typically differ from those in perfect competition?

They are downward-sloping in monopolistic competition. Signup and view all the answers

Which combination of elasticity values indicates strong competition in the markets for colas and coffee?

Elasticities between -4 and -8. Signup and view all the answers

What is the primary benefit of monopolistic competition mentioned in the content?

Diversity of products available to consumers. Signup and view all the answers

What is typically observed about entry and profits in monopolistically competitive markets?

Entry occurs until profits are driven to zero. Signup and view all the answers

What characterizes an oligopolistic market?

A few firms dominate the market with high barriers to entry. Signup and view all the answers

What is emphasized in the Nash Equilibrium within an oligopolistic market?

Each firm does the best it can given its competitors’ actions. Signup and view all the answers

Which model is used to study oligopoly behavior regarding homogeneous goods?

Cournot Model Signup and view all the answers

How does a firm's output decision change in response to its competitor's expected output in the Cournot model?

It is dependent on the perceived output of the competitor. Signup and view all the answers

What happens when firms in an oligopoly choose to collude?

They can create a pricing strategy to stabilize the market. Signup and view all the answers

In a duopoly, what is the primary focus of the Cournot model?

The simultaneous output decisions of the two firms. Signup and view all the answers

What defines a reaction curve in the context of oligopoly?

The relationship between a firm’s output and the output of its competitors. Signup and view all the answers

Which industry is typically considered an example of oligopoly?

Automobiles Signup and view all the answers

Study Notes

Oligopoly I

Oligopoly is a market structure where a few firms dominate the market, and entry of new firms is difficult.
Firms in oligopolies may compete with each other or collude.
Different behaviors, such as competition or collusion, will result in different outcomes for firms and markets.
Game theory helps to understand the behavior of firms in oligopolistic markets.
A Nash equilibrium is a set of strategies where each firm does the best it can given the actions of its competitors.

Monopolistic Competition

Monopolistic competition is a market where firms produce differentiated products.
Firms can enter and exit the market freely.
Firms' products are close, but not perfect, substitutes.
There are significant cross-price elasticities of demand, meaning products are substitutable, but demand curves are downward sloping.
Examples include toothpaste brands, restaurants, hair salons.

Monopolistic Competition: Short Run

In the short run, firms may earn economic profits if the price exceeds average cost, due to the differentiated product and firm's market share
The yellow-shaded rectangle in the diagram illustrates the economic profits.

Monopolistic Competition: Long Run

In the long run, new firms enter the market attracted by profits, this reduces the market share and shifts the demand curve downward.
The price falls to average cost as new competition is faced.
In the long-run equilibrium, firms earn zero economic profit, although price still exceeds marginal cost.

Monopolistic Competition and Efficiency

Under monopolistic competition, prices usually exceed marginal cost, leading to a deadweight loss represented by a yellow area in the graph.
There is an inefficiency in the market from downward sloping demands.
Gains from product diversity may exceed the inefficiency costs caused by downward sloping demands.

Oligopoly in Colas and Coffee

The market for soft drinks and coffee feature monopolistic competition.
Various brands have slightly different characteristics.
The cross-price elasticities of demand for these products are significant.

Oligopoly: Cournot Model

Firms produce a homogenous good, treating competitor output as fixed.
All firms decide simultaneously how much to produce.
Firms' output is a function of what they think their competitors will produce.
A reaction curve shows profit-maximizing output for each firm, given its forecast of competitors' output.
The intersection of reaction curves represents the Cournot Equilibrium, where firms' predictions are correct.

Cournot Model: Example of Competition

Two identical firms face a linear market demand.
Marginal costs are zero.
Firms solve for their reaction curves and Cournot Equilibrium points.
Equilibrium results in production quantity and market price that differ from the market price and production quantity if a monopoly.

Cournot Model: Example of Collusion

Firms collude and set production quantity as a joint maximization point to enhance profit margin.
Using a shared-revenue maximizing market approach, firms determine equilibrium quantity and market price.

Cournot Model: Compared using Monopoly Diagram

A diagram illustrating the relationship between the price, quantity, and corresponding total revenues generated in different market forms (i.e., Monopoly, Cournot equilibrium, and Perfect Competition).

Reading

Students are required to read from Pindyck & Rubinfeld (2015) for chapter 12 on Microeconomics.
Optional reading is available for innovation and competition in the smartphone industry and Apple/Samsung smartphone sales.

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Description

This quiz covers key concepts in oligopoly and monopolistic competition, including market structures, firm behaviors, and game theory applications. Understanding the distinctions between these two market types will enhance your economic insights. Test your knowledge on strategic interactions and product differentiation.