Oligopoly and Monopolistic Competition

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.