Monopolistic Competition

and Oligopoly

©2002 South-Western College Publishing

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 What is
imperfect competition?
A market structure
between the extremes
of perfect competition
and monopoly
2
What is monopolistic
competition?
• many small sellers
• differentiated product
• easy entry and exit
3
 What is
product differentiation?
The process of creating
real or apparent
differences between
goods and services
4
What does many small
sellers mean?
Each firm is so small
relative to the total
market that each firm’s
pricing decisions have a
negligible effect on the
market price 5
 What is
nonprice competition?
A firm competes using
advertising, packaging,
product development,
better service, rather
than lower prices
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How easy is entry and
exit in monopolistic
competition?
Not as easy as in perfect
competition because of
product differentiation

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Why is a monopolistic
competitive firm a
price maker?
Product differentiation
gives the firm some
control over its price
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 What are examples of
monopolistic competition?
• grocery stores
• hair salons
• gas stations
• video rental stores
• restaurants
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 How efficient is
monopolistic
competition?
Less resources are used
and a higher price is
charged than would be
the case under perfect
competition
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 What is oligopoly?
• few sellers
• either homogeneous or
a differential product
• difficult market entry

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 How few are a
few sellers?
When the firms are so
large relative to the total
market that they can
affect the market price
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What is a significant
barrier to entry?
Economies of scale

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 What is
nonprice competition?
Competition in ways
other than pricing
policies

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 What is the
distinguishing
feature of oligopoly?
mutual
interdependence

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 What is mutual
interdependence?
A condition in which an
action by one firm may
cause a reaction on
the part of other firms
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 How do oligopolists
determine price?
They play the game “follow
the leader” that economists
call price leadership

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 What is
price leadership?
A pricing strategy in
which a dominant firm
sets the price for an
industry and the other
firms follow
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 What is a cartel?
A group of firms
formally agreeing to
control the price and
output of a product

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 What are examples
of cartels?
• Organization of Petroleum
Exporting Countries (OPEC)
• International Telephone
Cartel (CCITT)
• International Airline Cartel
(IATA)
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Key Concepts

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 Key Concepts
• What is imperfect competition?
• What is monopolistic competition?
• What is product differentiation?
• What is nonprice competition?
• Why is a monopolistic competitive firm a price
maker?
• How does a firm decide what price to charge
and how many units to produce?
• Why is a normal profit made in the long-run?

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 Key Concepts cont.
• How efficient is monopolistic competition?
• What is oligopoly?
• What is nonprice competition?
• What is the distinguishing feature of
oligopoly?
• What does a kinked demand curve show?
• How do oligopolists determine price?
• What is a cartel?

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Summary

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Imperfect competition is the market
structure between the extremes of
perfect competition and monopoly
Monopolistic competition and
oligopoly belong to the imperfect
competition category.

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Monopolistic competition is a
market structure characterized by
(1) many small sellers, (2) a
differentiated product, and (3) easy
market entry and exit. Given these
characteristics, firms in monopolistic
competition have a negligible effect
on the market price.

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Product differentiation is a key
characteristic of monopolistic
competition. It is the process of
creating real or apparent
differences between products.

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Nonprice competition includes
advertising, packaging, product
development, better quality, and
better service. Under imperfect
competition, firms may compete
using nonprice competition,
rather than price competition.

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Oligopoly is a market structure
characterized by (1) few sellers, (2)
a homogeneous or differentiated
product, and (3) difficult market
entry. Oligopolies are mutually
interdependent because an action
by one firm may cause a reaction
on the part of other firms.

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The nonprice competition model is
a theory that might explain
oligopolistic behavior. Under this
theory, firms use advertising and
product differentiation, rather than
price reductions, to compete.

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Price leadership is another theory
of pricing behavior under oligopoly.
When a dominant firm in an
industry raises or lowers price,
other firms follow suit.

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A cartel is a formal agreement
among firms to set prices and
output quotas. The goal is to
maximize profits, but firms have
an incentive to cheat, which is a
constant threat to a cartel.

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 Quiz

©2002 South-Western College Publishing 33

1. An industry with many small sellers, a
differentiated product, and easy entry
would best be described as which of the
following?
a. Oligopoly.
b. Monopolistic competition.
c. Perfect competition.
d. Monopoly.
B. An oligopoly has only a few sellers. A
monopoly only has one, and perfect
competition has homogeneous
products.
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2. Which of the following industries is the
best example of monopolistic
competition?
a. Wheat.
b. Restaurant.
c. Automobile.
d. Water service.
B. Wheat would be in a perfectly
competitive market. Automobiles would
be an oligopoly. And the water service
is an example of a regulated monopoly.

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3. Which of the following is not a
characteristic of monopolistic
competition?
a. A large number of small firms.
b. A differentiated product.
c. Easy market entry.
d. A homogeneous product.
D. A characteristic of monopolistic
competition is differentiated products.

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4. A monopolistically competitive firm in
the long run earns the same economic
profit as a
a. perfectly competitive firm.
b. monopolist.
c. cartel.
d. none of the above.
A. In the long-run, a normal profit is
made because of the ease of entry
and exit. Once economic profits
are made, more firms will enter
the industry, driving price down.
When losses are made, firms
leave the industry, driving price
up, restoring profits. 37
10. The “Big Three” U.S. automobile
industry is described as a (an)
a. monopoly.
b. perfect competition.
c. monopolistic competition.
d. oligopoly.

D. An oligopoly is a market form

with only a few sellers.

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 11. The cigarette industry in the United
States is described as a (an)
a. monopoly.
b. perfect competition.
c. monopolistic competition.
d. oligopoly.
D. The cigarette industry has only a few
sellers.

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 12. A characteristic of an oligopoly is
a. mutual interdependence in
pricing decisions.
b. easy market entry.
c. both (a) and (b).
d. neither (a) nor (b).

A. The distinguishing feature of an

oligopoly is mutual interdependence.
No one firm will make a decision
without first considering the reaction
of its competitors to its policy change.
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15. Which of the following is evidence that
OPEC is a cartel?
a. Agreement on price and output
quotas by oil ministries.
b. Ability to raise prices regardless of
demand.
c. Mutual interdependence in pricing
and output decisions.
d. Ability to completely control entry.
A. A cartel is characterized by collusion,
the coming together and agreeing to
certain policies, for example, the level of
prices. 41
END

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