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Monopolistic Competition

Excess Profits- New entrants- Demand curve facng the original firm will shift to
the left. At the new equilibrium point. Lower prices, lower sales and elimination
of excess profits

Long run equilibrium is characterised by

1) Excess capacity : As the firms output is not prdocued at the min average
cost. So there exists excess capacity equivalent to between the quantities
2) Productive efficiency is not realized here since production occurs where
the average cost exceeds average total cost
3) Allocaitve efficiency is not achieved because product price exceeds
marginal cost. This results in misallocation of resources and allocancy loss
Pay Off Matrix
High Price
Low Price

High Price

Low Pirce

Objefctive of each player is to choose a strategy that maximizes the pay

off from the game. Taking into account the likely strategies pursued by
other player in the game. The non cooperative solution that emerges from
this is known as Nash Equilibrium.
A sets high price and B sets low price. B will make a profit of 75 Million
Euros. While A will loose 10 million Euros. Each firms payoff depends not
only on its own strategy but also on the rivals strategy. The best strategy
would be to collude and set high prices. This is a cooperative solution
which leads to a maximum combined profits of 100 million euros.but each
firm has incentives to cut prices and increase market share so long as
other does not retaliate. Infact the firms engage in price wars and cut the
prices to match with the rivals This leads to a non copperative solution
with a combined profit of 10 million units.
Oligopoly and Interdepdance
The tension between competition and collusion when there is
interdependence that is, a desire to collude to max joint profits and a
desire to compete to raise market share and profits at the expense of
A group of firms that agrees to cooperate and act like a single monopolist.
The firms agree to total the output to the level a monopolist would
produce. Cartel members decide on a production quota for each frim

Consider a cartel formed by 2firms with identical cost structures whre

average cost = marginal cost=constantOptimal strategh for cartel is to
restrict output. If each firm doubles the production the total production
Collusion is hard when
1) Product supply is not high
2) Demand and cost condition are changing rapidly
3) When there are many firms in the industy.
In the absence of collusion, each firms demand curve depends upon how
competitors react
Success of a cartel is being able to act like a monopolist that depends on a
number of factors
1) Smaller the number of members in the cartel it is easier to monitor
activities of all firms and detect any cheating
2) Trading prices of all members are published rather than keeping them
Few characteristics of oligopoly
1) Sometimes there maybe two to three frims dominating the market or 6-7
firms dominating the market with a differentiated product or a similar kind
of product. They may act in collusion yet they would compete
2) Complicated interdepdance. If firms cannot predict the reactions of the
rivals with certainity, they cannot estimate their own demands and
marginal revenue.

Herfindahl Index
Larger the H Index, the greater the monopoly power. It is equal to the sum of
the squared percentage of all the firms in the industry. One on extreme if you
are a monopoly having a 100 Percent market share.

Kink Demand Curve

Oligopoly demand curve has a kink demand curve at the current market price
and MR curve has a vertical break that is Gap. Price cuts will be matched by
the rivals while price rise will not induce a response from competitors and
hence the firm will loose market share to other players and competitors Kink
at a point reflects the asymmetric effect of a price change. The firm jumps
discontinuously from one part of the MR curve to another rpart when it
reaches output Q. If there is any shift of the cost between MC1 and MC3, it

will cut the broken segment of the MR curve, then there would be no change
in either price or output from such a shift.

For price discrimination, the following three conditions have to be met

1) Monopoly Power : The seller has the control overoutput and price
2) Market Segmentation: The seller must be able to segregate buyers into
distinct classes, each of which has a different willingness or the ability to
pay for the product. This is based on different price elasticitys of demand
3) No resale : Purchaser cannot resell the product or the service.