Monopolistic competition and

oligopoly
Content
● The main features of monopolistic competition
● Monopolistic competition in the short run
● Monopolistic competition in the long run
● Monopolistic versus perfect competition
● Monopolistic competition and the welfare of
society

● Oligopoly: main characteristics

 Between monopoly and perfect
competition
● The cases of perfect competition and monopoly illustrate some
important ideas about how markets work, but most markets in
the economy include elements of both these cases and,
therefore, are not completely described by either of them.

● Many industries fall somewhere between the polar cases of

perfect competition and pure monopoly. Economists call this
situation imperfect competition.

● Imperfect competition includes industries in which firms have

competitors but do not face so much competition that they are
price takers.
The Four Types of Market Structure
Between monopoly and perfect competition

Number of Firms?

Many
firms

Type of Products?

One Few Differentiated Identical

firm firms products products

Monopolistic Perfect
Monopoly Oligopoly
Competition Competition

• Tap water • Aircraft

• Clothing • Wheat
manufacturing
Monopolistic competition
●Markets that have some features of competition
and some features of monopoly.

● Attributes of Monopolistic Competition:

●Many sellers
●Product differentiation
●Free entry and exit
Monopolistic competition
Many Sellers

● There are many firms competing for the same

group of customers.

● Each firm is small compared to the market.

Monopolistic competition
Product Differentiation

● Each firm produces a product that is at least

slightly different from those of other firms.
● Rather than being a price taker, each firm
faces a downward-sloping demand curve.
● Product examples include movies, books,
computer games, shoes, clothes, restaurants,
cookies, furniture, etc.
Monopolistic competition
Free Entry or Exit

●Firms can enter or exit the market without

restriction.
●The number of firms in the market adjusts
until economic profits are zero.
Monopolistic competition in the
short run
● Each firm in a monopolistically competitive market
is, in many ways, like a monopoly. Because its
product is different from those offered by other firms,
it faces a downward-sloping demand curve.

● Thus, the monopolistically competitive firm follows a

monopolist’s rule for profit maximization: It chooses
to produce the quantity at which marginal revenue
equals marginal cost and then uses its demand curve
to find the price at which it can sell that quantity.
Monopolistic competition in the
short run
● If the price of the firm is above its average total
cost, the firm will have profit in the short run.

● If the price of the firm is below its average total

cost, the firm will have loss in the short run.
 Monopolistic
Monopolistic competition
Competition in the Short Run in the
short run
(a) Firm Makes Profit

Price

MC

ATC

Price
Average
total cost
Profit Demand

MR

0 Profit- Quantity
maximizing
quantity
 Monopolistic
Monopolistic competition
Competitors in the Short Run in the
short run
(b) Firm Makes Losses

Price

MC
ATC
Losses

Average
total cost
Price

MR Demand

0 Loss- Quantity
minimizing
quantity
Long-run equilibrium in
monopolistic competition

● The previous two situations (firms making profit or

loss in the short run) do not last long.
● Short-run economic profits encourage new firms
to enter the market. This:
● Increases the number of products offered.
● Reduces demand faced by firms already in the
market.
● Existing firms’ demand curves shift to the left.
● Demand for the existing firms’ products fall, and
their profits decline.
Long-run equilibrium in
monopolistic competition

● Conversely, short-run economic losses

encourage firms to exit the market. This:
● Decreases the number of products offered.
● Increases demand faced by the remaining
firms.
● Shifts the remaining firms’ demand curves to
the right.
● Increases the remaining firms’ profits.
Long-run equilibrium in
monopolistic competition

● This process of entry and exit continues until

the firms in the market are making exactly
zero economic profit.

● Once the market reaches this equilibrium,

new firms have no incentive to enter, and
existing firms have no incentive to exit.
 Long-run
A Monopolistic monopolistic
Competitor competitor
in the Long Run

Price

MC
ATC

P = ATC

Demand
MR
0
Profit-maximizing Quantity
quantity
Long-run equilibrium in
monopolistic competition

● Two characteristics of the long-run equilibrium:

● As in a monopoly, price exceeds marginal cost.
● Profit maximization requires marginal revenue
to equal marginal cost.
● The downward-sloping demand curve makes
marginal revenue less than price.
● As in a competitive market, price equals average
total cost.
● Free entry and exit drive economic profit to
zero.
Monopolistic vs perfect
competition

● There are two noteworthy differences between

monopolistic and perfect competition - excess
capacity and markup.
Monopolistic vs perfect
competition

● Excess Capacity
● There is no excess capacity in perfect competition
in the long run.
● Free entry results in competitive firms producing
at the point where average total cost is
minimized, which is the efficient scale of the firm.
● There is excess capacity in monopolistic
competition in the long run.
● In monopolistic competition, output is less than
the efficient scale of perfect competition.
 Monopolistic
Monopolistic vs perfect
versus Perfect Competition in the Long Run

competition in the long-run

(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm

Price Price

MC MC
ATC ATC

P
P = MC P = MR
(demand
curve)

MR Demand

0 Quantity Efficient Quantity 0 Quantity produced = Quantity

produced scale Efficient scale

Excess capacity
Monopolistic vs perfect
competition

● Markup Over Marginal Cost

● For a perfectly competitive firm, price equals
marginal cost.
● For a monopolistically competitive firm, price
exceeds marginal cost because the firm always
has some market power.
● Because price exceeds marginal cost, an extra
unit sold at the posted price means more profit
for the monopolistically competitive firm.
 Monopolistic
Monopolistic vs perfect
versus Perfect Competition

competition

(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm

Price Price

MC MC
ATC ATC
Markup

P
P = MC P = MR
(demand
Marginal curve)
cost
MR Demand

0 Quantity Quantity 0 Quantity produced Quantity

produced
 Monopolistic
Monopolistic vs perfect
versus Perfect Competition

competition

(a) Monopolistically Competitive Firm (b) Perfectly Competitive Firm

Price Price

MC MC
ATC ATC
Markup

P
P = MC P = MR
(demand
Marginal curve)
cost
MR Demand

0 Quantity Efficient Quantity 0 Quantity produced = Quantity

produced scale Efficient scale

Excess capacity

Copyright©2003 Southwestern/Thomson Learning

Monopolistic competition and the
welfare of society
● Monopolistic competition does not have all the
desirable properties of perfect competition.

● There is the normal deadweight loss of monopoly

pricing in monopolistic competition caused by the
markup of price over marginal cost.

● Because of the markup, some consumers who value

the good at more than the marginal cost of production
(but less than the price) will be deterred from buying it.
Monopolistic competition and the
welfare of society
● There is no easy way for policymakers to fix the
aforementioned inefficiency of monopolistic pricing.

● To enforce marginal-cost pricing, policymakers

would need to regulate all firms that produce
differentiated products.

● Because such products are so common in the

economy, the administrative burden of such
regulation would be overwhelming.
Monopolistic competition and the
welfare of society

To sum up:
●From the standpoint of the economic theorist,
the allocation of resources in monopolistically
competitive markets is not perfect.

●Yet from the standpoint of a practical

policymaker, there may be little that can be done
to improve it.
 Advertising
● When firms sell differentiated products and charge
prices above marginal cost, each firm has an
incentive to advertise in order to attract more
buyers to its particular product.

● Critics of advertising argue that firms advertise in

order to manipulate people’s tastes.

● They also argue that it impedes competition by

implying that products are more different than
they truly are.
Advertising

● Defenders argue that advertising provides

information to consumers.
● They also argue that advertising increases
competition by offering a greater variety of
products and prices.
● The willingness of a firm to spend money on
advertising can be a signal to consumers about
the quality of the product being offered.
Perfect vs monopolistic competition vs monopoly
Oligopoly
● Oligopoly, like monopolistic competition, lies
between perfect competition and monopoly.

Main characteristics of oligopoly:

● Small number of firms, each of which has a large
market share.
● Natural, legal or economic barriers prevent the entry
of new firms.
● Products may be homogeneous (steel) or
differentiated (automobiles).
 Oligopoly
● Because oligopolistic markets have only a small
number of firms, each firm must act strategically.

● Each firm knows that its profit depends not only on

how much it produces but also on how much the
other firms produce.

● In making its production decision, each firm in an

oligopoly should consider how its decision might
affect the production decisions of all the other firms.
Oligopoly
● Because of the few sellers, a key feature of
oligopoly is the tension between cooperation and
self-interest.

● Oligopolists are best off when they cooperate and

act like a monopolist - producing a small quantity
of output and charging a price above marginal
cost (forming a cartel).
Oligopoly
● Squabbling among cartel members over how to divide the
profit in the market can make agreement among members
difficult.

● In addition, antitrust laws prohibit explicit agreements

among oligopolists as a matter of public policy.

● Each oligopolist is tempted to raise production and

capture a larger share of the market. As each of them
tries to do this, total production rises, and the price falls.
At the same time, self-interest does not drive the market
all the way to the competitive outcome.
Oligopoly
To sum up:
●When firms in an oligopoly individually choose
production to maximize profit, they produce a quantity of
output greater than the level produced by monopoly and
less than the level produced by competition.

●The oligopoly price is less than the monopoly price but

greater than the competitive price.
Oligopoly and public policy
● Cooperation among oligopolists is undesirable from
the standpoint of society as a whole because it leads
to production that is too low and prices that are too high.

● Policymakers use the antitrust laws to prevent

oligopolies from engaging in behavior that reduces
competition.

➢A look at EU competition law:

https://www.youtube.com/watch?v=-ll6UdVyhWo
Summary
● Monopolistic competition and oligopoly lie between
perfect competition and monopoly.
● A monopolistically competitive market is
characterized by three attributes: many firms,
differentiated products, and free entry.
● The equilibrium in a monopolistically competitive
market differs from perfect competition in that each
firm has excess capacity and each firm charges a
price above marginal cost.
Summary
● Monopolistic competition does not have all of the
desirable properties of perfect competition.

● There is a standard deadweight loss of monopoly

caused by the markup of price over marginal cost.

● The product differentiation inherent in

monopolistic competition leads to the use of
advertising and brand names
Summary
● Oligopoly is a market structure in which only a few
sellers offer similar or identical products.

● Oligopoly firms are interdependent, and they face a

temptation to cooperate to increase their joint
economic profit.

● However, often that is not possible. Antitrust laws

prohibit explicit agreements among oligopolists as a
matter of public policy
Topic 8 - MCQ
1. Which of the following conditions does NOT describe a rm in a monopolistically
competitive market?
a) It sells a product different from its competitors.
b) It takes its price as given by market conditions.
c) It maximizes pro t both in the short run and in the long run.
d) It has the freedom to enter or exit in the long run.
3. In monopolistic competition, the products of different sellers are assumed to be
a) similar but slightly different.
b) either identical or differentiated.
c) identical perfect substitutes.
d) unique without any close or perfect substitutes.
4. What is true of a monopolistically competitive market in long-run equilibrium?
a) Price is greater than marginal cost.
b) Price is equal to marginal revenue.
c) Firms make positive economic pro ts.
d) Firms produce at the minimum of average total cost.
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Topic 8 - MCQ
4. Which of the following market types has all rms selling products so identical that buyers do not
care from which rm they buy?
a) perfect competition b) oligopoly c) monopolistic competition d) monopoly

5. Which of the following market types has only a few competing rms?
a) perfect competition b) monopoly c) monopolistic competition d) oligopoly

6. As the number of rms in an oligopoly grows large, the industry approaches a level of output
that is ________ the competitive level and ________ the monopoly level.
a. less than, more than
b. more than, less than
c. less than, equal to
d. equal to, more than
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References
● Mankiw, G. (2017) Principles of Economics, 8th
edition, South-Western Cengage Learning,
Chapter 16 & 17