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Oligopoly & Monopolistic
Competition
Monopolistic Competition
• Many sellers and buyers
• Differentiated product
• Perfect mobility of resources
• Example: Fast-food outlets
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Monopolistic Competition
• Many sellers of differentiated (similar but not
identical) products
• Limited monopoly power
• Downward-sloping demand curve
• Increase in market share by competitors
causes decrease in demand for the firm’s
product
Monopolistic Competition
Short-Run Equilibrium
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Monopolistic Competition
Long-Run Equilibrium
Oligopoly
• Few sellers of a product
• Barriers to entry
• Duopoly - Two sellers
• Pure oligopoly - Homogeneous product
• Differentiated oligopoly - Differentiated
product
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Sources of Oligopoly
• Economies of scale
• Large capital investment required
• Patented production processes
• Brand loyalty
• Control of a raw material or resource
• Government franchise
• Limit pricing
Measures of Oligopoly
• Concentration Ratios
– 4, 8, or 12 largest firms in an industry
• Herfindahl Index (H)
– H = Sum of the squared market shares of all
firms in an industry
• Theory of Contestable Markets
– If entry is absolutely free and exit is entirely
costless then firms will operate as if they are
perfectly competitive
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Cournot Oligopoly Model
• Assumptions:
Homogeneous Goods
No Collusion
Firms have Market Power
Fixed Number of Firms
Competition on Quantity
Rational Firms
Cournot Model
• Proposed by Augustin Cournot
• Behavioral assumption
– Firms maximize profits under the assumption that
market rivals will not change their rates of
production.
• Bertrand Model
– Firms assume that their market rivals will not
change their prices. Ensures Duopoly will lead to
PC with P=MC
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Cournot Model
• Example
– Two firms (duopoly)
– Identical products
– Marginal cost is zero
– Initially Firm A has a monopoly and then Firm B
enters the market
Cournot Model
• Adjustment process
– Entry by Firm B reduces the demand for Firm
A’s product
– Firm A reacts by reducing output, which
increases demand for Firm B’s product
– Firm B reacts by increasing output, which
reduces demand for Firm A’s product
– Firm A then reduces output further
– This continues until equilibrium is attained
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Cournot Model
• Equilibrium
– Firms are maximizing profits simultaneously
– The market is shared equally among the firms
– Price is above the competitive equilibrium and
below the monopoly equilibrium
Kinked Demand Curve Model
• Proposed by Paul Sweezy
• If an oligopolist raises price, other firms will
not follow
• If an oligopolist lowers price, other firms
will follow
• Implication is that demand curve will be
kinked, MR will have a discontinuity, and
oligopolists will not change price when
marginal cost changes
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Kinked Demand Curve Model
Price Leadership
• Implicit Collusion
• Price Leader (Barometric Firm)
– Largest, dominant, or lowest cost firm in the
industry
– Demand curve is defined as the market
demand curve less supply by the followers
• Followers
– Take market price as given and behave as
perfect competitors
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Price Leadership
Cartels
If firms successfully coordinate their actions,
they can collectively behave like a monopoly.
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Cartels
• Collusion
– Cooperation among firms to restrict
competition in order to increase profits
• Market-Sharing Cartel
– Collusion to divide up markets
• Centralized Cartel
– Formal agreement among member firms to
set a monopoly price and restrict output
– Incentive to cheat
Cartels
• Oligopolistic firms have an incentive to collude
so as to increase their profits.
• Cartels helps each firm to reduce its output
and increase prices, thereby increasing
individual and collective profits.
• Firms have an advantage to cheat in a cartel,
so collusion usually end unsuccessfully.
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Centralized Cartel
Cartels and Elasticity
• If less elastic the market demand curve that
the potential cartel faces, all else the same,
the higher the price the cartel sets and the
greater the benefit from cartelizing.
• If penalty of cartelizing is low, firms will opt for
it.
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Three Characteristics of Cartels
i. Secret agreements b/w firms
ii. Their objective is to secure pecuniary
gains for cartel members.
iii. Sustaining the cartel requires crafting
incentive-compatible agreements b/w
firms
Deterrence Approach to Int’l Cartel
Enforcement
I. Imposing a fine
a) How much fine should be imposed?
b) Bankruptcy of the firm as an anti-competitive
outcome
c) Fine as a cost of doing business
II. Corporate leniency Program
III. Jail the Executive
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If pecuniary gain from cartelisation equals
G; and the probability of the antitrust
authority detecting and punishing the
cartel equals p, then a fine f equal to (G/p)
will provide the necessary collective
deterrent.
Problems in Legal Enforcement
• Organizing cartels in location outside legal
jurisdiction.
• Probability of imposing fine decreases -> Fine
increases : Bankruptcy is the ceiling
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The END
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