Chapter 15 – Monopolistic Competition and Oligopoly
CHAPTER 15
MONOPOLISTIC COMPETITION AND
OLIGOPOLY
Chapter Overview
In previous chapters, we’ve explored two opposite ends of the spectrum of
market structures: perfect competition and monopoly. In this chapter, we’ve
moved to the gray area in between, learning about imperfect competition
and the characteristics of industries that fall into the categories of
monopolistic competition and oligopoly. Knowing about these market
structures helps business owners make optimal decisions about production
and pricing. Such knowledge also helps consumers make sense of “rms’
behavior and the abundance of advertising they see in the real world.
Market structure can tell us a lot about how “rms make decisions, but there
are still a number of other factors that we haven’t explored yet. Up until now,
we’ve focused on the amount of any given good that “rms choose to
produce. In the next chapter, we’ll see how markets for the factors of
production play an important role in how “rms choose to produce goods.
Learning Objectives
LO 15.1: Name the de”ning features of oligopoly and monopolistic
competition
LO 15.2: Calculate the pro”t-maximizing price and quantity for a
monopolistically competitive “rm in the short run.
LO 15.3: Describe a monopolistically competitive market in the long run.
LO 15.4: Analyze the welfare costs of monopolistic competition.
LO 15.5: Explain how product differentiation motivates advertising and
branding.
LO 15.6: Describe the strategic production decision of “rms in an oligopoly.
LO 15.7: Explain how basic tenets of game theory apply to an oligopoly’s
incentive to compete or collude.
LO 15.8: Compare the welfare of producers, consumers, and society as a
whole in an oligopoly to monopoly and perfect competition.
Chapter Outline
WHICH ONE OF THESE IS JUST LIKE THE OTHERS?
What Sort of Market?
Oligopoly and Monopolistic Competition (LO 15.1)
Monopolistic Competition
Monopolistic Competition in the Short Run (LO 15.2)
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Chapter 15 – Monopolistic Competition and Oligopoly
Monopolistic Competition in the Long Run (LO 15.3)
The Welfare Costs of Monopolistic Competition (LO 15.4)
Product Di3erentiation, Advertising, and Branding (LO 15.5)
BOX FEATURE: WHERE CAN IT TAKE YOU? – THE ADVERTISING AGE
BOX FEATURE: REAL LIFE – WHAT REALLY SELLS LOANS?
BOX FEATURE: FROM ANOTHER ANGLE – COKE, PEPSI, AND THE NOT-SO-
SECRET FORMULA
Oligopoly
Oligopolies in Competition (LO 15.6)
Compete or Collude? Using game theory to analyze oligopolies (LO 15.7)
Oligopoly and Public Policy (LO 15.8)
Beyond the Lecture
Class Activity/ Writing Assignment: Oligopoly, Monopolistic
Competition in the Long Run, and Product differentiation,
Advertising, and Branding (LO 15.1, LO 15.3, LO 15.5)
Place students in groups and ask them to think of a product or “rm that was
once popular but is either no longer popular or no longer exists at all. Ask
students to consider what happened that cause the product or “rm to cease
being popular. This can be used to generate a discussion on competition and
why monopolistic competition tends to result in zero economic pro”ts in the
long run.
Class Media: Oligopoly and Market Structures (LO 15.1)
Have your students watch this short video. It presents a great summary of
market structures, as well as their characteristics. Some questions to ask
include:
1. Is perfect competition always possible or even desirable?
2. What economic phenomena could make oligopoly or even monopoly a
desired market structure?
Class Discussion: Oligopolies in Competition (LO 15.6)
Discuss the Justice Department case against the Ivy League universities in
1991, which students can read about here. Consider the following:
1. Why would schools want to share information?
2. Should they be legally prevented from sharing information about
students and faculty?
Class Media: Oligopoly and Game Theory (LO 15.7)
Have your students watch this short video. This is from a British game show
called “Golden Balls”, in which two contestants are playing a Prisoner’s
Dilemma game. Watch the video “rst before showing your students, so you
know the outcome of the game! You’ll be able to pause at some spots and
explain some concepts of game theory. Students generally have some pretty
big reactions when they see the outcome of the game.
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Chapter 15 – Monopolistic Competition and Oligopoly
Clicker Questions
There are three main purposes to clicker questions. First, they are a great
way to do a quick and instant “on demand” test of student understanding of
the material. You can cover material, and instantly get feedback on student
comprehension. You can see whether you need to explain certain topics
again, or move on to the next subject. Second, they are a great method to
break up the class and take a moment away from lecture. It gets the
students actively involved. Finally, certain clicker questions can be framed in
a “discussion” manner, in which you can invite students to talk about the
possible right answer with their peers. You can instruct students to convince
their classmate of a right or wrong answer.
1. What is true about oligopoly and/or monopolistic competition? [LO 15.1]
A. Products in oligopoly are always di3erentiated
Feedback: Advertising and branding are methods in which products can be
di3erentiated.
2. Why is zero economic pro”t the long run result of monopolistic
competition? [LO 15.2]
D. Government regulation
Feedback: Remember that prices will not be identical. However, free entry
means that if it’s pro”table, others will enter. This increases competition and
drives down prices.
3. Despite the existence of deadweight loss and ineLciency compared to
perfect competition, why might monopolistic competition not necessarily be
seen as bad? [LO 15.4, LO 15.5]
A. Consumers don’t mind paying higher prices
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Chapter 15 – Monopolistic Competition and Oligopoly
Feedback: Perhaps more of a discussion question. You can ask students if
they prefer slightly higher prices with variety, or lower prices with
homogeneity of goods.
4. What does it mean to say that oligopolies are strategically dependent?
[LO 15.6]
D. Firms will generally attempt to collude with each other
Feedback: My strategy depends on your strategy. This is because you’re a
big enough player in the market that your actions affect the market and my
price, and therefore my actions.
5. From the “rm’s perspective, the most ideal form of collusion would result
in… [LO 15.7]
A. All other “rms going out of business
Feedback: Note that if the market (all “rms combined) get the monopoly
pro”t, they’ll still have to be distributed among the individual “rms. But this
is still more pro”table than competing against each other. Remember that in
most cases, collusion and cartels are illegal.
Solutions to End-of-Chapter Questions and Problems
Review Questions
1. Explain why an oligopolist (with few competitors) pays more attention to
what its competitors are doing than a producer in a competitive market (with
many competitors) does. [LO 15.1]
Answer: Even though a “rm in an oligopoly has fewer competitors than a
“rm in a perfect competition, the behavior of the other “rms matters
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Chapter 15 – Monopolistic Competition and Oligopoly
2. If a market has few barriers to entry and many “rms, how might “rms still
have positive economic pro”t? Describe a strategy a “rm in this type of
market might use to maintain economic pro”ts. [LO 15.1]
Answer: If a market has few barriers to entry and many “rms, a “rm in
this market could still have positive economic pro”t if it is offering a good
3. McDonald’s, Burger King, and Wendy’s all produce hamburgers, among
other things. However, if you prefer burgers from McDonald’s, you might
consider other burgers an imperfect substitute. With this in mind, how would
you expect McDonald’s to set its prices in the short run? Describe the
relationship between price, marginal revenue, and marginal cost. [LO 15.2]
Answer: In the short run, McDonald’s will set its prices like a monopolist.
McDonald’s will maximize pro”ts by producing where marginal revenue
4. Consider Jimmy Choo designer shoes. In what way does Jimmy Choo face
many competitors? In what way does Jimmy Choo face no competitors? [LO
15.2]
Answer: Jimmy Choo is a small player in the market for shoes and faces
5. Restaurants offer related but di3erentiated products to their consumers.
In the long run, new restaurants enter the market and imitate the cuisine and
atmosphere of successful competitors. How would you expect a restaurant to
set its prices in the long run? Describe the relationship between price and
average total cost. Does a restaurant earn economic pro”ts? [LO 15.3]
Answer: In the long run, restaurants will enter the market as long as
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Chapter 15 – Monopolistic Competition and Oligopoly
6. In both perfectly competitive and monopolistically competitive markets,
when “rms are making positive economic pro”ts, other “rms will enter until
price equals ATC and pro”ts are zero. Despite these similarities, in a perfectly
competitive market total surplus is maximized, while in a monopolistically
competitive market surplus is not maximized. Explain this di3erence. [LO
15.3]
Answer: In monopolistically competitive markets, “rms face downward-
sloping demand curves, which means price equals ATC on the decreasing
7. Suppose a perfectly competitive market for hot-dog stands in New York
City becomes monopolistically competitive when gourmet, discount, and
ethnic hot-dog retailers show up, making each cart slightly different. If hot
dogs from di3erent stands are now imperfect substitutes and there are
numerous carts in the city, compare the producer and consumer surplus and
total social welfare before and after the change. [LO 15.4]
Answer: In the short run, moving from perfect competition to a
monopolistically competitive market will reduce social welfare because
the monopolistically competitive “rms will maximize pro”ts by producing
8. Given that the market for smartphones is ineLcient, explain why
consumers of smartphones might not want the price to be regulated. [LO
15.4]
Answer: Consumers like lower prices, but they also like product variety.
Regulating the price of smart phones would reduce product variety if
9. Imagine that you have a program on your cell phone that allows you to
walk up to any item in the supermarket and have your phone recognize it
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Chapter 15 – Monopolistic Competition and Oligopoly
and display all the necessary information about the product. The program
tells you where and how it is made, and when it is predicted to go on sale
next. Does a “rm selling goods in this setting need to advertise? Why or why
not? [LO 15.5]
Answer: Yes; despite the neat cell phone app, the “rm still needs to
advertise. The purpose of advertising is not just to inform consumers
10. Why might the cost of advertising be relevant to a consumer’s decision
about which brand of a product to purchase? [LO 15.5]
Answer: The cost of advertising acts as a credible (costly to fake) signal
of product quality. Presumably, a producer will not spend a lot of money
11. Suppose that the market for e-readers is an oligopoly controlled by
Amazon, Barnes and Noble, Sony, and Apple. Barnes and Noble is
considering increasing its output. How would this affect the market price?
How would it affect the pro”ts of each company? [LO 15.6]
Answer: If one producer in an oligopoly increases output, the price will
fall for all producers. The oligopolist that increased quantity will increase
12. Compare the eLciency of perfectly competitive markets, monopoly
markets, and oligopoly markets. Explain why the same pro”t-maximizing
behavior for the individual “rm leads to di3erent levels of eLciency in these
three types of markets. [LO 15.6]
Answer: In all three types of markets, producers maximize pro”t by
producing where MR = MC. The eLcient outcome is to produce where P =
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Chapter 15 – Monopolistic Competition and Oligopoly
13. The Organization of the Petroleum Exporting Countries (OPEC) is a
cartel of 12 countries that controls roughly two-thirds of the world’s oil
production. The cartel gives countries quotas for production. Why might a
country be tempted to produce above quota for a year? How do you think
other OPEC countries might respond if it did so? [LO 15.7]
Answer: A country might be tempted to produce above its quota because
it will increase its pro”ts by doing so. If everyone else holds to their
quotas, the country that cheats and overproduces will enjoy all of the
14. Isabella runs an IT solutions business for her college peers and has
only one competitor, Franco. Isabella and Franco have decided to collude and
provide monopoly-level output. Given that they are both freshmen and
intend to run their businesses for the next three years, is this agreement
sustainable? Would your answer change if Franco knew he planned to
transfer to another college next year? [LO 15.7]
Answer: If Isabella and Franco’s agreement to collude were sure to be a
repeat game (every semester for three years), it could be sustainable. If
15. The U.S. Postal Service (USPS) has a government monopoly on home
mail delivery, but several private companies, such as FedEx, UPS, and DHL,
compete with the USPS for other types of delivery service. Describe the
di3erences in producer and consumer surplus, and in overall social welfare,
that would occur in each of the following scenarios. [LO 15.8]
a. The USPS has a monopoly on every type of mail or package.
b. Consumers are allowed to choose between USPS, UPS, FedEx, and DHL for
home mail delivery.
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Chapter 15 – Monopolistic Competition and Oligopoly
c. There are an in”nite number of local and national mail providers.
Answer:
a. Consumer surplus is lowest in this scenario. Monopoly pricing is the
b. Consumers are better o3 in this scenario. The introduction of some
c. Consumer surplus is highest in this scenario. Under perfect
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