CHAPTER 10
MONOPOLISTIC COMPETITION AND OLIGOPOLY
In this chapter, you will find:
Learning Outcomes
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Solutions to Problems Appendix
INTRODUCTION
Students have now been introduced to the polar cases of perfect competition and monopoly, but most firms in
the economy are neither. This chapter examines two market structures—monopolistic competition and
LEARNING OUTCOMES
10-1 Outline the monopolistic and competitive elements of monopolistic competition.
Monopolistic competition describes a market in which many producers offer products that are substitutes
but are not viewed as identical by consumers. Product differentiation allows each supplier some power
10-2 Describe the sources of oligopoly and explain why some industries become oligopolies.
An oligolpoly is an industry dominated by just a few firms. Oligopolists are said to be interdependent
10-3 Explain why predicting oligopoly behavior is so difficult.
There is no general theory of oligopoly but rather a set of theories, each based on the diversity of
observed behavior in an interdependent market. The theories that are used to explain oligopoly behavior
are: collusion, price leadership, and game theory. These models identify formal and informal efforts to
Chapter 10 Monopolistic Competition and Oligopoly 146
10-4 Summarize the similarities and differences of an oligopoly with perfect competition in terms of the
price, output, and long-run profitability.
With monopolistic competition, there are so many firms in the market that each behaves independently.
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 234 FOR THE FOLLOWING SECTION
Monopolistic Competition: This section relies on Edward Chamberlin’s model.
Characteristics of Monopolistic Competition: A market structure characterized by a large number of firms
selling products that are close substitutes, yet different enough that each firm’s demand curve slopes
downward. Each supplier is a price maker. Barriers to entry are low and firms can enter or leave the industry
in the long run. Sellers also behave competitively.
• Product Differentiation
USE POWERPOINT SLIDES 4-6 FOR THE FOLLOWING SECTION
Short-Run Profit Maximization or Loss Minimization: Elasticity of demand for a monopolistic
competitor depends on the number of rival firms and the firm’s ability to differentiate its product.
USE POWERPOINT SLIDES 7-9 FOR THE FOLLOWING SECTION
Zero Economic Profit in the Long Run: Because market entry is easy, monopolistically competitive firms
earn zero economic profit in the long run. Monopolistically competitive firms spend large amounts on
advertising, which contributes to an increase in average costs.
USE POWERPOINT SLIDES 10-14 FOR THE FOLLOWING SECTION
Monopolistic Competition and Perfect Competition Compared: If the two types of firms have the
USE POWERPOINT SLIDES 15-18 FOR THE FOLLOWING SECTION
An Introduction to Oligopoly: An industry characterized by just a few firms whose behavior is
interdependent.
Varieties of Oligopoly: In some industries the product is homogeneous; in others, it is differentiated across
producers.
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USE POWERPOINT SLIDE 19 FOR THE FOLLOWING SECTION
Models of Oligopoly: Because oligopolists are interdependent, no one general theory of oligopoly explains
their behavior, but several theories have been developed.
USE POWERPOINT SLIDES 20-22 FOR THE FOLLOWING SECTION
Collusion and Cartels:
• Collusion is an agreement among firms in the industry to divide the market and to fix the price.
• A cartel is a group of firms that agree to collude, thus they act as a monopoly.
USE POWERPOINT SLIDES 23-24 FOR THE FOLLOWING SECTION
Price Leadership: A price leader is a firm whose price is adopted by the rest of the industry.
Obstacles:
violates U.S. antitrust laws;
the greater the product differentiation, the less effective price leadership is;
USE POWERPOINT SLIDES 25-34 FOR THE FOLLOWING SECTION
Game Theory: a model that analyzes oligopolistic behavior as a series of strategic moves and countermoves
by rival firms.
• Prisoner’s Dilemma: a game that shows why players have difficulty cooperating even when both players
would benefit from cooperation.
• Strategy: In game theory, the operational plan pursued by a player.
• Payoff matrix: In game theory, a table listing the payoffs that each player can expect based on the
Chapter 10 Monopolistic Competition and Oligopoly 148
USE POWERPOINT SLIDE 35 FOR THE FOLLOWING SECTION
Comparison of Oligopoly and Perfect Competition: There is no single model of oligopoly.
• Price Is Usually Higher under Oligopoly: Price is usually higher and output lower under an
USE POWERPOINT SLIDE 36 FOR THE FOLLOWING SECTION
Comparison of Market Structures
CHAPTER SUMMARY
Whereas the output of a monopolist has no close substitutes, a monopolistic competitor must contend with
many rivals. But because of differences among the products offered by different firms, each monopolistic
competitor faces a downward-sloping demand curve.
An oligopoly is an industry dominated by a few sellers. In undifferentiated oligopolies, such as steel or oil, the
product is a commodity—meaning that it does not differ across firms. In differentiated oligopolies, such as
automobiles or breakfast cereals, the product differs across firms.
Because an oligopoly consists of just a few firms, each may react to another firm’s changes in quality, price,
output, services, or advertising. Because of this interdependence, the behavior of oligopolists is difficult to
analyze. No single approach characterizes all oligopolistic markets.
TEACHING POINTS
1. A point that may be useful to stress in your lecture is that monopolistic competition is an intermediate
market structure that displays characteristics of both perfect competition and monopoly. Like perfect
competition, there are many buyers and sellers and there is free entry and exit of firms. Like monopoly
(because products are not perfectly substitutable), each firm faces a downward-sloping demand curve for
its product, and thus has some influence over price. Therefore, like a monopoly, the monopolistically
Chapter 10 Monopolistic Competition and Oligopoly 149
2. One interesting feature of monopolistic competition is that a firm is in long-run equilibrium when the
demand curve it faces is tangent to its average cost curve. The key concept is that entry of competing
3. Oligopoly is sometimes called the “brand name” model of market structure because firms may choose
to differentiate their products by means of brand names and then compete on the basis of advertising as
well as price. However, as the text points out, oligopoly need not require brand names. Firms may
4. You may wish to examine a number of industries with many products (e.g., cereals, soaps) to
determine whether they are monopolistically competitive or oligopolistic. The idea that individual
5. The latter part of the chapter is devoted to a discussion of oligopoly. The text considers cartels, price
leadership, and game theory models.
6. While a variety of models has been developed to explain firm behavior in oligopolistic industries, no
7. A good example of an oligopoly is the toothpaste industry. The firms involved parry back and forth
with “new, improved formulas.” They segment the market by appealing to the young, the old, and
smokers. If any particular brand “catches fire” and sales are hot, very similar products are almost
immediately introduced. The same may be said for soaps and laundry detergents.
Chapter 10 Monopolistic Competition and Oligopoly 150
SOLUTIONS TO PROBLMS APPENDFIX
1. (Short-Run Profit Maximization) A monopolistically competitive firm faces the following demand and
cost structure in the short run:
Output Price FC VC TC TR Profit/Loss
0 $100 $100 $ 0 ____ ____ ________
1 90 ____ 50 ____ ____ ________
2 80 ____ 90 ____ ____ ________
3 70 ____ 150 ____ ____ ________
4 60 ____ 230 ____ ____ ________
5 50 ____ 330 ____ ____ ________
6 40 ____ 450 ____ ____ ________
7 30 ____ 590 ____ ____ ________
a. Complete the table.
b. What is the highest profit or lowest loss available to this firm?
c. Should this firm operate or shut down in the short run? Why?
d. What is the relationship between marginal revenue and marginal cost as the firm increases output?
a. Output Price FC VC TC TR Profit/Loss
0 $100 $100 $ 0 $100 $ 0 -$100
1 90 100 50 150 90 –60
2. (Monopolistic Competition and Perfect Competition Compared) Illustrated below are the marginal cost
and average total cost curves for a small firm that is in long-run equilibrium.
a. Locate the long-run equilibrium price and quantity if the firm is perfectly competitive.
b. Label the price and quantity p1 and q1.
c. Draw in a demand and marginal revenue curve to illustrate long-run equilibrium if the firm is
monopolistically competitive. Label the price and quantity p2 and q2.
d. How do the monopolistically competitive firm’s price and output compare to those of the perfectly
competitive firm?
e. How do long-run profits compare for the two types of firms?
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4. (Oligopoly Power) What are three sources of oligopolies?
5. (Varieties of Oligopolies) Do the firms in an oligopoly act independently or interdependently? Explain
your answer.
Firms in an oligopoly act interdependently. This means that the demand for one firm’s output depends on
Chapter 10 Monopolistic Competition and Oligopoly 152
6. (Price Leadership) Why might a price–leadership model of oligopoly not be an effective means of
collusion in an oligopoly?
Price leadership is subject to a variety of obstacles. It violates antitrust law. The greater the product
7. (Collusion and Cartels) Why would each of the following induce some members of OPEC to cheat on
their cartel agreement?
a. Newly joined cartel members are less–developed countries.
b. The number of cartel members doubles from 12 to 24.
c. International debts of some members grow.
d. Expectations grow that some members will cheat.
a. Many of the OPEC countries are less developed and need oil revenues to help diversify their
economies. If the underdevelopment or slow growth continues while the rest of the world continues
8. (Collusion and Cartels) Use revenue and cost curves to illustrate and explain the sense in which a cartel
behaves like a monopolist.
Suppose all firms in an industry formed a cartel. Given the market demand curve, D, the cartel must
Chapter 10 Monopolistic Competition and Oligopoly 153
9. (Game Theory) Suppose there are only two automobile companies, Ford and Chevrolet. Ford believes
that Chevrolet will match any price it sets, but Chevrolet too is interested in maximizing profit. Use the
following price and profit data to answer the following questions.
Ford‘s Chevrolet‘s Ford’s Chevrolet’s
Selling Selling Profits Profits
Price Price (millions) (millions)
$ 4,000 $ 4,000 $ 8 $ 8
4,000 8,000 12 6
4,000 12,000 14 2
8,000 4,000 6 12
8,000 8,000 10 10
8,000 12,000 12 6
12,000 4,000 2 14
12,000 8,000 6 12
12,000 12,000 7 7
a. What price will Ford charge?
b. What price will Chevrolet charge once Ford has set its price?
c. What is Ford’s profit after Chevrolet’s response?
d. If the two firms collaborated to maximize joint profits, what prices would they set?
e. Given your answer to part (d), how could undetected cheating on price cause the cheating firm’s
profit to rise?
a. $8,000. Under the matching assumption (If Ford and Chevrolet both charge $4,000, the profits
would be $8; if they both charge $8,000, the profits are $10; and if they both charge $12,000, the
Chapter 10 Monopolistic Competition and Oligopoly 154
10. (Game Theory) While grading a final exam, an economics professor discovers that two students have
virtually identical answers. She is convinced the two cheated but cannot prove it. The professor speaks
with each student separately and offers the following deal: Sign a statement admitting to cheating. If
both students sign the statement, each will receive an “F” for the course. If only one signs, he is allowed
to withdraw from the course while the other student is expelled. If neither signs, both receive a “C” since
the professor does not have sufficient evidence to prove cheating.
a. Draw the payoff matrix.
b. Which outcome do you expect? Why?
a. The payoff matrix is
Student A signs
Student A does NOT sign
Student B does NOT sign
A withdraws; B is expelled
A gets a C; B gets a C
to each signing the statement.
11. (Oligopoly Behavior) Why is firm behavior under oligopoly so difficult to predict?
Because of the interdependent nature of oligopolies where each firm must consider carefully how
12. (Market Structures) Determine whether each of the following is a characteristic of perfect
competition, monopolistic competition, oligopoly, and/or monopoly:
a. A large number of sellers
b. Product is a commodity
c. Advertising by firms
d. Barriers to entry
e. Firms that are price makers
a. Perfect competition and monopolistic competition