C.  Monopolistic Competition and Oligopoly

1.  Monopolistic competition

a.  Characteristics

(1)  Many firms

(2)  Differentiated product

(3)  Free entry and exit

• Ex. -

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b.  Short run equilibrium

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c.  Long run equilibrium

• If profits or losses exist, firms will enter or exit the market

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d.  Economic efficiency

• Comparison with perfect competition

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• P > MC =>  not enough of the product is produced => deadweight loss

• Production is not where average cost is minimized => excess capacity

• Monopoly power (and thus deadweight loss) is likely to be small

• Consumers benefit from product diversity - more choice of products

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2.  Oligopoly

a.  Characteristics

(1)  Few sellers

(2)  Homogeneous or differentiated product

(3)  Entry is difficult

• Ex. -

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b.  Barriers to entry

(1)  Economies of scale

(2)  Patents and copyrights

(3)  Name recognition and market reputation

(4)  Strategic actions by existing firms

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c.  Oligopoly models

• Firms are interdependent

• Nash equilibrium - each firm does the best it can given its competitors actions

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(1)  Kinked demand curve

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• Assumes rivals will match price decrease but ignore price increase

• Explains price rigidity - price remains stable even if costs change

• Doesn't explain how initial price is determined

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(2)  Price leadership

• One firm regularly announces price changes and other firms match

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(a)  Price signaling

• Form of implicit collusion where a firm announces a price increase and hopes others follow

• Done when collusion is illegal

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(b)  Dominant firm model

• One firm has a large share of the market

• Other firms follow the dominant firm's lead

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(3)  Cartels

• Firms collude to act in the best interest of the cartel as a whole

• Illegal to do so in the U.S.

• Ex. - Organization of Petroleum Exporting Countries (OPEC)

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(a) Conditions for success

i)  Stable organization whose members agree on price and production levels

• Members may have different costs and goals

• Temptation to cheat on agreement

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ii)  Potential for monopoly power - demand is not highly elastic

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(b)  Equilibrium

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