Oligopolies & Monopolistic Competition Flashcards
What characterises oligopolies selling homogenous products?
Few Sellers in a Business
2 sellers are referred to as a duopoly
We assume that they are selling a homogenous product
Looks similar to a monopoly – few firms with market power
BUT there is the need to acknowledge the behaviour of competitors who have identical products
Oligopolies have the advantage of economies of scale and barriers to entry
Potential for oligopolies to earn long-run positive economic profits
In a homogenous duopoly, what determines consumer decisions?
Because the goods are perfect substitutes, the only determinant of consumer decisions will be the price of the product
If prices are the same, we assume that the market is perfectly split
This is the residual demand curve – the strategic interaction at play
What happens when firms try to maximise profits in a homogenous duopoly?
They attempt to set a price that is slightly below their competitiors, but above the marginal cost of production
However, the other firm has the incentive to deviate from this strategy
What happens is that they both keep undercutting each other until their prices equal the marginal cost of production
What is the state of equilibrium in a homogenous duopoly?
Therefore, the equilibrium in oligopoly of homogenous goods is: P1 = P2 = MC
This results in the same equilibrium of perfectly competitive model
This shows that it is not the number of firms but the type of products produced that influences market power
What are the key characteristics of a heterogenous oligopoly?
Few Sellers
Differentiated Products = still substitutes, but not perfect substitutes
Still Barriers to Entry = potential for long run economic profits
What determines consumer decisions in a heterogenous oligopoly?
Demand for one firm needs to account for the price being charged by other firms
A rise in the price of Coke will lead to a decrease in demand for coke and an increase in demand for Pepsi
The size of the increase in demand for Pepsi will depend on the degree of substitution (the similarity)
As such, Coke has to determine the demand for their product at every price Pepsi could possibly charge (residual demand curve)
They then choose the best price given their competitors’ choices
What kind of equilibrium will occur in a heterogenous oligopoly?
Pepsi is similar, resulting in strategic interaction between both firms
This will create a Nash Equilibrium, characterised by positive economic profits
Due to some degree of product differentiation, undercutting price doesn’t lead to the capture of the entire market – therefore the incentive to decrease the price to the marginal cost isn’t there
How are heterogenous oligopolies impacted by the introduction of more firms?
There is the potential for another firm to enter the market
Assuming they have a slightly differentiated good, they will still be able to sell, but they may have to set a lower price to compete
With each new firm that enters in, the competition between firms with similar products drives down prices and profits
The more firms that enter, the closer we get to a perfect competition outcome
What is the role of marketing in a heterogenous oligopoly?
Because firms selling homogenous products cannot make a long-run profit, there becomes an incentive for firms to differentiate their products
This is where marketing comes in – firms spend a lot of money convincing consumers that their product is unique/superior
Why would firms in a homogenous/heterogenous oligopoly be tempted to collude?
There is also an incentive to deviate and set prices higher than marginal cost
Instead of constantly undercutting, firms can agree to stop cutting prices in an attempt to make long-run economic profits
This is essentially forming a monopoly, and splitting monopoly profits
However, there is also an incentive to cheat
What are the conditions for monopolistic competition?
Many Buyers
Many Sellers
Heterogeneous Goods (Price Making Ability)
Consumers have perfect information
Firms seek to maximise profits
Firms can freely enter and exit the market (no long-run economic profits)
What is an impact of a shock to the demand curve in a market of monopolistic competition?
There can be particular issues with certain firms, that can lead to a decrease in the number of firms operating in the industry
This increases the demand for the remaining firms
What happens if there are too many firms operating in a market of monopolistic competition?
Sometimes, the appearance of short-run economic profits can lead to too many firms entering the market
This reduces market share for all firms in the market
What is the impact of monopolistic competition on total economic surplus?
Although monopolistic competition has no long-run economic profits, it is still not efficient in the long-run
It is producing at the point where marginal benefit is greater than marginal cost, which leads to underproduction and a dead-weight loss
Further, the firms are not operating at the lowest point of average total cost
The firm is maximising their profits, but not minimising their costs
