Monopolistic Competition
Imperfect competition refers to those market structures
that fall between perfect competition and pure
monopoly.
Monopolistic Competition
Imperfect competition refers to those market structures that fall between
perfect competition and pure monopoly.
Types of Imperfectly Competitive Markets
Monopolistic Competition
Many firms selling products that are similar but not identical.
Oligopoly
Only a few sellers, each offering a similar or identical product to the
others.
Monopolistic Competition
Features of Monopolistic Competition
Many buyers and sellers
Product differentiation
Free entry and exit
Selling cost
Non-price competition
Independent pricing policy
Monopolistic Competition
Product Differentiation
Each firm produces a product that is at least slightly different from
those of other firms.
Ratherthan being a price taker, each firm faces a downward-sloping
demand curve.
Monopolistic Competition
Free Entry or Exit
Firms can enter or exit the market without restriction.
The number of firms in the market adjusts until economic profits are zero.
Supernormal- profits
This encourages new firms to enter the market.
Increases the number of products offered.
Reduces demand faced by firms already in the market.
Incumbent firms’ demand curves shift to the left.
Demand for the incumbent firms’ products fall, and their profits
decline.
Economic losses encourage firms to exit the market
This:
Decreases the number of products offered.
Increases demand faced by the remaining firms.
Shifts the remaining firms’ demand curves to the right.
Increases the remaining firms’ profits.
The Long-Run Equilibrium
Firms will enter and exit until the firms are making exactly zero economic
profits.
Allocative Inefficiency (excess
capacity)
OLIGOPOLY
Oligopoly is a market type in which (characteristics):
A small number of firms compete/ sellers.
Interdependence of decision making
Barriers to entry
Product may be homogeneous or there may be product
differentiation
Indeterminate demand curve of an Oligopolist.
OLIGOPOLIST MODELS
1.Non collusive model
•Cournot model 2.Collusive Model
•Edgeworth model • Cartels
•Bertrand model • Price leadership
•Stackelberg model • Mergers
•Sweezy’s model
Kinked Demand Model
Model developed by Paul Sweezy
In this model, the firm is afraid to change its
price.
Itis a tool which explains the stickiness of prices
in oligopolistic markets, but not as a tool for
determination of prices itself.
Kink reflects the following
behaviour
If entrepreneur reduces his price he expects that his
competitor would follow suit, matching the price cut,
so that although the demand in the market increases,
the share of competitor remains unchanged.
However the entrepreneur expects that his competitors
will not follow him if he increases his price, so that he
will lose a considerable part of his customer.
Price Rigidity: Characteristic of oligopolistic markets by which firms
are reluctant to change prices even if costs or demands change.
Kinked Demand Curve model: oligopoly model in which each firm
faces a
demand curve kinked at the currently prevailing price: at higher
prices
demand is very elastic, whereas at lower prices it is inelastic.
Criticism of kinked demand
model
It does not explain the price and output decision of the
firm.
It does not define the level at which the price will be set in
order to maximise profits.
It does not explain the level of price at which kink will
occur. It does not explain the height of the kink.
It is not the theory of pricing, rather a tool to explain why
the price once determined will tend to remain fixed.
Collusive oligopoly Model
Temptation to Collude
When a small number of firms share a market, they can increase their
profit by forming a cartel and acting like a monopoly.
A cartel is a group of firms acting together to limit output, raise
price, and increase economic profit.
Cartels are illegal but they do operate in some markets.
Despite the temptation to collude, cartels tend to collapse. (We explain
why in the final section.)
Cartel is formed with the view
To eliminate uncertainty surrounding the market
Restraining competition and thereby ensuring gains to cartel
group.
Cartel works through a Board of Control, board determines the
market share to each of its members.
Dominant Firm Price
Leadership
At each price dominant firm will be able to supply the
section of total market not supplied by small firm.
The dominant firm maximizes his profit by equating MC
and MR, while the small firms are price takers, and may or
may not maximize their profit, depending on their cost
structure.
Why Would Firms - Behave this Way?
Only one firm may be large enough to set prices.
Alternatively, it may be in their best interest to do
this.
