1. Chapter 10
Monopolistic Competition
and Oligopoly
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2000 South-Western College Publishing
1

2. In this chapter, you will
learn to solve these
economic puzzles:
Are Howwill Ivan’s Oysterand
does the NCAA
Cheerios, Rice Krispies,
Why
other brands sold by firms in the
Why doFour basketball
Final OPEC economic
and other
Bar make zero industry
breakfast cereal usedown?
tournament
cartels tend to long-run?
profit in the break
produced under monopolistic
competitioncompetition
imperfect or oligopoly?
2

3. What is
Imperfect Competition?
A market structure between
the extremes of perfect
competition and monopoly
3

4. What is Monopolistic
Competition?
• many small sellers
• differentiated product
• easy entry and exit
4

5. What is
Product Differentiation?
The process of creating
real or apparent
differences between
goods and services
5

6. What does Many Small
Sellers mean?
Each firm is so small
relative to the total market
that each firm’s pricing
decisions have a negligible
effect on the market price
6

7. What is
Nonprice Competition?
A firm competes using
advertising, packaging,
product development,
better service, rather than
lower prices
7

8. How easy is entry and
exit in Monopolistic
Competition?
Not as easy as in Perfect
Competition because of
product differentiation
8

9. Why is a Monopolistic
Competitive firm a
price maker?
Product differentiation
gives the firm some
control over its price
9

10. What does the demand
curve for Monopolistic
Competition look like?
It is less elastic (steeper)
than for a perfectly
competitive firm and
more elastic (flatter) than
for a monopolist
10

11. What are examples of
Monopolistic Competition?
• grocery stores
• hair salons
• gas stations
• video rental stores
• restaurants
11

12. How effective is
Advertising?
Somewhat effective in the
short-run but less
effective in the long-run
12

13. What effect does
Advertising have on
Average Costs?
It raises the long-run
average cost curve
13

14. P The effect of Advertising
$4.00
With advertising
$3.50
Cost per unit
$3.00 LRAC2
$2.50
$2.00
$1.50
$1.00 LRAC1
Without advertising
$.50
2 4 6 8 10 12 14 16 18 Q
14

15. How does a firm
decide what price to
charge and how many
units to produce?
MR = MC
15

16. P
$50 MR=MC
$40 MC
$30
$25
$20 ATC
$15 Profit
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
16

17. Why is a Normal Profit
made in the Long-run?
The combination of the
leftward shift in the
firm’s demand curve
and the upward shift in
the LRAC curve
17

18. P Normal Profit
$40
$35 MC
$30
$25
$20 LRAC
$15
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
18

19. How efficient is
Monopolistic Competition?
Less resources are used and
a higher price is charged
than would be the case
under Perfect Competition
19

20. P Monopolistic Competition
$40
$35 Minimum MC
$30 LRAC
$25
$20 ATC
$15
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
20

21. P Perfect Competition
$40
Price & Cost per unit
Minimum MC LRAC
$35 LRAC
$30
MR
$25
$20
$15
$10
$5
1 2 3 4 5 6 7 8 9 Q
21

22. What is Oligopoly?
• few sellers
• either homogeneous or
a differential product
• difficult market entry
22

23. How few are a
few Sellers?
When the firms are so
large relative to the total
market that they can
affect the market price
23

24. What is a significant
Barrier to Entry?
Economies of scale
24

25. What is
Nonprice Competition?
Competition in ways other
than pricing policies
25

26. What is the
distinguishing feature
of Oligopoly?
Mutual interdependence
26

27. What is Mutual
Interdependence?
A condition in which an
action by one firm may
cause a reaction on the
part of other firms
27

28. What does Mutual
Interdependence do to
the Demand Curve?
A kinked demand curve
is a possible result of
this characteristic
28

29. What does a Kinked
Demand Curve show?
It shows that rivals will
match a firm’s price
decrease, but ignore a
price increase
29

30. P Oligopolist’s Kinked Demand Curve
$400
$350 Rivals ignore price changes
$300
$250
$200
$150
$100
Rivals match price changes
$50
5 10 15 20 25 30 35 40 45 Q
30

31. How do Oligopolists
determine price?
They play the game “follow
the leader” that economists
call price leadership
31

32. What is
Price Leadership?
A pricing strategy in which
a dominant firm sets the
price for an industry and
the other firms follow
32

33. What is a Cartel?
A group of firms
formally agreeing to
control the price and
output of a product
33

34. What are examples
of Cartels?
• Organization of Petroleum
Exporting Countries
(OPEC)
• International Telephone
Cartel (CCITT)
• International Airline Cartel
(IATA)
34

35. What is the major
weakness of a Cartel?
Member firms cheating
35

36. P Why a Cartel Member Has an
Incentive to Cheat
$40
Price & Cost per unit
$35 MC LRAC
$30
MR2
$25
$20 MR1
$15
$10
$5
1 2 3 4 5 6 7 8 9 Q
36

37. Key Concepts
37

38. Key Concepts
• What is Imperfect Competition?
• What is Monopolistic Competition?
• What is Product Differentiation?
• What is Nonprice Competition?
• Why is a Monopolistic Competitive firm a price
• How does a firm decide what price to charge an
• Why is a Normal Profit made in the Long-run?
38

39. Key Concepts cont.
• How efficient is Monopolistic Competition?
• What is Oligopoly?
• What is Nonprice Competition?
• What is the distinguishing feature of Oligopoly?
• What does a Kinked Demand Curve show?
• How do Oligopolists determine price?
• What is a Cartel?
39

40. Summary
40

41. Imperfect competition is the
market structure between the
extremes of perfect competition and
monopoly Monopolistic competition
and oligopoly belong to the
imperfect competition category.
41

42. Monopolistic competition is a
market structure characterized by (1)
many small sellers, (2) a differentiated
product, and (3) easy market entry and
exit. Given these characteristics, firms
in monopolistic competition have a
negligible effect on the market price.
42

43. Product differentiation is a key
characteristic of monopolistic
competition. It is the process of
creating real or apparent differences
between products.
43

44. Nonprice competition includes
advertising, packaging, product
development, better quality, and
better service. Under imperfect
competition, firms may compete
using nonprice competition, rather
than price competition.
44

45. Short-run equilibrium for a
monopolistic competitor can yield
economic losses, zero economic
profits, or economic profits. In the
long run, monopolistic competitors
make zero economic profits.
45

46. P
$50 MR=MC
$40 MC
$30
$25
$20 ATC
$15 Profit
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
46

47. Comparing monopolistic
competition with perfect competition,
we find that the monopolistic
competitive firm does not achieve
allocative efficiency,charges a higher
price, restricts output, and does not
produce where average costs are at a
minimum.
47

48. P Monopolistic Competition
$40
$35 Minimum MC
$30 LRAC
$25
$20 ATC
$15
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
48

49. P Perfect Competition
$40
Price & Cost per unit
Minimum MC LRAC
$35 LRAC
$30
$25 MR
$20
$15
$10
$5
1 2 3 4 5 6 7 8 9 Q
49

50. Oligopoly is a market structure
characterized by (1) few sellers, (2) a
homogeneous or differentiated
product, and (3) difficult market entry.
Oligopolies are mutually
interdependent because an action by
one firm may cause a reaction on the
part of other firms.
50

51. The nonprice competition model
is a theory that might explain
oligopolistic behavior. Under this
theory, firms use advertising and
product differentiation, rather than
price reductions, to compete.
51

52. The kinked demand curve is a
model that explains why prices may
be rigid in an oligopoly. The kink is
established because an oligopolist
assumes that rivals will match a price
decrease, but ignore a price increase.
52

53. P Oligopolist’s Kinked Demand Curve
$400
$350 Rivals ignore price changes
$300
$250
$200
$150
$100
Rivals match price changes
$50
5 10 15 20 25 30 35 40 45 Q
53

54. Price leadership is another theory
of pricing behavior under oligopoly.
When a dominant firm in an industry
raises or lowers price, other firms
follow suit.
54

55. A cartel is a formal agreement
among firms to set prices and output
quotas. The goal is to maximize
profits, but firms have an incentive
to cheat, which is a constant threat
to a cartel.
55

56. P Why a Cartel Member Has an
Incentive to Cheat
$40
Price & Cost per unit
$35 MC LRAC
$30
MR2
$25
$20 MR1
$15
$10
$5
1 2 3 4 5 6 7 8 9 Q
56

57. Comparing oligopoly with
perfect competition, we find that the
oligopolist allocates resources
inefficiently, charges a higher price,
and restricts output so that price
may exceed average cost.
57

58. Chapter 10 Quiz
©2000 South-Western College Publishing
58

59. 1. An industry with many small sellers, a
differentiated product, and easy entry would
best be described as which of the following?
a. Oligopoly.
b. Monopolistic competition.
c. Perfect competition.
d. Monopoly.
B. An oligopoly has only a few sellers. A
monopoly only has one, and perfect
competition has homogeneous products.
59

60. 2. Which of the following industries is the best
example of monopolistic competition?
a. Wheat.
b. Restaurant.
c. Automobile.
d. Water service.
B. Wheat would be in a perfectly competitive
market. Automobiles would be an oligopoly.
And the water service is an example of a
regulated monopoly.
60

61. 3. Which of the following is not a
characteristic of monopolistic competition?
a. A large number of small firms.
b. A differentiated product.
c. Easy market entry.
d. A homogeneous product.
D. A characteristic of monopolistic
competition is differentiated products.
61

62. 4. A monopolistically competitive firm will
a. maximize profits by producing where MR = MC.
b. probably not earn an economic profit in the long
run.
c. shut down if price is less than average variable cost.
d. do all of the above.
D. Both a monopolistically competitive
firm and a perfectly competitive firm
share these characteristics.
62

63. 5. The theory of monopolistic competition
predicts that in long-run equilibrium a
monopolistically competitive firm will
a. produce the output level at which price
equals long-run marginal cost.
b. operate at minimum long-run average
cost.
c. overutilize its insufficient capacity.
d. produce the output level at which price
equals long-run average cost.
D
63

64. P Monopolistic Competition
$40
$35 Minimum MC
$30 LRAC
$25
$20 ATC
$15
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
64

65. 6. A monopolistically competitive firm is
inefficient because the firm
a. earns positive economic profit in the long
run.
b. is producing at an output where marginal
cost equals price.
c. in not maximizing its profit.
d. produces an output where average total
cost is not minimum.
D.
65

66. P Monopolistic Competition
$40
$35 Minimum MC
$30 LRAC
$25
$20 ATC
$15
$10 AVC
$5
MR D
1 2 3 4 5 6 7 8 9 Q
66

67. 7. A monopolistically competitive firm in the
long run earns the same economic profit as a
a. perfectly competitive firm.
b. monopolist.
c. cartel.
d. none of the above.
A. In the long-run, a normal profit is
made because of the ease of entry and
exit. Once economic profits are made,
more firms will enter the industry,
driving price down. When losses are
made, firms leave the industry,
driving price up, restoring profits.
67

68. 8. One possible effect of advertising on a firm’s
long-run average cost curve is to
a. raise the curve.
b. lower the curve.
c. shift the curve rightward.
d. shift the curve leftward.
A. The ATC curve is raised because of
the added expense of the advertising.
68

69. 9. Monopolistic competition is an inefficient
market structure because
a. firms earn zero profit in the long-run.
b. marginal cost is less than price in the long-
run.
c. a wider variety of products is available
compared to perfect competition.
d. all of the above.
B. In the long-run, marginal cost is less
than price because of the downward
sloping demand curve and a marginal
revenue curve that is more steeply
sloped beneath the demand curve.
69

70. 10. The “Big Three” U.S. automobile
industry is described as a (an)
a. monopoly.
b. perfect competition.
c. monopolistic competition.
d. oligopoly.
D. An oligopoly is a market form with
only a few sellers.
70

71. 11. The cigarette industry in the United
States is described as a (an)
a. monopoly.
b. perfect competition.
c. monopolistic competition.
d. oligopoly.
D. The cigarette industry has only a few sellers.
71

72. 12. A characteristic of an oligopoly is
a. mutual interdependence in pricing
decisions.
b. easy market entry.
c. both (a) and (b).
d. neither (a) nor (b).
A. The distinguishing feature of an oligopoly
is mutual interdependence. No one firm
will make a decision without first
considering the reaction of its competitors
to its policy change.
72

73. 13. The kinked demand curve theory attempts
to explain why an oligopolistic firm
a. has relatively large advertising
expenditures.
b. fails to invest in research and
development (R and D).
c. infrequently changes its price.
d. engages in excessive brand proliferation.
C. Everything else being equal, if firm A raises
its price, other firms will not raise theirs,
and A will experience a big decline in sales.
If A lowers its price, other firms will follow
suit and A will not gain many sales.
73

74. 14. According to the kinked demand theory,
when one firm raises its price, other firms
will
a. also raise their price.
b. refuse to follow.
c. increase their advertising expenditures.
d. exit the industry.
B. They will refuse to follow firm A because
they can gain more by charging a lower
price, their sales will increase because
fewer people will buy from firm A.
74

75. 15. Which of the following is evidence that
OPEC is a cartel?
a. Agreement on price and output quotas by
oil ministries.
b. Ability to raise prices regardless of
demand.
c. Mutual interdependence in pricing and
output decisions.
d. Ability to completely control entry.
A. A cartel is characterized by collusion, the
coming together and agreeing to certain
policies, for example, the level of prices.
75

76. Internet Exercises
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76

77. END
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