MONOPOLISTIC

COMPETITION
and
OLIGOPOLY
 Monopolistic Competition

Characteristics:
1. Relatively large number of sellers
2. Differentiated products
3. Very limited amount of control over the market price
4. Relatively easy entry into and exit from the market
5. There is non-price competition like advertising, promotion.
Ex. Retail and service sectors
food processing industries
clothing and textile
The Demand Curve:

D=P=AR

MR
Q
Short-Run Profit Maximization:
In monopolistic competition, each firm must choose a price, quantity and degree of
product differentiation to maximize profits. Profits may be negative, zero or positive in the short-
run.

Rules for profit maximization:

1. The firm must select output for which MR = MC
2. The firm should produce in the short - run if price exceeds average cost
 Cost & Revenue
Cost &
Revenue
MC MC

ATC

8
ATC LOSS
6 7
5.5 profit
5 D D

MR MR

Q Q
0 6 8 5
 Oligopoly
Characteristics:
1. Few sellers
2. There is mutual interdependence among the few sellers
3. Products sold maybe homogenous or differentiated
4. There is a rigid price
5. There maybe a price leader
6. There are some barriers to entry into the market
7. There is non-price competition
Ex: automobile industry
telecom industry
Types of Oligopoly:
1. Duopoly – only two sellers
2. Pure oligopoly – sell homogenous products
3. Differentiated oligopoly – sell differentiated products

Sources of Oligopoly:
4. Economies of scale
5. Huge capital investments and specialized inputs
6. Few firms own a patent for the exclusive right to produce a commodity or to use a particular
production process
7. Established firms may have a loyal following of customers based on product quality and service.
8. Few firms own and control the supply of raw materials required in production
9. Government may give a franchise to only a few firms to operate in the market.
The Kinked Demand Curve Model
 Introduced by Paul Sweezy in 1939 to explain the price rigidity in oligopolistic models.
 He postulated that if an oligopolist raise its price. It would lose most of its customers
because other firms would not follow by raising their prices.
 An oligopolist could not increase its share in the market by lowering its price because
competitors would quickly match price cuts.
 As a result, oligopolists face a demand curve that has a kink at the prevailing price and highly
elastic for price increases but much elastic for price cuts.
Cost &
Revenue 1. The Kinked Demand Curve = ABC
2. Elastic portion of KDC = AB
11 3. Inelastic portion of KDC = BC
4. Truncated MR = AGEH
5. The MPO = 5
6. At the MPO:
A MC
B  TR = 45
9  TC = 40
 TP = 5
 Per unit revenue = 9
8 G  Per unit cost = 8
 Per unit profit = 5
E D

H Q
0 5 6
Collusion – a secret agreement entered into by firms who decide to act together .
 All firms in the industry agree to establish price levels which are most profitable for the
industry as a whole rather than to set prices as individual units.

Advantages:
1. Increased profits
2. Decreased uncertainty
3. Better opportunity to block entry of new firms

When collusive arrangement is openly accomplished through formal agreement, then there is
said to be a CARTEL.
Cartel – a formal organization of firms in the industry which seeks to maximize profit through
price and output regulation
 Decision making is entrusted to the central organization which is responsible to its
members.

2 types of cartels
1. Market sharing cartel – gives each member the exclusive right to operate in a particular
geographical area.
2. Centralized cartel – a formal agreement among the oligopolistic producers of a product to
set the monopoly price, allocate output among its members, and determine how profits are
to be shared.