ECON 260 Study Guide - Final Guide: Monopolistic Competition, Concentration Ratio, Imperfect Competition

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The 2 extreme market structures:
1. Perfect competition: many firms, identical products
2. Monopoly: one firm
In between these extremes: imperfect competition
1. Oligopoly: only a few large sellers offer similar/identical products (airline industry)
Difficult entry
Mutual interdependence
Each firm chooses its P and Q
A firm’s decision will affect other firms which will cause them to react
2. Monopolistic competition: many firms sell similar but NOT IDENTICAL products
Free entry
Monopoly
Perfect competition
Monopolistic competition
# of sellers
One
Many
Many
Free entry/exit
No
Yes
Yes
Long run economic profits
Positive
Zero
Zero
The products firms sell
Identical
Differentiated
Firm has market power?
Yes
None, price-taker
Yes
D-curve facing firm
Downward-sloping
(market demand)
Horizontal
Downward-sloping
Close substitutes
None
Many
Duopoly= an oligopoly with 2 firms
o Ex: AT&T and Horizon
Collusion= an agreement among firms in a market about quantities to produce or prices to
charge
o Ex: AT&T and Verizon could agree to each produce half of the monopoly output.
Cartel= a group of firms acting in unison
o Ex: AT&T and Verizon in the outcome with collusion.
Collusion versus Self Interest
o Both firms would be better off if they both stick to the cartel agreement
o But each firm has incentive to renege on the agreement
o Lesson: It is difficult for oligopoly firms to form cartels and honor their agreements.
Concentration ratio= the percentage of the market’s total output supplied by its four largest
firms
o The higher the concentration ratio, the less competition.
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