Economics 1021A/B Chapter Notes -Big-Box Store, Monopoly Profit, Marginal Cost
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Nov 28, 2011
Economics – Textbook Notes
What is Oligopoly?
Oligopoly lies between perfect competition and monopoly. The firms in oligopoly might
produce an identical product and compete only on price, or they might produce a
differentiated product and compete on price, product quality, and marketing. Oligopoly is
a market structure in which:
Natural or legal barriers prevent then entry of new firms
A small number of firms compete
Barriers to Entry
Natural or legal barriers to entry can create oligopoly.
Economics of scale and demand can create a natural oligopoly
Duopoly is an oligopoly market with two firms
There is no room in this market for three firms
But id there were only one firm, it would make an economic profit and a second
firm would enter to take some of the business and economic profit
A legal oligopoly arises when a legal barrier to entry protects the small number of firms
in a market
Small Number of Firms
Because barriers to entry exist, oligopoly consists of a small number of firms, each of
which has a large share of the market.
Such firms are interdependent, and they face a temptation to cooperate to increase their
joint economic profit.
o With a small number of firms in a market, each firm’s actions influence
the profits of all the other firms
Temptation to Cooperate
o When a small number of firms share a market, they can increase their
profits by forming a cartel and acting like a monopoly
A cartel is a group of firms acting together – colluding – to limit
output, raise price, and increase economic profit
Cartels are illegal
Examples of Oligopoly
The dividing line between oligopoly and monopolistic competition is hard to pin down.
The Herfindahl-Hirschman Index is used to figure out the difference
Two Traditional Oligopoly Models
The Kinked Demand Curve
The kinked demand curve model of oligopoly is based on the assumption that each firm
believes that if it raises its price, others will not follow, but if it cuts its price, other firms
will cut theirs.