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Chapter 11

ECON-UA 2 Chapter Notes - Chapter 11: Wtwo, Strategic Dominance, Price Fixing

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Marc Lieberman

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Chapter 11: Monopolistic Competition and Oligopoly
1. The Concept of Imperfect Competition: have more than one firm, but they violate one or
more of the requirements of perfect competition
2. Monopolistic Competition: hybrid of perfect competition & monopoly
a. Differentiated Products
a.i. Perfect competition offers a standardized product, but in monopolistic
competition, each seller produces a somewhat different product from the
a.ii. Causes a downward-sloping demand curve: can sell more by charging
less, or raise its price w/out losing all of its customers
a.iii. What makes a product differentiated?
a.iii.1. Quality
a.iii.2. Difference in location
a.iii.3. Subjectivity
a.iv. Bc a monopolistic competitor faces a downward sloping demand curve,
the firm chooses its price - it is a price setter
b. Many Buyers & Sellers
b.i. Rules out strategic interaction among firms in the market
b.i.1. When a firm makes a decision it does not take into account
how its decision will affect other firms & how they might respond
c. Easy Entry & Exit
c.i. Plays same role as in perfect competition: ensuring that firms earn zero
economic profit in the long run
d. Monopolistic Competition in the Short Run
d.i. Goal to maximize profit by producing where MR = MC
d.ii. Unlike a monopoly, when a monopolistic competitor raises its price, its
customers can buy a close substitute from some other firm → the demand
curve facing a firm will be more elastic under monopolistic competition
than monopoly
e. Monopolistic Competition in the Long Run
e.i. Firms can earn positive, negative, or zero economic profit in the short run,
but in the long run, due to free entry & exit each firm earns zero
economic profit
f. Excess Capacity Under Monopolistic Competition
f.i. In the long run, a monopolistic competitor will operate with excess
capacity: will not sell enough output to achieve minimum cost per
f.i.1. By increasing output to reach minimum cost per unit, each
additional output would cause cost to rise more than revenue
would rise (MC > MR)
f.i.1.a. Firm would suffer a loss since P < ATC
f.ii. Excess Capacity & Prices
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f.ii.1. P < ATC in the long run; excess capacity suggests
monopolistic competition is costly to consumers
f.ii.1.a. Caused by differentiated output
f.ii.2. Consumers usually benefit from product differentiation
f.ii.2.a. Higher prices are the price we pay for product
g. Nonprice Competition: any action a firm takes to shift the demand curve for its
output to the right
g.i. Leads to profits for the early adopters in the short run by temporarily
increasing demand
g.ii. But in the long run, entry & emulation by other firms reverses the initial
rightward shift in demand & the costs of nonprice competition shifts the
ATC curve upwards, resulting in zero economic profit
3. Oligopoly: market dominated by a small number of strategically interacting firms
a. Measuring Market Concentration
a.i. Strategic interaction is greater when a market is highly concentrated
a.ii. Concentration ratios: percentage of total outputs or sales attributable to
the top firms in the market
a.iii. The Herfindahl-Hirschman Index: converts the percentage of market
share of each firm in the industry into a whole number, then square it,
then sum the squared numbers
a.iii.1. Gives more weight to the presence of the largest firms
a.iii.2. Used by FTC & Dept of Justice
a.iii.3. Mergers will generally not invite gov’t scrutiny or opposition
if they
a.iii.3.a. Increase the HHI by less than 100; or
a.iii.3.b. Keep the HHI under 1500
a.iv. Some Provisos on the Measures
a.iv.1. In some cases, these measures distort the true degree of
market concentration
a.iv.2. Does not include foreign production
a.iv.3. Census data is nationwide, while the relevant markets are
sometimes local
b. How Oligopolies Arise
b.i. Economies of Scale
b.i.1. A large firm will have lower cost per unit than a small firm
b.i.2. Can create a natural oligopoly if the MES occurs when a
firm produces for a large fraction of the market
b.i.2.a. Small firms can’t compete, only a few large ones survive
→ oligopoly
b.i.3. Ex. airlines, college textbook publishers
b.ii. Reputation as a Barrier
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