Session 3 Economics Summary

Monopolistic and Oligopolistic Competition

Introduction A number of assumptions underlie the logic of pure competition: (1) a large number of firms and household are interacting in each market; (2) firms in a given market produce undifferentiated, or homogeneous, products; and (3) new firms are free to enter industries and to compete for profits. The first two imply that firms have no control over input prices or output prices; the third implies that opportunities for positive profit are eliminated in the long run. Monopoly A market in which individual firms have some control over price is imperfectly competitive. Three forms of imperfect competition are monopoly, oligopoly, and monopolistic competition. A pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes, and in which there are significant barriers to entry. For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it. The marginal revenue is not equal to product price, as it is in competition. Instead, marginal revenue is lower than price because to raise output one unit and to be able to sell that one unit, the firm must lower the price it charges to all buyers. Compared with a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits. Monopolists will always charge a price higher than marginal cost (the price that would be set by perfect competition), because marginal revenue always lies below the demand curve for a monopoly. Monopolistic Competition and Oligopoly A monopolistically competitive industry has the following structural characteristics: (1) a large number of firms, (2) no barriers to entry, and (3) product differentiation. Relatively good substitutes for a monopolistic competitor’s products are available. Monopolistic competitors try to achieve a degree of market power by differentiating their products. An oligopoly is an industry dominated by a few firms that, by virtue of their individual size