Chapter 22 - CHAPTER 24 Monopolistic Competition Oligopoly...

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CHAPTER 24 Monopolistic Competition, Oligopoly, and Game Theory In addition to monopoly, the subject of Chapter 23, there are two other forms of “structural market failure” that we need to discuss. The first, monopolistic competition, deals with markets that are basically competitive but have the extra twist of product differentiation, which makes each good slightly different from its substitutes. The second, oligopoly , often referred to as “monopoly of the few,” occurs when a small number of firms control a large enough share of the market that, if they were to band together, they could act like a monopoly. Chapter 24 begins with the theory of monopolistic competition, then briefly explains short-run pricing and output behavior and the problem of excess capacity, which plagues monopolistically competitive firms. The chapter then moves into the theory of oligopoly and looks at short-run oligopoly pricing and output decisions according to three different theories: the cartel theory, the kinked demand curve theory, the price leadership theory. The chapter then moves to game theory and a brief look at the theory of contestable markets and its impact on our perceptions of noncompetitive market structures. Finally, some applications of game theory are presented and discussed. CHAPTER OBJECTIVES Upon completing this chapter, your students should be able to: 1. Explain the details of the theories of monopolistic competition and oligopoly. 2. Discuss the excess capacity theorem. 3. Explain why some monopolistic competitors would rather be monopolists. 4. Explain why some oligopolists would rather be monopolists. 5. Discuss the problems associated with forming, implementing, and maintaining a cartel. 6. Discuss contestable markets theory. 7. Explain the details of prisoner’s dilemma, a well-known game examined in game theory. KEY TERMS monopolistic competition • cartel excess capacity theorem kinked demand curve theory oligopoly price leadership theory concentration ratio game theory cartel theory contestable market 234
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235 Chapter 24 CHAPTER OUTLINE I.THE THEORY OF MONOPOLISTIC COMPETITION A.Basic Assumptions —The theory of monopolistic competition is built on three basic assumptions: 1.There Are Many Sellers and Buyers —Much as in perfect competition, there are many sellers and many buyers; however, unlike perfect competition, monopolistically competitive firms have some control over price for the following reason. 2.Each Firm (in the Industry) Produces and Sells a Slightly Differentiated Product —Differences among products may be due to brand names, packaging, location, advertising, service, etc. Product differentiation may be real or imagined —that is, the perceived difference between products may or may not actually exist.
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