LS 13 - CHAPTER 13B Oligopoly What Is Monopolistic...

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1 Oligopoly CHAPTER 13B What Is Monopolistic Competition? Monopolistic competition is a market with the following characteristics: ± A large number of firms. ± Each firm produces a differentiated product. ± Firms compete on product quality, price, and marketing. ± Firms are free to enter and exit the industry. We will not cover monopolistic competition outside of its definition. Know the difference between it and oligopoly. What Is Oligopoly? The distinguishing features of oligopoly are ± Natural or legal barriers that prevent entry of new firms ± A small number of firms compete
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2 What is Oligopoly? Barriers to Entry Either natural or legal barriers to entry can create oligopoly. Figure 13.9 shows two oligopoly situations. In part (a), there is a natural duopoly —a market with two firms. What is Oligopoly? In part (b), there is a natural oligopoly market with three firms. A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms. What is Oligopoly? Small Number of Firms Because an oligopoly market has a small number of firms, the firms are interdependent and face a temptation to cooperate. Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions. Cartel: A cartel and is an illegal group of firms acting together to limit output, raise price, and increase profit. Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break down.
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3 Two Traditional Oligopoly Models The Kinked Demand Curve Model In the kinked demand curve model of oligopoly, each firm believes that if it raises its price, its competitors will not follow, but if it lowers its price all of its competitors will follow. Figure 13.11 shows the kinked demand curve model. The firm believes that the demand for its product has a kink at the current price and quantity. Two Traditional Oligopoly Models Two Traditional Oligopoly Models Above the kink, demand is relatively elastic because all other firm’s prices remain unchanged. Below the kink, demand is relatively inelastic because all other firm’s prices change in line with the price of the firm shown in the figure.
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Two Traditional Oligopoly Models The kink in the demand curve means that the MR curve is discontinuous at the current quantity—shown by that gap AB in the figure. Two Traditional Oligopoly Models Fluctuations in MC that remain within the discontinuous portion of the MR curve leave the profit- maximizing quantity and price unchanged. For example, if costs increased so that the MC curve shifted upward from MC 0 to MC 1 , the profit- maximizing price and quantity would not change. Two Traditional Oligopoly Models The beliefs that generate the kinked demand curve are not always correct and firms can figure out this fact. If
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LS 13 - CHAPTER 13B Oligopoly What Is Monopolistic...

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