ECN1014

Introductory Economics
LECTURE 7B
IMPERFECT COMPETITION:
MONOPOLISTIC COMPETITION AND OLIGOPOLY
READING:
SLOMAN AND GARRATT, CHAPTER 5

Learning Objectives
After this lecture, you should be able to:

Identify the major characteristic of monopolistic competition

and oligopoly.
Analyse the strategic behaviour of oligopoly.

Collusive oligopoly
Formal collusion
Tacit collusion
Non-collusive (or competitive) oligopoly

Monopolistic Competition
Reading:
Sloman and Garratt,
Chapter 5, p.114-115

Students are not expected to deal with any

diagram associated with monopolistic
competition. Knowing the characteristics
and firms behaviour will suffice.

Introducing Monopolistic Competition

Monopolistic competition refers to a market

structure composed of many sellers which sells

differentiated products (i.e. product varieties).
Its fundamental characteristics are a combination of
perfect competition and monopoly.
Examples of monopolistic competition:

Book sellers and publishers

Sports wear
Restaurants
Consumer electronics

Characteristics and Conditions

Large number of sellers

Small market share

No collusion
Independent actions

Differentiated products

Product attributes
Different services
Location
Brand names and packaging

Price maker

Downward-sloping demand curve because of differentiated

products
Relatively elastic demand because of many similar substitutes
Appeal by firms to customer loyalty with their own products

Easy entry and exit

Low capital requirement

Financial barriers mainly come from the need for

Advertising
Establishing trademarks and brand names

Oligopoly
Reading:
Sloman and Garratt,
Chapter 5, pp.117-119; 122

Collusive oligopoly: Students are not

expected to cover tacit collusion from p.119
onwards.
Non-collusive oligopoly: Students are not
expected to know assumptions about rivals
behaviour from p.123 onwards.

Introducing an Oligopoly
Oligopoly refers to a market dominated by a few

large producers.
Because of small number of producers, oligopolistic
firms tend to have considerable market power.
Examples of oligopolistic industries:

Aircraft manufacturing
Car manufacturing
Banking and financial services
Oil production

Characteristics and Conditions

A few large producers

The number of producers can be explained by the breaking-up

of a monopoly or mergers of a few smaller firms.

Homogenous or differentiated products

If products are differentiated, then the firms are likely to

engage in non-price competition through heavy advertising.

Price makers, but mutually interdependent

Firms can determine and adjust their own price and output to
maximise profit.
However, in doing so firms may need to consider the strategic
behaviour of other rivals.
There is mutual interdependence, since the each firms profit
depends on both its own and other rivals commercial
strategies.

Significant barriers to entry

Barriers are similar to those of monopoly but may vary from

industry to industry.

Economies of scale
Ownership and control over key resources
Preemptive and retaliatory pricing
Advertising strategies

Oligopoly and Strategic Behaviour

Remember that within an oligopolistic market is

composed of a few large sellers which are highly

interdependent on each other.
The commercial decision made by one firm can
affect the profitability or survival of other firms.

Collusive oligopoly: should they collude and cooperate?

Non-collusive oligopoly: should they cheat and compete?

These two strategies are incompatible.

Collusion is better than competition.

Competition tends to reduce industry profit.

Collusive Oligopoly
As firms are mutually interdependent, they may wish

to collude with each other and act as if they were a

monopoly and jointly maximise industry profits.

Price

Under a formal collusion,

Industry MC

firms form a cartel,

where all act like a
monopoly by

Industry D = AR
Industry MR

Qmax

Quantity

Setting the agreed

production quota at Qmax
Charging the agreed
industry price at P.

Total market share or

production at Qmax is
divided among firms.

Non-Collusive Oligopoly: Breakdown of Collusion

There is no guarantee that collusive arrangements

can be maintained indefinitely.

As long as each firms commercial interests are
concerned, there is always a tendency to cheat by

Cutting prices below the agreed level

Raising production above the agreed quota

Once a collusive agreement is breached by the

cheating firm, other firms will do the same in

retaliation, thus resulting in price-wars and
competition.