MicroEconomics theory and application 12th by browning an zupan chapter 13

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 13: Monopolistic Competition and Oligopoly
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives



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Explain how price and output are determined under
monopolistic competition.
Describe the characteristics of Oligopoly and the Cournot
Model.
Compare several key noncooperative oligopoly models,
including Stackelberg and the dominant firm.
Show how price and output are determined under the
cooperative oligopoly model of cartels.

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2

Explain how price and output are determined under monopolistic
competition.

13.1 PRICE AND OUTPUT UNDER
MONOPOLISTIC COMPETITION

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Price and Output Under Monopolistic
Competition


Monopolistic competition – a market characterized by:
 unrestricted entry and exit
 a large number of independent sellers producing
differentiated products



Differentiated product – a product that consumers view as
different from other similar products.

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Determination of Market Equilibrium


The demand curve facing each firm is downward-sloping but fairly
elastic, reflecting a firm’s market power.



Differs from a monopoly:
 Firm demand curve is not the market demand.
 Entry into the market is not restricted.



Firms compete on product differentiation as well as price.



Long-run equilibrium:




attained as a result of firms entering (or leaving) the industry in response to profit
incentives.
Price > MC
zero economic profit

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Figure 13.1 – Monopolistic Competition

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Monopolistic Competition and
Efficiency
Excess capacity – the result of firms failing to produce at
lowest possible average cost
 The firm does not operate at the minimum point on the
LR average cost curve.
 Total output is wrong from a social perspective due to
deadweight loss
 Deadweight loss is analytically reduced if the
interdependence between individual firms’ demand is
taken into account

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Figure 13-2 – Alleged Deadweight Loss
of Monopolistic Competition

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Is Government Intervention Warranted?
Three reasons why government intervention is probably not
warranted:
 Any deadweight loss is likely to be small, due to the
presence of competing firms and free entry.
 Any possible inefficiency cost must be weighed against
the product variety produced and the benefits of such
variety to consumers.
 The costs of intervention must be balanced against the
potential gain from expanding output.

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Describe the characteristics of Oligopoly and the Cournot Model.

13.2 OLIGOPOLY AND THE COURNOT
MODEL

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Oligopoly
Oligopoly – an industry structure characterized by:
 a few firms producing all or most of the output of some
good that may or many not be differentiated
 mutual interdependence: a firm’s actions have an
effect on its rivals and induce a react by the rivals
 barriers to entry which can influence pricing behavior
 many theoretical models

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The Cournot Model


Duopoly – an industry with two firms



Cournot Model – a model of oligopoly that assumes each
firm determines its output based on the assumption that any
other firms will not change their outputs.



Equilibrium is reached when neither firm has any incentive
to change output

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Figure 13.3 - The Cournot Model

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Reaction Curves


Reaction Curve – a relationship showing one firm’s most
profitable output as a function of the output chosen by the
other firm(s)



Cournot equilibrium occurs at the intersection of two
reaction curves:
 Total output is usually between that of pure monopoly
and competition.
 Price exceeds MC.
 Price exceeds AC => economic profit > 0
 Collusion can increase combined profits of firms.
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Figure 13.4 – The Cournot Model with
Reaction Curves

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Evaluation of the Cournot Model
The assumption that each firm takes the output of a rival
firm as constant is implausible if the market is adjusting
toward equilibrium.
However,
 if equilibrium is established, firms will not see the
assumption invalidated.
 the assumption is more plausible the larger the number
of firms in the market.

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Compare several key noncooperative oligopoly models, including
Stackelberg and the dominant firm.

13.3 OTHER OLIGOPOLY MODELS

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Other Oligopoly Models


The Stackelberg Model – a model of oligopoly in which a
leader firm selects its output first, taking the reactions of
follower firms into account



Dominant Firm Model – a model of oligopoly in which the
leader or dominant firm assumes its rivals behave like
competitive firms in determining their output

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The Stackelberg Model


Residual demand curve – a firm’s demand curve based on
the assumption that the firm knows how much output rivals

will produce for each output the firm may choose



Key point: a firm’s conjectures in an oligopoly about how
rivals will respond can affect firms’ outputs, profits, and
total industry output.



Which model is better, the Stackelberg model or the
Cournot model? It depends upon the particular market
under examination

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Figure 13.5 - The Stackelberg Model

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The Dominant Firm Model


The leader assumes its rivals behave like competitive firms in determining their

output.



Also known as “the dominant firm with a competitive fringe” model.



At any price, the dominant firm can sell an amount equal to the total quantity
demanded at that price minus the quantity the fringe firms produce.



At equilibrium, price > MC for the dominant firm but price = MC for the fringe
firm



Total output < output for a competitive industry



Model is applicable if there are many fringe firms.

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Figure 13.6 - The Dominant Firm Model

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The Elasticity of the Dominant Firm’s
Demand Curve
ηD = ηM (1/MS) + εSF((1/MS) – 1)
where:

ηD = elasticity of the dominant firm’s demand
ηM = elasticity of the market demand
MS = the dominant firm’s market share

εSF = elasticity of supply of the fringe firms
(continued)

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The Elasticity of the Dominant Firm’s
Demand Curve
(continued)

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Show how price and output are determined under the cooperative
oligopoly model of cartels.

13.4 CARTELS AND COLLUSION

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