Chapter 7 Monopolistic Competition and Oligopoly

1. Chapter 7Monopolistic Competition and Oligopoly Section 3

2. Economics and You • Different companies produce different brands that are similar. However, to attract customers, they must make their products unique: • Perfect Competition is one with a large number of firms all producing the same product. No single seller sells too much of the product thus never controlling the supply or price. • A Monopoly is a market in which a single seller dominates and controls price and supply. • Monopolistic Competition is when many companies compete in an open market to sell products that are similar but not identical. • An Oligopoly is a market dominated by a few large, profitable firms.

3. Monopolistic Competition • Companies hold a Monopoly over its own particular product design. • These firms sell goods that are similar enough to be substitutes but are not identical • Jeans are an example (names, styles, colors, and sizes). Also bagel shops, ice cream, gas, retail stores.

4. Four Conditions of Monopolistic Competition • Many Firms: They do not have high start-up costs. They can begin selling goods and earning money after a small initial investment (new firms can join the market quickly) • Few Artificial Barriers to Entry: Very few barriers to entry. Patents do not protect against slightly different products and too many firms do not allow them to work together to keep others out. • Little Control Over Price: Each firm’s goods are a little different so people are willing to pay more for the difference. Firms have more freedom to raise or lower their prices. However, if prices rise too high, people will buy a substitute. • Differentiated Products: Firms can control their price because they can differentiate their products from others. The firms can profit from the differences between his or her products.

5. Non-Price Competition • Because products are a little different, non-price competition is created or competition through ways other than lower prices. • Physical Characteristics: Offer a new size, color, shape, texture, or taste (shoes, pens, cars, etc). These will model a person’s personality, job, family, or income. • Location: Goods can be separated by where they are sold (gas stations, movie theatres, and grocery stores). • Service Level: Firms can charge higher prices if they offer higher levels of service (restaurants) • Advertising, Image, Status: Advertising is used to point out differences (t-shirts)

6. Prices, Output, and Profit • Monopolistic competition looks just like perfect competition. • Prices: Prices will be higher because firms have some power to raise prices. However, the ease at which new firms can enter the market keep prices down (elastic demand). • Output: In monopolistic competition, firms sell their products at higher prices than do perfectly competitive firms, but at lower prices than monopolies • Profits: The firms earn just enough to cover all of their costs. If it makes too much profit, a rival firm will work to steal its competition away, or a new firm will enter the market and offer a cheap substitute. • Production Costs and Variety: There will be many firms, each producing too little output to minimize costs and use resources efficiently, however, consumers can benefit from having a wide variety to choose from.

7. Oligopoly • A market dominated by a few large firms (if the 4 largest firms produce 70%-80% of the total output). They can set prices higher and output lower. Firms include air travel, cars, breakfast cereals, and household appliances. • Barriers to Entry: There can be barriers that keep new firms from entering the market. They can be technological or they can be created by a system of government licenses or patents. Also economic realities of the market discourage competition (Coke and Pepsi). High start-up costs present additional barriers to entry. Creates economies of scale (the average cost of production decreases as output increases). Therefore, 3-4 firms can reach a profitable level of output before the market becomes too crowded.

8. Cooperation and Collusion • Many times these firms will act like a monopoly. The government tries to regulate this. • Price Leaders: can set prices and output for entire industries as long as other member firms go along with the leader’s policy. This can also start a price war (undercutting prices) • Collusion: an agreement among members of an oligopoly to illegally set prices and production levels. One outcome is called price fixing (same or similar prices) • Cartel: an agreement by a formal organization of producers to coordinate prices and production. Illegal in the US, but OPEC exists internationally. These can collapse if output levels are controlled, but most try to produce more (cheat) and prices will eventually fall.