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Oligopolies

  • Oligopoly: An industry in which individual firms can influence market conditions
  • Contestable Markets: A market where firms can costlessly enter and exit

Is is possible to charge a monopoly price in a contestable market? No

  • A monopolist will produce where MC = MR
    • Quantity supplied to the market is QM at a price of PM
  • A monopoly price means the firm is making profit
    • This incentivizes other firms to enter the market
    • Eventually, this makes being a monopolist unsustainable since firms can freely enter and leave (make a profit then leave the market once it’s unsustainable)

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Chpt 11: Market Power, Collusion, and Oligopoly

PM

QM

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Oligopolies

  • Oligopoly: An industry in which individual firms can influence market conditions
  • Contestable Markets: A market where firms can costlessly enter and exit

For a monopolist to prevent this, they have to charge a lower price

  • Recall that the MC intersects the lowest point of AC
    • The supply curve for a firm is only the portion of MC above where it intersects AC
    • Any point below is too expensive for the firm to produce
  • To survive in the market, the firm would charge a price of P0 and and produce a quantity Q0
    • Produce at the minimum price to survive in the market
  • Notice that at a price of P0 the market demand is Q0
    • Consumer demand is much higher than what the monopolist is able to produce individually
    • The difference between Q1 and Q0 is supplied by competitors who enter the market

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Chpt 11: Market Power, Collusion, and Oligopoly

PM

QM

3 of 9

Oligopolies

  • Contestable Markets: A market where firms can costlessly enter and exit
  • The monopolist in this graph will produce 12 units at a price of $10
    • Consumers demand 40 units given by the demand curve
    • This leaves a shortage of 28 units = 40 - 12
  • Other firms will compete to supply those 28 units

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Chpt 11: Market Power, Collusion, and Oligopoly

4 of 9

Oligopolies

  • Contestable Markets: A market where firms can costlessly enter and exit
  • The monopolist in this graph will produce 12 units at a price of $10
    • Consumers demand 40 units given by the demand curve
    • This leaves a shortage of 28 units = 40 - 12
  • Other firms will compete to supply those 28 units

How many firms will exist in this market?

  • = Market demand / Monopolist supply
    • 40/12 = 3.33
    • This shows that roughly 3 firms will supply the total market demand
  • Price is low enough that an individual firm won’t be able to supply the market
    • Since the monopolist is producing at the cheapest price, other firms can’t produce more than them without increasing price and losing out

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Chpt 11: Market Power, Collusion, and Oligopoly

5 of 9

Oligopolies

  • Contestable Markets: A market where firms can costlessly enter and exit
  • Natural Monopoly: An industry in which each firm’s average cost curve is decreasing until it intersects market demand
  • A monopolist will produce where MC = MR which supplies the market Q2 units at a price of P2
  • A competitive market would want a price of P0 and a quantity of Q0 where MC meets the demand curve

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Chpt 11: Market Power, Collusion, and Oligopoly

P2

P1

P0

6 of 9

Oligopolies

  • Contestable Markets: A market where firms can costlessly enter and exit
  • Natural Monopoly: An industry in which each firm’s average cost curve is decreasing until it intersects market demand
  • A monopolist will produce where MC = MR which supplies the market Q2 units at a price of P2
  • A competitive market would want a price of P0 and a quantity of Q0 where MC meets the demand curve

Where does a natural monopolist produce then?

  • AC meets the demand curve
  • Producing a quantity of Q1 and selling it at a price of P1
  • This allows the monopolist to meet demand and prevent new entrants into the market
    • Recall that a natural monopoly intersects the demand curve right when AC stops decreasing
    • Since a firm supply is only above where MC and AC intersect, P1 is the lowest price the monopolist can supply the market

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Chpt 11: Market Power, Collusion, and Oligopoly

P2

P1

P0

7 of 9

Monopolistic Competition

  • Monopolistic competition: The theory of markets where there are many similar but differentiated products

Suppose that you charge a price P and produce a quantity Q in the short-run; shown in the top graph

  • Notice that this is much higher than the price where MC = MR
    • Meaning you’re earning positive profit
  • In the long-run, competitors will see your positive profits and enter the market

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Chpt 11: Market Power, Collusion, and Oligopoly

8 of 9

Monopolistic Competition

  • Monopolistic competition: The theory of markets where there are many similar but differentiated products

Suppose that you charge a price P and produce a quantity Q in the short-run; shown in the top graph

  • In the long-run, competitors will see your positive profits and enter the market
    • This cuts into your demand and shifts the demand curve leftwards - shown in the bottom graph
    • The long-run price quantity produced is Q’ units where MC=MR
    • The long-run price is where Q’ meets the demand curve
  • The long-run graph shows that the firms earn zero profit
    • No more entry by competitors into the market

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Chpt 11: Market Power, Collusion, and Oligopoly

9 of 9

Monopolistic Competition

  • Monopolistic competition: The theory of markets where there are many similar but differentiated products

Suppose that you charge a price P and produce a quantity Q in the short-run; shown in the top graph

  • In the long-run, competitors will see your positive profits and enter the market
    • The demand curve shifts leftwards
    • The long-run price is P’ and produce is Q’ units
  • Notice that P’ is not at the minimum point of the AC curve
    • P’ meets where demand is tangent to AC
    • This is marginally more expensive than a competitive market
  • This suggest that a competitive market could produce the same output at a lower cost
    • Consumer surplus under a competitive market > Consumer surplus in a monopolistically competitive market
    • Note that consumer surplus is just based on the price difference, there’s no accounting for the benefits of different products

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Chpt 11: Market Power, Collusion, and Oligopoly