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MCD2020 Microeconomics
Tutorial 10: Monopolistic Competition and Oligopoly
(Chapters 1 6 &1 7 )
Learning objectives:
1. Understand the models of competition that lie between monopoly and perfect
competition
2. Compare the outcome under monopolistic competition and under perfect
competition
3. Compare the outcome under monopolistic competition and monopoly
4. Examine the market outcomes in an oligopoly market
5. Discuss the prisoners’ dilemma and how it applies to the strategic behaviour of
oligopoly
Exercises marked with ★ are core content, and should be prioritised during class time.
Two market types between perfect competition and monopoly are:
- Monopolistic competition Example: Coffee shops (e.g., Starbucks, local cafés).
- Oligopoly Example: Soft drink market (e.g., Coca-Cola, Pepsi).
Learning Objective 1
★ Question 1 – Characteristics of monopolistic competition
The table below lists several market characteristics. For each one: Indicate whether it applies to monopolistic competition by writing “Yes” or “No” in the second column. The third column provides a brief explanation of the characteristic in the context of monopolistic competition to help you decide. . Characteristic Monopolistic Competition Yes / No Explanation Many sellers Many small firms compete in the market. Identical or similar products Firms sell the same or almost the same products Differentiated products Each firm’s product is slightly different. Easy entry and exit for firms Low barriers to entry and exit Few firms dominate the market Market power is concentrated in a few firms Firms have significant control over price Firms can strongly influence market prices Few or no close substitutes Few, if any, alternative goods meet the same need Heavy use of adverting and branding Strong focus on marketing and building brand identity Strong price competition Firms mainly compete by charging lower prices Large start-up costs Significant costs to enter the market
★ Question 3 - Monopolistic competition and consumer surplus (loss of consumer welfare)
The following figure illustrates the market for Sparkle toothpaste in long-run equilibrium. The profit-maximising level of output is QM and the price is PM. Based on the diagram, circle or fill in the correct word to complete the following paragraph: Sparkle’s profit is …………., since at quantity QM, …………………. equals ……………………. The consumer surplus from the purchase of Sparkle toothpaste is area ………….. The efficient level of output occurs where the ……………. curve intersects the …………………. curve, at …………. So, the deadweight loss is area …………, the area above ……….. and below …………, from ………… to ………..
Learning Objective 3
★ Question 4 - Monopolistic competition and monopoly compared
Firms in monopolistic competition and monopoly both face downward-sloping demand curves, but their market outcomes differ. a) Using separate diagrams for each market structure, draw and label the long-run equilibrium for:
- A monopolistically competitive firm
- A monopoly
Learning Objective 4
★ Question 5 – Characteristics of oligopoly market
The table below lists several market characteristics. For each one: Indicate whether it applies to oligopoly by writing “Yes” or “No” in the second column. The third column provides a brief explanation of the characteristic in the context of oligopoly to help you decide. Characteristic Oligopoly Yes / No Explanation Many sellers Only a few firms dominate. Identical or similar products Some oligopolies sell similar products (e.g., petrol). Differentiated products Many oligopolies differentiate through branding and features Easy entry and exit for firms High costs and strong barriers block new entrants. Few firms dominate the market A small number of large firms control most of the market. Firms have significant control over price Few competitors allow more influence on price Few or no close substitutes Depends - Substitutes exist (e.g. tea or coffee for soft drinks). No close substitutes (e.g. air tickets) Heavy use of adverting and branding Used to strengthen brand loyalty and market share. Strong price competition Price wars can occur, especially in similar-product oligopolies. (e.g. air lines) Large start-up costs Large investments needed for production, marketing, or distribution.
Learning Objective 5
★ Question 6 – Prisoners’ dilemma
A pair of bank robbers, Bonnie and Clyde, have been caught. The police have enough evidence to convict them both on an unlicensed gun charge (which carries a sentence of one year) but suspect that they have been involved in a bank robbery (which carries a sentence of 20 years). The police need at least one of the two to confess to the bank robbery, so they interview the two in separate rooms. The decision whether to confess or not to confess for both Bonnie and Clyde can be described using the following matrix: a) Explain why Bonnie’s dominant strategy is to confess? Why Clyde’s dominant strategy is to confess? …………………………………………………………………………………………………………………………………………… …………………………………………………………………………………………………………………………………………… ……………………………………. b) If they would both cooperate and stay silent how many years would they sentenced to stay in prison? …………………………………………………………………………………………………………………………………………………………… ………………………………………………………
Q. 7 Prisoners’ dilemma and oligopoly strategy Assume that Coca Cola and Pepsi Cola are the only companies supplying soft drinks in Australia, and they are considering whether to advertise on television or not. Successful advertising could attract more customers away from the other company, but at the same time advertising will lower profit because it is very expensive. a) What is the dominant strategy for each of them? Explain your answer. ……………………………………………………………………………………………………………………………………………………………… ……………………………………………………………………………………………………………………………………………………………… …………………………………………………………………………………………………………………… b) The Australian Government is very concerned with the obesity level caused by the consumption of soft drink and is considering a new law banning soft drink advertising on television. How would this policy affect the profit of both companies? ……………………………………………………………………………………………………………………………………………………………… ……………………………………………………………………………………………………………………………………………………………… c) Could this ban still be good public policy? Explain your answer. …………………………………………………………………………………………………………… …………………………………………………………………………………………………………… ……………………………………………………………………………………………………
Independent Learning Question 1 Fill in the table to compare market structures Do firms: Perfect Competition Monopolistic Competition Oligopoly Monopoly Have higher average costs? Pick Q so that MR = MC? Pick Q so that P = MC? Earn economic profits in the long-run Face a downward-sloping demand curve Have MR less than price? Exit in the long run if profits are less than zero
f) Use your answer to part (e) to explain why cartel agreements are often not successful. ………………………………………………………………………………………………………………………………………………… ………………………………………………………………………………………………………………… g) Calculating non- cooperative equilibrium using the Nash equilibrium formula, the j joint output will be equal to of the competitive output and equal to diamonds. ………………………………………………………………………………………………………………………………………………… …………………………………………………………………………………………………………………
