Table 5.1 shows the four significant categories of sector structures and their characteristics.

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Table 5.1 industry Structure Characteristics

Free entry and exit

Barriers come entry

No entry

Perfect competition is ~ above one end of the market structure spectrum, with countless firms. The word, “numerous” has actually special definition in this context. In a perfect competitive industry, every firm is so tiny relative to the market that the cannot influence the price that the good. Every perfectly competitive firm is a price taker. Therefore, countless firms method that each firm is so tiny that that is a price taker.

Monopoly is the other excessive of the sector structure spectrum, v a solitary firm. Monopolies have monopoly power, or the ability to adjust the price the the good. Syndicate power is also called sector power, and also is measure up by the Lerner Index.

This chapter defines and also describes two intermediary market structures: monopolistic competition and oligopoly.

Monopolistic Competition = A sector structure defined by a distinguished product and also freedom that entry and also exit.

Monopolistically compete firms have actually one characteristic that is choose a syndicate (a differentiated product provides market power), and one characteristic that is prefer a competitive certain (freedom the entry and exit). This kind of market structure is typical in market-based economies, and a trip to the grocery keep reveals huge numbers of distinguished products: toothpaste, to wash soap, breakfast cereal, and also so on.

Next, we define the market structure oligopoly.

Oligopoly = A industry structure identified by barriers to entry and a few firms.

Oligopoly is a fascinating market structure due to interaction and interdependency between oligopolistic firms. What one firm go affects the other firms in the oligopoly.

Since monopolistic competition and oligopoly space intermediary sector structures, the next section will review the properties and also characteristics that perfect competition and monopoly. These attributes will administer the defining attributes of monopolistic competition and also oligopoly.

5.1.2 evaluation of Perfect Competition

The perfect competitive market has four characteristics:

(1) Homogenous product,

(2) large number of buyers and also sellers (numerous firms),

(3) liberty of entry and also exit, and

(4) Perfect information.

The opportunity of entry and exit of firms wake up in the lengthy run, because the number of firms is resolved in the quick run.

An equilibrium is characterized as a allude where there is no propensity to change. The principle of equilibrium can be extended to encompass the brief run and also long run.

Short run Equilibrium = A point from which there is no tendency to change (a steady state), and a fixed number of firms.

Long operation Equilibrium = A allude from which there is no tendency to change (a steady state), and entry and also exit of firms.

In the quick run, the number of firms is fixed, vice versa, in the long run, entry and exit of that company is possible, based on profit conditions. We will certainly compare the short and also long run for a competitive firm in figure 5.1. The 2 panels in number 5.1 space for the firm (left) and also industry (right), with vastly different units. This is emphasized by utilizing “q” for the firm’s calculation level, and “Q” because that the market output level. The graph shows both brief run and long operation equilibria for a perfect competitive firm and also industry. In brief run equilibrium, the firms faces a high price (PSR), produces quantity QSR in ~ PSR = MC, and also earns optimistic profits πSR.


Figure 5.1 brief Run and Long run Equilibria because that a perfect Competitive Firm

Positive profits in the brief run (πSR > 0) bring about entry of other firms, as there room no barriers to entry in a compete industry. The entry of brand-new firms shifts the supply curve in the industry graph from supply SSR to supply SLR. Entrance will take place until earnings are pushed to zero, and long operation equilibrium is got to at Q*LR. In the lengthy run, financial profits space equal come zero, so there is no motivation for entry or exit. Every firm is earning precisely what the is worth, the opportunity costs of all resources. In lengthy run equilibrium, revenues are zero (πLR = 0), and also price amounts to the minimum average cost point (P = min AC = MC). Marginal costs equal average costs at the minimum average cost point. In ~ the lengthy run price, it is provided equals demand at price PLR.

5.1.3 testimonial of Monopoly

The attributes of syndicate include: (1) one firm, (2) one product, and also (3) no entry (Table 5.1). The monopoly solution is displayed in number 5.2.


Figure 5.2 syndicate Profit Maximization

Note the long-run profits can exist because that a monopoly, since barriers to entrance halt any type of potential entrants native joining the industry. In the following section, us will check out market frameworks that lie in between the 2 extremes the perfect competition and monopoly.

5.2 Monopolistic Competition

Monopolistic vain is a sector structure defined by complimentary entry and exit, prefer competition, and differentiated products, prefer monopoly. Differentiated products administer each firm through some market power. Advertising and marketing of each individual product provide uniqueness that reasons the need curve of each great to it is in downward sloping. Cost-free entry suggests that each firm competes with various other firms and profits room equal to zero on lengthy run equilibrium. If a monopolistically competitive certain is earning positive financial profits, entry will take place until financial profits are equal to zero.

5.2.1 Monopolistic compete in the Short and also Long Runs

The need curve that a monopolistically competitive firm is downward sloping, indicating that the firm has actually a degree of market power. Sector power derives indigenous product differentiation, because each certain produces a different product. Each an excellent has plenty of close substitutes, so industry power is limited: if the price is boosted too much, consumers will change to competitors’ products.


Figure 5.3 Monopolistic competition in the quick Run and Long Run

Short and also long run equilibria because that the monopolistically competitive firm are presented in figure 5.3. The need curve facing the certain is bottom sloping, but fairly elastic as result of the ease of access of near substitutes. The brief run equilibrium appears in the left hand panel, and is almost identical to the monopoly graph. The only distinction is the for a monopolistically vain firm, the need is fairly elastic, or flat. Otherwise, the short run profit-maximizing equipment is the exact same as a monopoly. The firm sets marginal revenue equal to marginal cost, produces calculation level q*SR and charges price PSR. The profit level is displayed by the shaded rectangle π.

The lengthy run equilibrium is displayed in the appropriate hand panel. Entry of various other firms wake up until revenues are equal to zero; complete revenues room equal to complete costs. Thus, the need curve is tangent come the average price curve at the optimal lengthy run quantity, q*LR. The lengthy run profit-maximizing amount is uncovered where marginal revenue amounts to marginal cost, which also occurs in ~ q*LR.

5.2.2 economic Efficiency and Monopolistic Competition

There space two sources of incompetent in monopolistic competition. First, dead weight loss (DWL) early to monopoly power: price is higher than marginal expense (P > MC). Second, overfill capacity: the equilibrium quantity is smaller than the lowest price quantity at the minimum allude on the average expense curve (q*LR minAC). These two sources of inefficiency deserve to be watched in number 5.4.


Figure 5.4 comparison of performance for Competition and also Monopolistic Competition

First, over there is dead weight loss (DWL) due to market power: the price is greater than marginal cost in long run equilibrium. In the ideal hand dashboard of number 5.4, the price at the long run equilibrium quantity is PLR, and also marginal price is lower: PLR > MC. This reasons dead load loss come society, because the compete equilibrium would be at a larger quantity wherein P = MC. Total dead weight loss is the shaded area in ~ the need curve and above the MC curve in number 5.4.

The second source that inefficiency linked with monopolistic compete is overabundance capacity. This can likewise be checked out in the right hand dashboard of number 5.4, whereby the lengthy run equilibrium quantity is reduced than the amount where average prices are shortest (qminAC). Therefore, the firm might produce at a lower price by boosting output to the level wherein average expenses are minimized.

Given these two inefficiencies associated with monopolistic competition, some individuals and groups have dubbed for government intervention. Regulation could be provided to minimize or get rid of the inefficiencies by removing product differentiation. This would an outcome in a solitary product instead of a huge number of nearby substitutes.

Regulation is more than likely not a great solution come the inefficiencies of monopolistic competition, for 2 reasons. First, the sector power of a usual firm in most monopolistically competitive industries is small. Each monopolistically competitive industry has numerous firms that produce sufficiently substitutable products to provide enough competition to result in fairly low levels of industry power. If the that company have small levels of sector power, then the deadweight loss and excess volume inefficiencies are most likely to be small.

Second, the benefit detailed by monopolistic vain is product diversity. The acquire from product diversity have the right to be large, together consumers room willing to salary for various characteristics and qualities. Therefore, the gain from product diversity is likely to outweigh the expenses of inefficiency. Evidence for this case can be seen in market-based economies, whereby there is a vast amount the product diversity.

The next chapter will introduce and also discuss oligopoly: strategy interactions between firms!

5.3 Oligopoly Models

An oligopoly is defined as a market structure with couple of firms and barriers come entry.

Oligopoly = A market structure with few firms and also barriers to entry.

There is regularly a high level of competition in between firms, as each firm makes decisions on prices, quantities, and advertising come maximize profits. Since there space a small number of firms in one oligopoly, each firm’s benefit level depends not only on the firm’s own decisions, but likewise on the decisions of the other firms in the oligopolistic industry.

5.3.1 strategy Interactions

Each for sure must think about both: (1) various other firms’ reactions to a firm’s very own decisions, and also (2) the own firm’s reactions to the various other firms’ decisions. Thus, over there is a constant interplay between decisions and reactions come those decisions by every firms in the industry. Every oligopolist must take right into account this strategic interactions as soon as making decisions. Since all firms in an oligopoly have outcomes that depend on the various other firms, this strategic interactions are the structure of the study and understanding the oligopoly.

For example, each car firm’s industry share counts on the prices and also quantities of all of the various other firms in the industry. If Ford lowers prices relative to other vehicle manufacturers, it will boost its sector share in ~ the expense of the other automobile companies.

When making decision that take into consideration the possible reactions of various other firms, firm managers usually assume the the managers of competing firms space rational and also intelligent. These strategic interactions type the research of game theory, the subject of thing 6 below. Man Nash (1928-2015), an American mathematician, to be a pioneer in game theory. Economists and also mathematicians usage the principle of a Nash Equilibrium (NE) to describe a typical outcome in video game theory the is commonly used in the research of oligopoly.

Nash Equilibrium = result where there is no tendency to adjust based on every individual picking a strategy provided the strategy of rivals.

In the research of oligopoly, the Nash Equilibrium assumes the each firm makes rational profit-maximizing decisions while stop the actions of competitor firms constant. This assumption is do to leveling oligopoly models, provided the potential for enormous complexity of strategy interactions in between firms. As an aside, this presumption is among the amazing themes that the motion picture, “A Beautiful Mind,” starring Russell Crowe as man Nash. The concept of Nash Equilibrium is likewise the structure of the models the oligopoly presented in the next three sections: the Cournot, Bertrand, and Stackelberg models the oligopoly.

5.3.2 Cournot Model

Augustin Cournot (1801-1877), a French mathematician, developed the very first model the oligopoly explored here. The Cournot design is a model of oligopoly in which firms produce a homogeneous good, assuming the the competitor’s output is fixed when deciding just how much come produce.

A numerical example of the Cournot design follows, where it is assumed the there are two similar firms (a duopoly), with output provided by Qi (i=1,2). Therefore, full industry calculation is same to: Q = Q1 + Q2. Market need is a duty of price and given by Qd = Qd(P), for this reason the inverse demand function is p = P(Qd). Note that the price depends on the sector output Q, which is the amount of both separation, personal, instance firm’s outputs. In this way, each firm’s output has an affect on the price and profits of both firms. This is the basis for strategic interaction in the Cournot model: if one firm rises output, that lowers the price facing both firms. The station demand role and cost duty are provided in Equation 5.1.

(5.1) ns = 40 – QC(Qi) = 7Qi ns = 1,2

Each firm choose the optimal, profit-maximizing calculation level given the various other firm’s output. This will result in a Nash Equilibrium, due to the fact that each for sure is holding the habits of the competitor constant. Certain One maximizes revenues as follows.

max π1 = TR1 – TC1

max π1 = P(Q)Q1 – C(Q1)

max π1 = <40 – Q>Q1 – 7Q1

max π1 = <40 – Q1 – Q2>Q1 – 7Q1

max π1 = 40Q1 – Q12 – Q2Q1 – 7Q1

∂π1/∂Q1= 40 – 2Q1 – Q2 – 7 = 0

2Q1 = 33 – Q2

Q1* = 16.5 – 0.5Q2

This equation is dubbed the “Reaction Function” of certain One. This is as far as the math solution can be simplified, and represents the Cournot solution for firm One. The is a reaction function since it describes Firm One’s reaction given the calculation level of certain Two. This equation to represent the strategic interactions between the two firms, as alters in certain Two’s calculation level will result in changes in for sure One’s response. Firm One’s optimal calculation level counts on for sure Two’s behavior and decision making. Oligopolists space interconnected in both behavior and outcomes.

The 2 firms are assumed to be similar in this duopoly. Therefore, certain Two’s reaction function will be symmetrical to the for sure One’s reaction role (check this by setting up and solving the profit-maximization equation because that Firm Two):

Q2* = 16.5 – 0.5Q1

The 2 reaction features can be supplied to resolve for the Cournot-Nash Equilibrium. There room two equations and also two unknowns (Q1 and Q2), so a numerical equipment is uncovered through substitution the one equation right into the other.

Q1* = 16.5 – 0.5(16.5 – 0.5Q1)

Q1* = 16.5 – 8.25 + 0.25Q1

Q1* = 8.25 + 0.25Q1

0.75Q1* = 8.25

Q1* = 11

Due come symmetry indigenous the presumption of identical firms:

Qi = 11 ns = 1,2Q = 22units p = 18 USD/unit

Profits for each for sure are:

πi = P(Q)Qi – C(Qi) = 18(11) – 7(11) = (18 – 7)11 = 11(11) = 121 USD

This is the Cournot-Nash solution for oligopoly, found by every firm assuming the the other firm stop its output level constant. The Cournot model deserve to be conveniently extended to an ext than two firms, yet the math does acquire increasingly complex as more firms room added. Financial experts utilize the Cournot model because is based upon intuitive and realistic assumptions, and the Cournot systems is intermediary between the outcomes that the two too much market structures of perfect competition and monopoly.

This can be checked out by solving the numerical instance for competition, Cournot, and monopoly models, and also comparing the solutions for each industry structure.

In a competitive industry, free entry outcomes in price same to marginal cost (P = MC). In the situation of the number example, pc = 7. As soon as this vain price is substituted into the inverse need equation, 7 = 40 – Q, or Qc = 33. Revenues are uncovered by addressing (P – MC)Q, or πc = (7 – 7)Q = 0. The competitive solution is offered in Equation (5.2).

(5.2) pc = 7 USD/unitQc = 33 unitsπc = 0 USD

The monopoly solution is discovered by maximizing earnings as a single firm.

max πm = TRm – TCm

max πm = P(Qm)Qm – C(Qm)

max πm = <40 – Qm>Qm – 7Qm

max πm = 40Qm – Qm2 – 7Qm

∂πm/∂Qm= 40 – 2Qm – 7 = 0

2Qm = 33

Qm* = 16.5

Pm = 40 – 16.5 = 23.5

πm = (Pm – MCm)Qm = (23.5 – 7)16.5 = 16.5(16.5) = 272.25 USD

The monopoly solution is offered in Equation (5.3).

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(5.3) pm = 23.5 USD/unit Qm = 16.5 unitsπm = 272.5 USD

The competitive, Cournot, and syndicate solutions have the right to be compared on the exact same graph for the numerical instance (Figure 5.5).