Price Determination under

Monopolistic Competition &

Oligopoly

Dr. Utpal Chattopadhyay

Asst. Professor, NITIE.

Monopolistic
Competition

Many firms
Differentiated products (is in general a
strategic marketing goal) products are
close substitutes to each other;
Demand curve not completely flat
Firms do not react to each others actions
(because there are so many)
Easy entry and exit

Examples: shirts, candy bars,

restaurants

Behavior of monopolistically
competitive firms

Firms in an industry group are similar

(symmetric in extreme), i.e. they have the same
incentives
What happens if firm changes price alone? (dd)
Same incentive for other firms to change price
(DD)
----> demand is steeper in this case

In the extreme: a very small firm changing the price alone

has a very flat demand curve!

Marketing is important: firms want to make their

product unique, in other words:

Demand for their product should get more inelastic

(steep)
Use advertising!

Demand curve if the firm (dd) or the

industry (DD) changes price

Short-run equilibrium

Like a monopolist: set price where

marginal revenue = marginal cost
Profits arise
---> market entry of similar products (firms)
Each firm competes for a percentage of total
demand, new entry means demand for the
individual firm must be lower (shifts left/down)
Shift must be so far, that profits disappear
I.e. Demand curve must finally be tangential to
long-run average cost curve

Long-run equilibrium

Due to market entry

demand shifted to the
left for the firm

Zero profit condition

met (Revenue=Costs)

Profit-maximization
condition met (MC=MR)

Problem: production is
not cost-efficient

Long-run average
costs not at minimum
cost of product
variety

Perfect Competition Vs.

Monopolistic Competition

PC: price equal to long-run marginal cost, in

MonC price is always higher as marginal cost:
there are people out there who value the
good more than the marginal cost to
produce it.
==> in principle production should rise
PC produces at minimum of long-run average
cost, MonC not at the minimum
Trade-Off between efficiency (cost) and
variety
Long-run profit situation is alike, because of
entry, but how short is the short-run??

Summary-Monopolistic
Competition

Very common market form

No interaction between firms
Firm could reduce average cost by producing
more
Firms try to bind their costumers to the firm:
Marketing, advertising plays a role (not in
perfect competition)
Make the product different from the crowd

Oligopoly

A. Few Sellers / Recognized

Interdependence

B. Cournot Model

Firms choose quantity

Assume that other firm does change

output

Example compared to PC and

Monopoly

Oligopoly - Bertrand

Model

Firms choose price rather than output.

With identical goods and constant MC,

then P=?

If products are differentiated. Example

Oligopoly - Chamberlin
(Monopolistic Competition)

Criticized Bertrand and Cournot

models because they failed to
recognize their interdependence. He
argued that intelligent managers
would know where the profitmaximizing price is and would be
reluctant to reduce price and leave all
members of the industry worse off.

Oligopoly - Stackelberg
Model -Price Leadership

Designate one firm as a dominant firm

and all the other's in the industry follow
this firm's cues. I.e. one firm announce
price changes and all the others follow.
Examples

Automotive industry

Banking Industry

Oligopoly - Stigler's

Theory

Incentive to collude is strong so as to

maximize joint profits but so is the
incentive to cheat. If any member can
secretly violate the agreement, he will
gain larger profits than by conforming
to it. Therefore enforcement, i.e.
detecting significant deviations from
the agreed-upon prices, is paramount

Stigler example

Suppose 3 identical firms with zero

costs , facing a market demand
curve of Q=180-5P. The monopoly
price and quantity is $18 and 90
and the three firms agree to each
supply 30. The $1620 industry
profits are split $540 to each.

Oligopoly

Oligopoly

d is the demand curve when everyone

knows (everyone makes 533.33), d' is
when there are secret cuts(if offered to
all his customers then $640, if only to
"new" customers - $700), d'' is secret cut
that steals away other firms customers
without the other firm reacting - $800).
Conclusion - there is a great temptation
to secretly cut prices. Key is detection
and response.

Oligopoly - Game Theory

Prisoner's Dilemma - Two suspected

criminals A and B are arrested and put in

separate cells unable to communicate. If
one confesses while the other does not, the
one who confesses is granted immunity and
goes free and the other goes to jail for 20
years. If both confess they both go to jail for
5 years. If both are silent, both go to jail for
only one year, for a lesser crime (concealed
weapons). The payoff matrix looks like this:

Oligopoly
Mr. A

Confesses
Remains
Silent

Mr. B
Confesses
Remains
Silent
[-5,-5]
[0,-20]
[-20,0]
[-1,-1]

Whatever A does, B is better off confessing.

Whatever B does, A is better off confessing. They
are both better off if they both remain silent.
How can this be?

Oligopoly

Duopolist's Dilemma
Firm A

Cut Price (Rs.

12)

Firm B
Cut Price (Rs.
12)

Fix Price (Rs.

18)

[720,720]

[1440,0]

Fix Price (Rs.

[0, 1440]
[810,810]
18)
Dominant Strategy is to cut price but both firms are
better off by fixing prices.

Can Collusion be
beneficial?

It reduces uncertainty in profit rate ,

demand uncertainty in the face of
production indivisibilities

Example

Can Collusion be
beneficial?

Indivisibilities in production.

Other problems - large fixed and some

avoidable costs with uncertain demand.