Table 5.1 mirrors the four major categories of sector structures and their characteristics.

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Table 5.1 industry Structure Characteristics

Free entry and also exit

Barriers to entry

No entry

Perfect competition is top top one finish of the industry structure spectrum, with numerous firms. The word, “numerous” has actually special definition in this context. In a perfect competitive industry, each firm is so little relative come the market that that cannot impact the price that the good. Each perfectly competitive certain is a price taker. Therefore, many firms means that every firm is so tiny that that is a price taker.

Monopoly is the other excessive of the market structure spectrum, v a single firm. Monopolies have monopoly power, or the ability to change the price the the good. Monopoly power is additionally called market power, and is measure by the Lerner Index.

This thing defines and also describes two intermediary industry structures: monopolistic competition and also oligopoly.

Monopolistic Competition = A industry structure characterized by a differentiated product and freedom the entry and exit.

Monopolistically competitive firms have actually one characteristic that is favor a monopoly (a identified product offers market power), and also one characteristic the is favor a competitive for sure (freedom of entry and exit). This form of market structure is typical in market-based economies, and also a trip to the grocery save reveals big numbers of identified products: toothpaste, to wash soap, breakfast cereal, and also so on.

Next, we define the industry structure oligopoly.

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

Oligopoly is a fascinating market structure because of interaction and interdependency between oligopolistic firms. What one firm walk 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 the perfect competition and also monopoly. These features will administer the defining qualities of monopolistic competition and oligopoly.

5.1.2 testimonial of Perfect Competition

The perfectly competitive sector has 4 characteristics:

(1) Homogenous product,

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

(3) liberty of entry and also exit, and

(4) Perfect information.

The opportunity of entry and exit the firms wake up in the lengthy run, since the variety of firms is solved in the quick run.

An equilibrium is identified as a allude where there is no tendency to change. The concept of equilibrium have the right to be extended to encompass the brief run and also long run.

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

Long run Equilibrium = A suggest from which over there is no propensity to readjust (a secure state), and entry and exit of firms.

In the brief run, the variety of firms is fixed, vice versa, in the lengthy run, entry and exit of that company is possible, based upon profit conditions. We will certainly compare the short and also long run for a competitive certain in figure 5.1. The 2 panels in number 5.1 space for the certain (left) and industry (right), through vastly different units. This is emphasized by making use of “q” because that the firm’s calculation level, and “Q” for the sector output level. The graph shows both quick run and also long operation equilibria for a perfect competitive firm and also industry. In brief run equilibrium, the firms encounters a high price (PSR), produces amount QSR at PSR = MC, and earns positive profits πSR.


Figure 5.1 brief Run and also Long run Equilibria for a perfectly Competitive Firm

Positive earnings in the short run (πSR > 0) result in entry of various other firms, together there space no obstacles to entry in a compete industry. The entrance of new firms shifts the it is provided curve in the sector graph from it is provided SSR to it is provided SLR. Entrance will take place until profits are thrust to zero, and also long run equilibrium is reached at Q*LR. In the lengthy run, financial profits space equal to zero, so there is no inspiration for entry or exit. Every firm is earning specifically what the is worth, the opportunity prices of all resources. In lengthy run equilibrium, revenues are zero (πLR = 0), and price equates to the minimum average cost point (P = min AC = MC). Marginal prices equal average prices at the minimum average price point. At the lengthy run price, it is provided equals need at price PLR.

5.1.3 review of Monopoly

The features of monopoly include: (1) one firm, (2) one product, and also (3) no entrance (Table 5.1). The syndicate solution is shown in figure 5.2.


Figure 5.2 syndicate Profit Maximization

Note the long-run profits have the right to exist for a monopoly, since barriers to entry halt any kind of potential entrants native joining the industry. In the next section, we will discover market frameworks that lie between the 2 extremes of perfect competition and also monopoly.

5.2 Monopolistic Competition

Monopolistic compete is a sector structure identified by complimentary entry and exit, like competition, and also differentiated products, choose monopoly. Distinguished products administer each firm with some sector power. Advertising and also marketing of each individual product carry out uniqueness that reasons the demand curve the each great to be downward sloping. Totally free entry suggests that every firm competes with other firms and profits room equal come zero on long run equilibrium. If a monopolistically competitive for sure is earning positive financial profits, entry will occur until financial profits are equal come zero.

5.2.1 Monopolistic vain in the Short and Long Runs

The need curve that a monopolistically competitive certain is bottom sloping, indicating the the firm has a level of industry power. Industry power derives from product differentiation, due to the fact that each firm produces a various product. Each great has many close substitutes, so market power is limited: if the price is enhanced too much, consumer will shift to competitors’ products.


Figure 5.3 Monopolistic vain in the short Run and also Long Run

Short and long run equilibria because that the monopolistically competitive for sure are presented in number 5.3. The demand curve encountering the for sure is bottom sloping, but reasonably elastic as result of the ease of access of close substitutes. The short run equilibrium appears in the left hand panel, and also is practically identical come the syndicate graph. The only distinction is the for a monopolistically competitive firm, the need is reasonably elastic, or flat. Otherwise, the brief run profit-maximizing solution is the very same as a monopoly. The for sure sets marginal revenue equal to marginal cost, produces output level q*SR and also charges price PSR. The profit level is presented by the shaded rectangle π.

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

5.2.2 economic Efficiency and also Monopolistic Competition

There room two resources of incompetent in monopolistic competition. First, dead load loss (DWL) early to syndicate power: price is greater than marginal cost (P > MC). Second, overfill capacity: the equilibrium quantity is smaller than the lowest cost quantity at the minimum allude on the average cost curve (q*LR minAC). This two sources of inefficiency can be viewed in number 5.4.


Figure 5.4 comparison of performance for Competition and Monopolistic Competition

First, over there is dead weight loss (DWL) due to market power: the price is higher than marginal expense in lengthy run equilibrium. In the ideal hand dashboard of number 5.4, the price at the long run equilibrium quantity is PLR, and marginal price is lower: PLR > MC. This reasons dead load loss come society, due to the fact that the competitive equilibrium would be at a bigger quantity whereby P = MC. Complete dead weight loss is the shaded area beneath the demand curve and above the MC curve in number 5.4.

The second source of inefficiency associated with monopolistic vain is overfill capacity. This can also be viewed in the best hand panel of number 5.4, wherein the long run equilibrium quantity is reduced than the quantity where average expenses are shortest (qminAC). Therefore, the firm could produce at a lower cost by boosting output to the level where average costs are minimized.

Given these 2 inefficiencies linked with monopolistic competition, some individuals and groups have dubbed for federal government intervention. Regulation can be used to reduce or remove the inefficiencies by removing product differentiation. This would result in a solitary product rather of a large number of close substitutes.

Regulation is most likely not a great solution to the inefficiencies of monopolistic competition, for 2 reasons. First, the sector power that a typical firm in most monopolistically competitive markets is small. Every monopolistically competitive market has numerous firms that develop sufficiently substitutable assets to carry out enough compete to result in relatively low levels of market power. If the this firm have small levels of market power, climate the deadweight loss and also excess capacity inefficiencies are likely to be small.

Second, the benefit listed by monopolistic competition is product diversity. The acquire from product diversity can be large, as consumers space willing to salary for different characteristics and also qualities. Therefore, the get from product diversity is likely to outweigh the costs of inefficiency. Proof for this case can be viewed in market-based economies, where there is a large amount the product diversity.

The next chapter will certainly introduce and also discuss oligopoly: strategic interactions in between firms!

5.3 Oligopoly Models

An oligopoly is identified as a industry structure with few firms and also barriers to entry.

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

There is often a high level the competition in between firms, as each firm provides decisions ~ above prices, quantities, and also advertising come maximize profits. Due to the fact that there are a small variety of firms in one oligopoly, every firm’s profit level depends not just on the firm’s own decisions, but additionally on the decision of the other firms in the oligopolistic industry.

5.3.1 strategic Interactions

Each certain must think about both: (1) various other firms’ reaction to a firm’s very own decisions, and (2) the own firm’s reaction to the other firms’ decisions. Thus, over there is a consistent interplay between decisions and also reactions come those decisions by all firms in the industry. Each oligopolist must take right into account these strategic interactions as soon as making decisions. Since all this firm in one oligopoly have actually outcomes that count on the various other firms, this strategic interactions space the structure of the study and also understanding the oligopoly.

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

When making decisions that take into consideration the feasible reactions of various other firms, firm managers usually assume the the managers of contending firms space rational and intelligent. This strategic interactions type the research of game theory, the topic of chapter 6 below. Man Nash (1928-2015), an American mathematician, was a pioneer in video game theory. Economists and mathematicians usage the concept of a Nash Equilibrium (NE) to explain a common outcome in game theory the is generally used in the study of oligopoly.

Nash Equilibrium = an outcome where there is no propensity to change based on each individual selecting a strategy provided the strategy that rivals.

In the research of oligopoly, the Nash Equilibrium assumes that each firm provides rational profit-maximizing decision while hold the behavior of competitor firms constant. This assumption is do to leveling oligopoly models, given the potential for enormous intricacy of strategic interactions between firms. Together an aside, this assumption is one of the exciting themes that the movement picture, “A Beautiful Mind,” starring Russell Crowe as john Nash. The concept of Nash Equilibrium is additionally the structure of the models of oligopoly presented in the following three sections: the Cournot, Bertrand, and also Stackelberg models that oligopoly.

5.3.2 Cournot Model

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

A numerical example of the Cournot design follows, wherein it is assumed the there space two similar firms (a duopoly), through output given by Qi (i=1,2). Therefore, total industry output is same to: Q = Q1 + Q2. Market demand is a function of price and given through Qd = Qd(P), therefore the inverse demand role is p = P(Qd). Keep in mind that the price depends on the sector output Q, i m sorry is the amount of both individual firm’s outputs. In this way, each firm’s output has actually an influence on the price and also profits that both firms. This is the basis for strategic interaction in the Cournot model: if one firm boosts output, the lowers the price encountering both firms. The inverse demand duty and cost duty are provided in Equation 5.1.

(5.1) ns = 40 – QC(Qi) = 7Qi i = 1,2

Each firm choose the optimal, profit-maximizing output level offered the various other firm’s output. This will an outcome in a Nash Equilibrium, since each for sure is hold the habits of the rival constant. Certain One maximizes earnings 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 much as the mathematical solution deserve to be simplified, and represents the Cournot systems for certain One. The is a reaction duty since it describes Firm One’s reaction offered the output level of firm Two. This equation to represent the strategy interactions between the 2 firms, as changes in for sure Two’s output level will result in changes in for sure One’s response. Certain One’s optimal output level counts on for sure Two’s behavior and also decision making. Oligopolists are interconnected in both behavior and outcomes.

The 2 firms room assumed come be the same in this duopoly. Therefore, firm Two’s reaction role will be symmetrical to the firm One’s reaction duty (check this by setting up and solving the profit-maximization equation because that Firm Two):

Q2* = 16.5 – 0.5Q1

The 2 reaction attributes can be used to settle for the Cournot-Nash Equilibrium. There space two equations and also two unknowns (Q1 and Q2), so a numerical solution is discovered 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 native the assumption of the same firms:

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

Profits because that each certain are:

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

This is the Cournot-Nash systems for oligopoly, discovered by each firm assuming that the other firm holds its output level constant. The Cournot model deserve to be easily extended to more than 2 firms, but the mathematics does obtain increasingly facility as more firms room added. Economists utilize the Cournot model since is based upon intuitive and also realistic assumptions, and also the Cournot equipment is intermediary in between the outcomes the the two too much market frameworks of perfect competition and monopoly.

This have the right to be viewed by addressing the numerical instance for competition, Cournot, and monopoly models, and comparing the solutions for each market structure.

In a competitive industry, complimentary entry results in price same to marginal price (P = MC). In the situation of the number example, pc = 7. When this compete price is substituted into the inverse need equation, 7 = 40 – Q, or Qc = 33. Earnings are uncovered by resolving (P – MC)Q, or πc = (7 – 7)Q = 0. The competitive systems is offered in Equation (5.2).

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

The monopoly solution is uncovered by maximizing revenues as a solitary 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 syndicate 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 deserve to be compared on the exact same graph because that the numerical example (Figure 5.5).