(10) Monopolistic Competition and Oligopoly

Total Video Time: 46 minutes



This module covers the market structures that a majority of firms in American fall under: monopolistic competition and oligopoly. Monopolistic competition occurs when many firms produce the same good but they all do it in a slightly different way. The key idea here is that consumers can observe differences in the products and have preferences over them. In perfect competition, we assume that I can’t tell the difference between wheat produced by Farmer Joe and wheat produced by Farmer Bob, so they have to charge the same price. But in monopolistic competition, we assume that I can tell the difference between a Big Mac and a Whopper and I might prefer one to the other. This means that McDonald’s and Burger King can increase their prices slightly and they won’t drive all of their consumers to the other restaurant.

Oligopoly occurs when more than one firm is in the industry but there are not a lot of firms. With few firms, the actions of each firm will impact all the other firms in the market, and that firm must expect a reaction. For example, shortly after Coca-Cola introduced Cherry Coke, Pepsico introduced Cherry Pepsi. They’ve done the same with other flavors: diet with lime, and vanilla, for example. There is an important strategic component in oligopolies that did not exist in the other markets. In perfect competition, every firm is so small that the actions of one firm are meaningless to other firms. In monopoly, there is only one firm so there is no other firm to worry about. In monopolistic competition, there is a small element of this — a new firm has to position its product with respect to existing firms and they have to market and advertise their product accordingly. But in oligopoly, this “interdependence” of firms is most noticeable.

There are several different models of oligopoly, not just one like there was for perfect competition and monopoly. They depend on specific assumptions about an industry: are firms choosing how much output to produce or what price to charge; do firms produe a homogeneous good; do firms compete or collude with each other; when one firm changes its prices, how does the other firm respond? We’ll keep things as simple as possible by assuming there are just 2 firms in our oligopolies (this is called a “duopoly”), but the principles we’ll see hold for more firms as well. We’ll examine a few of these different models and discuss their implications for things we see in the real world. For example, why do Coke and Pepsi advertise so much when everybody knows what Coke and Pepsi are and what they taste like?  Why are cartels illegal and what would happen if they weren’t?


Video 10.1: Hotel Example of Monopolistic Competition (14 minutes)

This video uses a simple example of 2 hotels in a small town to discuss the differences between perfect competition and monopolistic competition. It examines the impacts on consumers and overall efficiency when firms can differentiate their product. It also helps explain why prices in big cities are higher than prices in suburbs, and provides another reason why prices of goods rise when gas prices increase.


Video 10.2: Cartels (18 minutes)

This video explains what cartels try to accomplish and why it may be difficult for them to do so (which is beneficial for consumers), then details the conditions necessary for a successful cartel. It introduces a duopoly example that will be used later in the Game Theory video.


Video 10.3: Game Theory (14 minutes)

This video discusses Game Theory and uses the example from the Cartels video to explain dominant strategies, Nash equilibrium, and Prisoner’s Dilemma.


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