Monopolistic Competition and Oligopoly

Between the Extremes

Most real markets are neither perfectly competitive nor monopolistic — they lie between.

Monopolistic competition (Chamberlin):

• Many firms, each with a slightly differentiated product (brands, locations, features).
• Each firm faces a downward-sloping demand (some market power) but there is free entry.
• Short run: like monopoly ($MR = MC$, possible profit).
• Long run: entry erodes profit, demand shifts left until $P = AC$ (tangency) — zero economic profit but at a point LEFT of $AC_{\min}$. The firm has excess capacity.

$$\text{Long run}: P = AC > AC_{\min} \qquad (\text{excess capacity})$$

Oligopoly: a few large firms whose decisions interact strategically.

Cournot duopoly: two firms simultaneously choose quantities. Each firm's optimal output depends on the other's — a reaction function:

$$q_1^*(q_2) = \frac{a - c}{2b} - \frac{q_2}{2}$$

The Nash equilibrium is where reaction functions intersect — neither firm can improve by changing its output alone.

Other models:

• Bertrand: firms compete on price — with identical products, price falls to marginal cost (the Bertrand paradox: two firms suffice for competition).
• Stackelberg: one firm moves first (leader), committing to output — the leader gains a strategic advantage.
• Cartel/collusion: firms coordinate to restrict output (joint profit maximisation), but each has an incentive to cheat (prisoner's dilemma).

Concentration ratios and the Herfindahl-Hirschman Index (HHI = sum of squared market shares) measure market power. Higher HHI → more concentrated → more oligopolistic.

The between-markets compared

Tip: The Cournot result is worth memorising as a scale: monopoly output < Cournot duopoly total < competitive output — and as the number of Cournot firms grows, the market glides smoothly toward the competitive benchmark.