# Monopolistic Competition and Oligopoly

Business I · Microeconomics · https://tryals.app/learn/business-i/monopolistic-competition-and-oligopoly

## Market Structures

Most real markets lie between perfect competition and monopoly. **Monopolistic competition** features many firms selling **slightly differentiated** products, giving them downward-sloping demand and some market power.

With **free entry**, short-run profits attract new firms until demand shifts left. In the long run, $P = AC$ at a point of **zero economic profit**.

| Feature | Monopolistic Comp | Oligopoly |
| --- | --- | --- |
| Firms | Many, differentiated | Few, strategic |
| Entry | Free | Barriers |
| Long-Run | Zero profit | Positive profit |

Because production stops left of $AC_{\min}$, firms operate with **excess capacity** in the long run.

## Strategic Oligopoly

**Oligopoly** involves a few large firms whose decisions **interact strategically**. In a **Cournot duopoly**, two firms simultaneously choose quantities using a **reaction function**:

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

The **Nash equilibrium** is where reaction functions intersect. 

**Bertrand** competition has firms compete on price. **Stackelberg** features a leader. **Cartels** restrict output, inviting **cheating**.

**HHI** sums squared market shares to measure power.

## Practice questions

5 of this lesson's 13 practice questions, with answers. The full set is in the app.

### 1. Monopolistic competition produces zero long-run profit like perfect competition, yet firms price above marginal cost. Why does entry not eliminate the markup?

A. Because advertising costs prevent prices from falling to marginal cost
B. Entry erodes demand rather than price-setting power
C. Because firms collude tacitly to maintain the markup
D. Because differentiated products face legal barriers to entry

**Answer:** B. Entry erodes demand rather than price-setting power

**Why:** Each firm keeps a downward-sloping demand curve because its product stays distinct, so entry shifts the curve inward until profit vanishes at a tangency left of minimum average cost. The result is the excess-capacity theorem, many firms each operating below efficient scale, which is the price of variety.

Page: https://tryals.app/practice/business-i/monopolistic-competition-and-oligopoly/monopolistic-competition-produces-zero-long-run-profit-like-perfect

### 2. Which spreadsheet formula computes HHI from market shares in cells A1:A5 (as percentages)?

A. =SUM(A1:A5)*SUM(A1:A5)
B. =SUMPRODUCT(A1:A5,A1:A5)
C. =SUMSQ(A1:A5)*COUNT(A1:A5)
D. =SUMPRODUCT(A1:A5,B1:B5)

**Answer:** B. =SUMPRODUCT(A1:A5,A1:A5)

**Why:** HHI = sum of squared shares. SUMPRODUCT(A1:A5, A1:A5) squares each share and sums, equivalent to SUMSQ(A1:A5) in some versions.

Page: https://tryals.app/practice/business-i/monopolistic-competition-and-oligopoly/which-spreadsheet-formula-computes-hhi-from-market-shares-in-cells

### 3. In the Bertrand model with identical products and equal costs, two firms are enough to drive the price to marginal cost.

**Answer:** True

**Why:** The Bertrand paradox: with homogeneous goods, each firm undercuts the other until $P = MC$. Two firms replicate the competitive outcome, a stark contrast to Cournot.

Page: https://tryals.app/practice/business-i/monopolistic-competition-and-oligopoly/in-the-bertrand-model-with-identical-products-and-equal-costs-two

### 4. Order market structures from most to least market power.

**Answer:**

1. Monopoly (single seller, full market power)
2. Oligopoly (few firms, strategic interaction)
3. Monopolistic competition (many firms, slight differentiation)
4. Perfect competition (many firms, homogeneous product)

**Why:** Market power decreases as the number of firms increases and product differentiation decreases.

Page: https://tryals.app/practice/business-i/monopolistic-competition-and-oligopoly/order-market-structures-from-most-to-least-market-power

### 5. In the Cournot example ($P = 100 - Q$, $MC = 10$), the monopoly output would be $Q_m = 45$ and the competitive output $Q_c = 90$. Cournot output is 60, **what fraction of the way from monopoly to competition?**

**Answer:** 33 (within ±5)

**Why:** $(60 - 45)/(90 - 45) = 15/45 = 1/3 \approx 33\%$. Cournot is one-third of the way from monopoly to competition, adding one competitor moves the market considerably.

Page: https://tryals.app/practice/business-i/monopolistic-competition-and-oligopoly/in-the-cournot-example-p-100-q-mc-10-the-monopoly-output