[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

A
B
PRICE (p )
p 1
Marginal
cost curve
Marginal
revenue
curve
Average
cost curve
Demand
curve
facing
firm
PRICE (p )
Equilibrium
price
Minimum
average cost
p e
p l
Marginal
revenue
curve
facing
firm
Marginal
cost curve
Average
cost curve
Demand curve
facing firm
Q 1
QUANTITY (Q )
Q e
Q l
QUANTITY (Q )
Figure 12.8
PROFIT MAXIMIZING FOR A
MONOPOLISTIC COMPETITOR
A monopolistic competitor chooses the quantity it will produce by setting marginal revenue
equal to marginal cost (Q 1 ), and then selling that quantity for the price given on its
demand curve (p 1 ). In panel A, the price charged is above average cost, and the monopolistic
competitor is making a profit, enticing other firms to enter the market. As firms
enter, the share of the market demand of each firm is reduced, and the demand curve
facing each firm shifts to the left. Entry continues until the demand curve just touches
the average cost curve (panel B). When the firm produces the quantity Q e , it just breaks
even; there is no incentive for either entry or exit.
occurs at exactly the level of output at which the demand curve is tangent to the average
cost curve. At any other point, average costs exceed price, so profits are negative.
Only at this point are profits zero. Accordingly, this is the profit-maximizing output.
The monopolistic competition equilibrium has some interesting characteristics.
Note that in equilibrium, price and average costs exceed the minimum average costs
at which the goods could be produced. Less is produced at a higher price. But there is
a trade-off here. Whereas in the perfectly competitive market every product was a
perfect substitute for every other one, the world of monopolistic competition offers
variety in the products available. People value variety and are willing to pay a higher
price to obtain it. Thus, that goods are sold at a price above the minimum average
cost does not necessarily indicate that the economy is inefficient.
Oligopolies
In oligopolies there are just a few firms, so each worries about how its rivals will
react to anything it does. This is true of the airline, cigarette, aluminum, and
automobile industries, as well as a host of others.
If an oligopolist lowers its price, it takes the chance that rivals will do the same
and deprive it of any competitive advantage. Worse still, a competitor may react to
a price cut by engaging in a price war and cutting the price still further. Different
oligopolies behave quite differently. The oligopolist is always torn between its desire
to outwit competitors and the knowledge that by cooperating with other oligopolists
to reduce output, it will earn a portion of the higher industry profits.
274 ∂ CHAPTER 12 MONOPOLY, MONOPOLISTIC COMPETITION, AND OLIGOPOLY