Chapter 10

Market Structure

10.1 MARKET STRUCTURE AND DEGREE OF COMPETITION

The process by which price and output are determined in the real world is strongly affected by the structure of the market. A market consists of all the potential buyers and sellers of a particular product. Market structure refers to the competitive environment in which the buyers and sellers of a product operate. Four different types of market structure are usually identified: perfect competition at one extreme, monopoly at the opposite extreme, and monopolistic competition and oligopoly in between. Perfect competition is the form of market organization in which !" there are many buyers and sellers of a product, each too small to affect the price of the product# $" the product is identical, or homogeneous# %" there is perfect mobility of resources# and &" economic agents have perfect knowledge of market conditions. Monopoly is the form of market organization in which a single firm sells a product for which there are no close substitutes. 'ntry into the industry is very difficult or impossible as evidenced by the fact that there is but a single firm in the industry". Monopolistic competition refers to the case in which there are many sellers of a differentiated product and entry into or exit from the industry is rather easy in the long run. Oligopoly is the case in which there are few sellers of a homogeneous or differentiated product. (hile entry into the industry is possible, it is not easy as evidenced by the limited number of firms in the industry". The conditions of monopoly, monopolistic competition, and oligopoly are often referred to as imperfect competition to distinguish them from perfect competition.

10.2 PERFECT COMPETITION

)n a perfectly competitive market, the market price of a product is determined at the intersection of the market demand curve and market supply curve of the product. The perfectly competitive firm is then a price taker and can sell any *uantity of the commodity at that price see +roblem !,.&". The best level of output of a firm in the short run is given at the point at which price P" or marginal revenue -." e*uals marginal cost -/". This is true as long as P exceeds the average variable cost A0/" of the firm. )f, at the best level of output, P is smaller than the average total cost AT/" but is larger than the average variable cost A0/", the firm incurs a loss, but its loss would be even greater if it stopped producing. The shut-down point for the firm is at P 1 A0/. The rising portion of the firm2s -/ curve that is above the A0/

curve then represents the competitive firms short-run supply curve see 'xample !". )n the long run, the firm will build the optimal scale of plant to produce the best level of output. The existence of profits will also attract more firms into the industry, while losses will cause some firms to leave it. This proceeds until the long3run e*uilibrium point is reached, at which all firms produce at the P that e*uals the lowest point on the long3run average cost 4A/" curve, and all firms break even see 'xample $". EXAMPLE 1. )n Fig. !,3!, the per3unit cost curves are those of Fig. 53! and d is the infinitely elastic demand curve faced by the perfectly competitive firm when the market price of the product is 67,. 8ince the firm can sell any *uantity of the product at P 67,, the change in total revenue per unit change in output, or -., also e*uals 67,. (ith P 1 67,, the best level of output of the firm is 9 units and is given by point E, where P 1 -. 1 -/ 1 67,. At Q 1 9, AT/ 1 6::# therefore, the firm earns a profit of EA 1 6%: per unit and 6%:" 9" 1 6$!, in total. )f P 1 6%9 instead, the firm would face demand curve d'. The best level of output of the firm is then &.: units and is given by point E', at which P' 1 -.' 1 -/ 1 6%9. At Q 1 &.:, AT/ 1 6:%# therefore, the firm incurs a loss of E' 1 6!; per unit and 6!;" &.:" 1 6;9.:, in total. )f the firm went out of business, however, it would incur the greater loss of A' 1 6$9 per unit the average fixed cost" and 6$9" &.:" 1 6!!; in total the total fixed costs of the firm". )f P 1 A0/ 1 6$9 point ! in the figure", the total loss of the firm e*uals its total fixed costs whether the firm produces or not. Thus, point ! is the firm2s shut3 down point. 8ince the firm always produces at P 1 -. 1 -/ as long as P < A0/", the rising portion of the -/ curve represents the short3run supply curve of the firm. )f input prices are constant, the market supply curve of the product is obtained by the horizontal summation of the individual firms2 supply curves. Thus, the market supply curve in Fig# !,3! is obtained on the assumption that there are !,, firms in the market identical to the one shown in Fig. !,3$. EXAMPLE 2. Figure !,3$ shows that when a perfectly competitive market is in long3run e*uilibrium at P 1 6&,, the best level of output of the perfectly competitive firm is 5 units and is given by point E, at which P 1 -. 1 4-/ 1 lowest 4A/ 1 6&,. =ecause of free or easy entry into and exit from the competitive market, all profits and losses are eliminated, and all firms break even. The firm operates the scale of plant given by the short3run average total cost 8AT/" curve shown in Fig. !,3$ at point its lowest point", so that short3run marginal cost 8-/" e*uals 4-/ also. )f a firm has more productive resources or inputs and lower 4A/, the more productive resources will be able, by threatening to leave, to extract higher rewards payments" from their employer to fully compensate them for their higher productivity. As a result, the lowest 4A/ will be the same for all competitive firms when they are in long3run e*uilibrium.

Fig. 10-1

Fig. 10-2

10.3 MONOPOLY
-onopoly is the form of market organization in which a single firm sells a product for which there are no close substitutes. Thus, the monopolist faces a market demand curve for the product that is negatively sloped, and -. > P. -onopoly can arise from several causes ?see +roblem !,.7 a"@. )n the short run, the best level of output of a monopolist is at the point at which -. 1 -/, as long as P < A0/ see 'xample %". )n the long run, the monopolist can build the optimal scale of plant to produce the best level of output. =ecause of blocked entry, a monopolist can earn long3run profits see 'xample &". EXAMPLE 3. )n Fig. !,3%, " is the demand curve faced by a monopolist and -. is the corresponding marginal revenue curve. Aote that the -. curve has twice the absolute slope of the " curve. The best level of output of the monopolist in the short run is given by point F, at which -. 1 -/. At Q 1 &,,, P 1 65 point A on the " curve" and AT/ 1 69 point ", so that the monopolist maximizes profits at A 1 6$ per unit and A #$ 1 65,, in total the shaded area in the figure". The monopolist would break even if P 1 AT/ and would minimize losses if P > AT/ but P < A0/ at the best level of output see +roblem !,.!,".

Fig. 10-3

EXAMPLE 4. )n Fig. !,3&, the best level of output of the monopolist in the long run is :,, units and is given by point ', at which P 1 4-/. At Q 1 :,,, P 1 6; point A' on the " curve" and the monopolist operates the optimal scale of plant at point ', where 8AT/ 1 4A/ 1 6&. Thus, the monopolist earns a long3run profit of A' ' 6% per unit and A' '$'#' 1 6!,:,, in total. =ecause of blocked entry, the monopolist does not usually produce at the lowest point on its 4A/ curve see Fig. !,3&" and can continue to earn profits in the long run.

Fig. 10-4

10.4 MONOPOLISTIC COMPETITION

-onopolistic competition is the form of market organization in which there are many sellers of a differentiated product and entry into and exit from the industry is rather easy in the long run. Thus, the demand curve facing a monopolistic competitor is negatively sloped but highly price elastic. The best level of output in the short run is given at the point at which -. 1 -/, provided that P < A0/. As in other forms of market organization, the firm under monopolistic competition can earn profits, break even, or incur losses in the short run. )f firms earn profits, more firms enter the market in the long run. This shifts the demand curve facing each firm to the left as its market share declines" until all firms break even. 8ince the demand curve facing a monopolistic competitor is negatively sloped, price and 4A/ are somewhat higher than under perfect competition. Thus, each firm operates with excess capacity, and this allows more firms overcrowding" to exist in the market. A monopolistically competitive firm can increase the degree of product variation as well as its selling

expenses in an effort to increase the demand for its product and make the demand less elastic. The optimal level of these efforts is given by the point at which -. 1 -/. EXAMPLE 5. )n Fig. !,3:, " is the highly price3elastic demand curve faced by a typical monopolistic competitor, and -. is the corresponding marginal revenue curve. The best level of output of the firm in the short run is 5 units and is given by point E, at which -. 1 -/. At Q 1 5, P 1 65 point A on the demand curve" and AT/ 1 69 point ", so that the monopolistic competitor maximizes profits of A 1 6$ per unit and A #$ 1 6!9 in total the shaded area in the figure". The monopolistic competitor would break even if P 1 AT/ and would minimize losses if P > AT/, as long as P < AB/ at the best level of output see +roblem !,.!:". Aote that Fig. !,3: is very similar to Fig. !,3%, except that the " curve is more price elastic for the monopolistic competitor than for the monopolist.

Fig. 10-5

EXAMPLE 6. 8ince the typical or representative monopolistically competitive firm earns a profit in the short run, more firms enter the market in the long run. This causes the demand curve of the typical firm to shift down to "' in Fig. !,39 as its market share declines", so as to be tangent to the 4A/ curve at the output level of 9 units, at which -.' 1 4-/ point E'". At Q 1 9, P 1 4A/ 1 8AT/ 1 69 point A'" and the firm breaks even in the long run. This compares to Q 1 7, at which P 4A/ 1 8AT/ 1 6: point E%" if the market had been organized along perfectly competitive lines. The slightly higher price and 4A/ under monopolistic competition P 1 69 as compared to P 1 6: under perfect competition" is due to product differentiation i.e.,

the cost of providing consumers with a variety of products rather than a single undifferentiated product". The difference between Q 1 7 and Q 1 9 can be taken as a measure of excess capacity under monopolistic competition, and this allows many more firms overcrowding" to exist in the market. For some serious criticisms leveled against the theory of monopolistic competition, see +roblem !,.!;.

Fig. 10-6

10.5 OLIGOPOLY
Oligopoly is the form of market organization in which there are few sellers of a homogeneous or differentiated product, and entry into or exit from the industry is difficult but possible see +roblem !,.!7". Cligopoly is the most prevalent form of market organization in the manufacturing sector of industrial countries, including the Dnited 8tates. The degree of prevalence can be measured by concentration ratios see +roblem !,.$,". The distinguishing characteristics of oligopoly are the interdependence and rivalry among the firms in the industry. There are many models of oligopoly, each based on the particular behavioral response of competitors. &he kinked demand curve model seeks to explain the price rigidity often encountered in oligopolistic markets see 'xample ;". &he centrali'ed cartel model can lead to the monopoly solution see +roblem !,.$%". Another oligolistic model is the one of price leadership by the dominant firm see 'xample 5". )n the short run, an oligopolist continues to produce even if it incurs a loss, as long as P < A0/. )n the long run, an oligopolist is not likely to produce at the lowest point on its 4A/ curve and can earn profits because of restricted entry into the industry.

EXAMPLE . The kinked demand curve model postulates that the demand curve facing an oligopolist has a kink at the prevailing price, and is much more elastic for price increases than for price cuts on the assumption that competitors do not match price increases but do match price cuts. )n Fig. !,3;, the demand curve lacing the oligopolist is ", or the line segments described by points A$#, and has a kink at the prevailing price of 6!, and *uantity of %, units point $". Aote that the curve is much more elastic above than below point $. The marginal revenue curve is -., which is described by points A(!)* A( is the segment corresponding to the A$ portion of the demand curve and !i corresponds to the $# portion of the demand curve. The kink at point $ on the demand curve causes the (! discontinuity in the marginal revenue curve. The oligopolists2 marginal cost curve can shift anywhere within the discontinuous or vertical portion of the -. curve i.e., from -/ to -/ ' in Fig. !,3;" without inducing the oligopolist to change the prevailing price of 6!, and its output of %, units. This model, however, rationalizes rather than explains price rigidity, and the existence of the kink has been *uestioned. 8ee +roblem !,.$$."

Fig. 10-

EXAMPLE !. Dnder price leadership by the dominant firm, the latter sets the industry price that maximizes its own total profits, allows the other firms in the industry to sell all they want at that price, and then comes in to fill the market. This is shown in Fig. !,35. )n the figure, "& line A$# (" is the total market demand curve

for the homogeneous product sold in the oligopolistic market and curve -/ is the horizontal summation of the marginal cost curves of the follower firms in the industry. 8ince the follower firms behave as perfect competitors, they produce where price set by the leader" e*uals -/ . Then "& E -/ 1 "+ is the demand curve faced by the leader or dominant firm. For example, if the leader sets P 1 6;, the followers supply !$ 1 :, units of the product, leaving nothing to be supplied by the leader. This gives the vertical intercept point !" on "+. )f the leader sets P 69, -/ 1 ), 1 &, units, leaving ,# 1 )- 1 $, units to be supplied by the leader point - on "+". At P 1 6$, -/ 1 , point &" and the leader would face the total *uantity demanded in the market point ". thus, the demand curve faced by the leader is "+ line !- (" and its marginal revenue curve is -.+. )f the marginal cost curve of the leader is -/+, the leader will set P 1 69 given by point - on "+, which is directly above the point where -/+ 1 -.+" in order to maximize its total profits. At P 1 69, the followers will supply ), 1 &, units see the figure" and the leader fills the market by selling ,# 1 $, units. (e could also have price leadership by the low3cost firm. 8ee +roblem !,.$&."

Fig. 10-!

Glossary
C"#$%&'i(") *&%$"' A formal agreement among oligopolists to set the monopoly price, allocate output among member firms, and share profits. C+,-"$i$i." /i%,01 12+%$-%3# 13--'4 *3%." The rising portion of the firm2s short3run marginal cost curve above its average variable cost curve. Di//"%"#$i&$") -%+)3*$1 +roducts that are similar, but not identical, and that satisfy the same basic need. )mperfect competition -onopoly, monopolistic competition, and oligopoly. Ki#5") )",&#) *3%." ,+)"' The model that seeks to explain price rigidity by postulating a demand curve with a kink at the prevailing price. M&%5"$ All the actual and potential buyers and sellers of a particular product.

M&%5"$ 1$%3*$3%" The competitive environment in which the buyers and sellers of the product operate. M+#+-+'i1$i* *+,-"$i$i+# The form of market organization in which there are many sellers of a differentiated product and entry into or exit from the industry is rather easy in the long run. M+#+-+'4 The form of market organization in which a single firm sells a product for which there are no close substitutes. O'ig+-+'4 The form of market organization in which there are few sellers of a homogeneous or differentiated product and entry into or exit from the industry is difficult. P"%/"*$ *+,-"$i$i+# The form of market organization in which !" there are many buyers and sellers of a product, each too small to affect the price of the product# $" the product is homogeneous# %" there is perfect mobility of resources# and &" economic agents have perfect knowledge of market conditions. P%i*" '"&)"%12iThe form of market collusion in oligopolistic firms in which the firm that serves as the price leader initiates a price change and the other firms in the industry soon match it. P%i*" $&5"% The situation of the seller under perfect competition: each firm has no effect on the price of the product it sells and can sell any *uantity at the given market price. S23$-)+6# -+i#$ The level of output at which the price of the product e*uals the average variable cost of the firm.

Review Questions
1. (hich of the following industries most closely approximates the perfectly competitive modelF a" Automobile ." /igarette c" Aewspaper d" (heat farming Ans. d" )n the first three choices the market has few sellers, the product is differentiated, and vast amounts of capital are needed in order to enter the industry. These conditions are not true in wheat farming. 2. The best, or optimum, level of output for a perfectly competitive firm is given by the point at which a" -. e*uals AT/. ." -. e*uals -/. c" -. exceeds -/ by the greatest amount. d" -. e*uals P. Ans. 3. ." 8ee points E and E' #n Fig. !,3!.

At the best, or optimum, short3run level of output, the firm a" maximizes total profits. ." minimizes total losses. c" either maximizes total profits or minimizes total losses. d" maximizes profits per unit. Ans. c" (hether the firm maximizes total profits or minimizes total losses in the short run depends on whether P exceeds AT/ or falls short of AT/ at the best level of output.

4.

The short3run supply curve of the perfectly competitive firm is given by the rising portion of the -/ curve above a" the shut3down point. ." the break3even point. c" the AT/ curve. d" all of the above. Ans. a" 8ee Fig. !,3!.

5.

(hen the perfectly competitive firm and industry are in long3run e*uilibrium a" P 1 -. 1 8-/ 1 4-/. ." P 1 -. 1 8A/ 1 4A/. c" P 1 -. 1 lowest point on the 4A/ curve. d" all of the above. Ans. d" 8ee point F in Fig. !,3$.

6.

(hen the perfectly competitive firm, but not the industry, is in long3run e*uilibrium a" P 1 -. 1 8-/ 1 8A/. ." P 1 -. 1 4-/ 1 4A/. c" P 1 -. 1 8-/ 1 4-/ 1 8A/ 1 4A/. d" P 1 -. 1 8-/ 1 4-/ 1 8A/ 1 lowest point on the 4A/ curve. Ans. c" 8ee Fig. !,3$ and +roblems !,.; and !,.5.

)n the short run, a monopolist a" earns a profit. ." breaks even. c" incurs losses. d" any of the above. Ans. d" 8ee 8ection !,.%.

!.

)f a monopolist incurs losses in the short run, then in the long run a" the firm will go out of business. ." the firm will stay in business. c" the firm will break even. d" any of the above is possible. Ans. d" 8ee 8ection !,.%.

7.

(hich of the following statements is false with respect to a monopolistically competitive firmF a" )t is one of many sellers of a differentiated product. ." )t can earn profits, break even, or incur losses in the short run. c" )t can produce at the lowest point on its 4A/ curve in the long run. d" )t breaks even in the long run. Ans. c" 8ee 8ection !,.&.

10. The distinguishing characteristic of oligopoly is a" the interdependence among the firms in the industry. ." the inelastic demand for the industry product. c" the existence of barriers to entry into the industry. d" all of the above. Ans. a" 8ee 8ection !,.:.

11. The kinked demand curve model a" seeks to explain the price rigidity often found in oligopolistic markets. ." implies that oligopolists recognize their interdependence. c" does not imply collusion on the part of the oligopolists. d" all of the above. Ans. d" 8ee 8ection !,.: and 'xample ;.

12. )n the case of price leadership by the dominant firm, all firms in the purely oligopolistic industry will produce their best level of output a" always. ." never. c" sometimes. d" often. Ans. a" This is so because the dominant firm will set the industry price at which it maximizes its total profits and all the other firms in the industry will behave as perfect competitors and produce at P 1 -/.

Solved Problems
MARKET STRUCTURE AND DEGREE OF COMPETITION
10.1. )dentify the characteristics in terms of which the four types of market structure are defined. The characteristics in terms of which perfect competition, monopoly, monopolistic competition, and oligopoly are defined and distinguished from one another are !" the number and size of buyers and sellers of the product in the market, $" the type of product bought and sold i.e., standardized, or homogeneous, as contrasted to differentiated", %" the degree of mobility of resources i.e., the ease with which firms can enter or exit the market", &" the degree of knowledge that economic agents i.e., firms, suppliers of inputs, and consumers" have of prices, costs, and demand and supply conditions. 10.2 a" (hat four different types of market organization are usually identifiedF ." (hy do we identify these four types of market organizationF c" (hy do we study the two extreme forms of market organization firstF a" The four different types of market organization usually identified are perfect competition, monopolistic competition, oligopoly, and monopoly. All but the first form fall into the realm of imperfect competition. ." (e identify these four types of market organization in order to systematize and organize their analysis. )n the real world, however, such a sharp distinction does not, in fact, exist. )n the real world firms often exhibit elements of more than one market form, and so it may be difficult to classify them into any one of the above market categories. c" (e look first at the two extreme forms of market organization i.e., perfect competition and monopoly" because historically, these are the models that were first developed. -ore importantly, their development is fuller and more satisfactory. The monopolistic competition and oligopoly models, though more realistic in terms of the actual forms of business organization in our economy and, in general, in most other industrial economies", are not very satisfactory and leave much to be desired from a theoretical point of view.

PERFECT COMPETITION
10.3 'xplain in detail exactly what is meant by each of the four component parts of the definition of perfect competition given in 8ection !,.!. a" According to the first part of the definition of perfect competition, there are a large number of sellers and buyers of the product, but they are individually too small in relation to the market to be able to affect the price of the product by their own actions. This means that a change in the output of a single firm will not percepti.ly affect the market price of the product. 8imilarly, each buyer of the product is too small to be able to extract from the seller such things as *uantity discounts and special credit terms. ." The product of each firm in the market is homogeneous, identical, or perfectly standardized. An example of this might be grade A winter wheat. As a result buyers cannot distinguish the output of one firm from that of another, and so are indifferent as to the particular firm from which they buy. This refers not only to the physical characteristics of the product but also to the GenvironmentH such as the pleasantness of the seller, selling location, etc." in which the purchase is made. c" There is perfect mobility of resources. That is, workers and other inputs can easily move geographically from one Iob to another, and respond very *uickly to monetary incentives. Ao input re*uired in the production of the product is monopolized by its owners or producers. )n the long run, firms can enter or leave the industry without much difficulty. That is, there are no patents or copyrights, Gvast amountsH of capital are not re*uired to enter the industry, and already established firms do not have any long3lasting cost advantage over new entrants because of experience or size. d" /onsumers, resource owners, and firms in the market have perfect knowledge of present and future prices, costs, and economic opportunity in general. Thus, consumers will not pay a higher price than necessary for the product. +rice differences are *uickly eliminated, and a single price prevails throughout the market for the product. .esources are sold to the highest bidder. (ith perfect knowledge of present and future prices and costs, producers know exactly how much to produce. 10.4 a" +lot the following market demand JK" and market supply J8" schedules for a product in a perfectly competitive market. Ketermine the e*uilibrium price and the e*uilibrium *uantity, and show the demand curve faced by a perfectly competitive firm in this market. (hy is the marginal revenue of the firm e*ual to the price of the productF ." (hat would happen if the product price were 6!$, to begin withF 6:, to begin withF c" 8how graphically what would happen if the market demand curve shifted to the right by $,, units but

remained parallel to the original demand curve. Cn the same figure show what would happen if subse*uently the market supply curve also shifted to the right by $,, units but remained parallel to the original supply curve. a" 8ee Fig. !,37. Figure !,37 a" shows that the e*uilibrium price is at P 1 67, and the e*uilibrium *uantity is at Q 1 9,,. These are determined at the intersection of the market demand curve and the market supply curve at point E. +art ." shows the demand curve d faced by a firm in a perfectly competitive market. This is horizontal or infinitely elastic i.e., the firm is a price taker", indicating that the firm can sell any *uantity of the product at P 1 67,. 8ince P is constant, the marginal revenue -.", that is, the change in the total revenue that the firm receives from selling each additional unit of the product, is e*ual to the price of the product. That is, d P 1 -. 1 67,.

Fig. 10-7

." )n Fig. !,37 a" we can see that at P 1 6!$,, J8 < JK and P falls toward 67, the e*uilibrium price". As P falls, JK increases and J8 declines until P 1 67, is reached at point E, where JK 1 J8. Lowever, at P 1 6:,, 7K < J8 and P rises toward 67,. As P rises, JK declines and J8 increases until P 1 67, is reached at point E, where JK 1 J8. Thus, P 1 67, is the e*uilibrium price in the sense that any divergence from it sets in motion automatic forces that push P toward 67,.

c" Figure !,3!, shows that with "', the e*uilibrium price is at P 1 6!$, and the e*uilibrium *uantity is at Q 1 9:, point '". (ith 8', the e*uilibrium price is at P 1 69, and the e*uilibrium *uantity is at Q 1 ;:, point 'M in the figure". Finally, with "' and 8', the e*uilibrium price is at P 1 67, and the e*uilibrium *uantity is at Q 1 5,, point /".

Fig. 10-10

10.5

Niven the short3run cost curves shown in Fig. !,3!! for a firm in a perfectly competitive market, find the firm's best level of output and its total profits if the e*uilibrium market price is a" 6!5, ." 6!%, c" 67, d" 6:, and e" 6%. a" (hen P 1 6!5, the best or optimum level of output is ;,,,, units point A". The firm earns a profit of AA 1 6& per unit and 6$5,,,, in total. This is the maximum total profit that the firm can earn at this price. ." (hen P 1 6!%, the best level of output is 9,,,, units point $", and the firm breaks even. c" (hen P 1 67, the best level of output is :,,,, units point #". At this level of output the firm incurs a loss of "# 1 6: per unit and 6$:,,,, in total. )f the firm went out of business, however, it would incur a total loss e*ual to its TF/ of 6&,,,,, obtained by multiplying the AF/ of "E 1 65 per unit by the :,,,, units". Thus, the firm would minimize its

total losses in the short run by staying in business.

Fig. 10-11

d" (hen P 1 6:, the best level of output is &,,,, units point ". Lowever, since P 1 A0/, and thus T. T0/ 1 6$,,,,,, the firm is indifferent whether it produces or not. )n either case, the firm would incur a short3 run total loss e*ual to its TF/ of 6&,,,,,. +oint is thus the shut3down point. e" 8ince at P 1 6%, P is smaller than the A0/, the T. of 67,,,, does not even cover the T0/ of 6!5,,,,. Therefore, the firm would incur a total loss e*ual to its TF/ of 6&,,,,, plus the 67,,,, by which the T0/ exceeds the T. i.e., 6!5,,,, E 67,,,, 1 67,,,,". Thus, it pays for the firm to shut down and minimize its total losses at 6&,,,,, its TF/" over the period of the short run. 10.6 a" Kraw the supply curve for the perfectly competitive firm of +roblem !,.:. Also draw the industry short3run supply curve on the assumptions that there are !,, identical firms in the industry and that factor prices remain unchanged as industry output expands and thus more factors are used" and ." explain

the graph of part a". c" (hat *uantity of the service will be supplied by each firm and the industry at a price of 67F at 6!5F at prices below 6:F a" 8ee Fig. !,3!$. ." The firm2s short3run supply curve is given by the rising portion of its -/ curve above its A0/ curve. )f the supplies of inputs to the industry are perfectly elastic that is, if the prices of the factors of production remain the same regardless of the *uantity of factors demanded per unit of time by the industry", then the market or industry short3run supply curve is obtained by the horizontal summation of the -/ curves over their respective A0/ curves" of all the firms in the industry. Aote that when a single firm expands its output and demands more factors", factor prices can reasonably be expected to remain unchanged. Lowever, when all firms together expand output and demand more factors", factor prices are likely to rise. c" )f the short3run market price for the service is 67, each of the !,, identical firms in the industry will produce and sell :,,,, units of the output point #" and the total for the industry will be :,,,,,, units. At P 1 6!5, each firm produces and sells ;,,,, units and the industry total is ;,,,,,, units. Ao output of the service is produced at prices below 6: per unit i.e., below the shut3down point, the supply curves coincide with the price axis".

Fig. 10-12

10.

8uppose that Fig. !,3!% refers to a perfectly competitive firm with scale of plant 8A/! and that the short3run market e*uilibrium price is 6!9. a" (hat output will this firm produce and sell in the short runF )s the firm making a profit or incurring a loss at this level of outputF ." Kiscuss the adIustment process for this firm in the long run, if only this firm and no other in the industry adIusted in the long run. a" The best or optimum level of output for this firm in the short run is given by the point at which P 1 8-/! At this level of output &,, units", the firm earns a profit of 6& per unit and 6!,9,, in total. ." )f only this firm adIusts in the long run a simplifying and unrealistic assumption for a perfectly competitive market", the firm will produce at P 1 8-/% 1 4-/. The firm will build the scale of plant indicated by 8A/% and will produce and sell 5,, units of output. The firm will earn a profit of 6: pet unit and 6&,,,, in total. Aote that since we are dealing with a perfectly competitive firm, we can safely assume that if only this firm expands its output, the effect on the e*uilibrium price will be imperceptible.

10.!

a" 'xplain the long3run adIustment process for the firm and the market in Fig. !,3!% in +roblem !,.;. ." (hat implicit assumption about factor prices was made in the solution to part a"F (hat would happen if input prices increased as more firms entered the market and demanded more inputsF a" )n the long run, all firms in the market will adIust their scale of plant and their level of output, and more firms will enter the market, attracted by the short3run profits. This will increase the industry supply of the product and thus cause a fall in the e*uilibrium price to 65 see Fig. !,3!%". At this price, P 1 -.$ 1 8-/$ 1 4-/ 1 8A/$ 1 4A/. 'ach firm produces :,, units of output if they all have the same cost curves" and receives only a Gnormal returnH e*ual to the implicit opportunity cost" on its owned factors. )f firms were incurring short3run losses to begin with, the exact opposite would occur. )n any event when all firms are in long3run e*uilibrium, they all produce at the lowest point on their 4A/ curve, they all break even, and they all spend little if anything on sales promotion. ." )n the solution to part a", the implicit assumption was made that factor prices remained unchanged as more firms entered the industry and industry output was expanded. )f, as more firms enter the market and demand more inputs, input prices increase, all of the firms2 cost curves shift up, so that when the perfectly competitive industry is in long3run

e*uilibrium, P 1 4-/ 1 lowest 4A/, but the lowest 4A/ is now higher than when input prices were assumed to be constant.

Fig. 10-13

MONOPOLY
10.7 )ndicate a" the possible sources of monopoly, ." the extent of its occurrence in the Dnited 8tates today, and c" the limitations on its market power. a" The firm may control the entire supply of the raw materials re*uired to produce the product. For example, until (orld (ar )), Alcoa controlled almost every source of bauxite the raw material necessary to produce aluminum" in the Dnited 8tates and thus had a monopoly in the production of aluminum in the Dnited 8tates. The firm may own a patent or copyright that precludes other firms from producing the same product. For example, when cellophane was first introduced, Ku +ont had monopoly power over cellophane produc3 tion because of patents the company held. A monopoly may be established by a government franchise. )n that case, the firm is set up as the sole producer and distributor of the product, subIect to government regulation. )n some industries, increasing returns to scale may operate over such a wide range of outputs as to leave only one firm producing the product. These situations are called Gnatural monopoliesH and are fairly common in the areas of public utilities and transportation. )n these cases the government usually allows the monopolist to operate, subIect to government regulation. For example, electricity rates in Aew Bork /ity are set so as to leave the supplier, /on 'dison, with only a Gnormal rate

of returnH say !, percent" on its investment. ." Aside from regulated monopolies, cases of pure monopoly in the Dnited 8tates have been rare in the past and are forbidden today by antitrust laws. 'ven so, the monopoly model is often useful in explaining observed business behavior in cases approximating pure monopoly, and also gives insights into the operation of other types of imperfectly competitive markets i.e., monopolistic competition and oligopoly". c" A monopolist does not have unlimited market power. The monopolist faces indirect competition for consumers2 dollars from all other products on the market. Furthermore, though there are no close substitutes for the product sold by the monopolist, substitutes may nevertheless exist. For example, even when Alcoa had monopoly power in the production and sale of aluminum in the Dnited 8tates, aluminum faced competition from steel, plastic, copper, and other materials. Fear of government prosecution and the threat of potential competition also act as checks on the monopolist2s market power. )n general, all monopoly power based on barriers to entry is subIect to decay in the long run, except that based on government franchise. 10.10 .eferring to Fig. !,3%, which shows output price and output determination for the monopolist, suppose that the average fixed cost of the monopolist increases by 6& and that its A0/ is 6: less than the new AT/ at the best level of output. Kraw a figure showing the best level of output and price, the amount of profit or loss per unit and in total, and whether it pays for the monopolist to produce or not. 8ee Fig. !,3!&. The figure shows that an increase in average fixed costs shifts the AT/ curve up by 6& but does not change the -/ curve. 8ince the " and -. curves are also unchanged, the best level of output for the monopolist remains at &,, units given by point E, at which -. 1 -/" and the price remains at 65 point A on the " curve". 8ince AT/ 6!, now point '", the monopolist incurs a loss of 'A 1 6$ per unit and 'A$'#' 1 65,, in total. The monopolist, however, minimizes losses by staying in business. =y going out of business the monopolist would incur the larger loss of 'A' 1 6: per unit e*ual to AF/" and 'A'$/#' 1 6$,,,, in total e*ual to its total fixed costs".

Fig. 10-14

10.11 'xplain why the monopolist would never produce on the inelastic portion of the demand curve. A monopolist produces at the point at which -. 1 -/, Iust the same as a perfect competitor. 8ince -/ is positive, -. must also be positive at the best level of output. =ut for -. to be positive, the demand curve faced by the monopolist must be elastic. Another way of saying this is that only when the demand curve is elastic will a reduction in the product price result in an increase in T. so that -. will he positive. Thus, a monopolist will never operate in the inelastic portion of the demand curve. 10.12 8tarting with Fig. !,3%, show graphically that the rising portion of the -/ curve above the A0/ curve does not represent the monopolist2s short3run supply curve. 8ee Fig. !,3!:. )n the figure, "% is a demand curve alternative to and less price elastic than" ", and its associated -.M curve crosses the -/ curve at point F the same point at which the -. curve crosses it". Aote that the -.M curve is halfway between the KM curve and the vertical or price axis as it should be". 8ince the -. and -.M curves cross the -/ curve at point F, the best level of output is &,, units in either case, even though the price P" is 65 point A" with demand curve " but 6!$ point A%" with demand curve "%. Thus, the same *uantity &,, units" could be supplied at different prices depending on the price elasticity of demand. )n general, the less price elastic

the demand curve is, the higher will be the price of the commodity.

Fig. 10-15

8ince there is no uni*ue relationship between the price of a commodity and the *uantity supplied under monopoly, we cannot derive the supply curve firm the rising portion of the monopolist2s -/ curve above the A0/ curve, as we can for a perfectly competitive firm. 10.13 .eferring to Fig. !,3&, which shows the monopolist2s long3run e*uilibrium, draw a figure a" showing that the monopolist would break even if costs rose sufficiently in the long run and ." showing the change in demand that would result in the monopolist2s producing at the lowest point on its 4A/ curve. a" 8ee Fig. !,3!9. )n the figure, the " and -. curves are the same as those in Fig. !,3&, but all the cost curves are higher. The reason is that in the long run there are no fixed costs, and an increase in costs shifts all cost curves upward. The best level of output of the monopolist is &,, units and is given by point E/ at which -. 1 8-/' 1 4-/'. At Q 1 &,,, P 1 8A/ 1 4A/ 1 65, and the monopolist breaks even.

Fig. 10-16

Fig. 10-1

." 8ee Fig. !,3!;. )n the figure, the 4A/ and 4-/ curves are the same as those in Fig. !,3&, but the "' and -.' curves are higher. 8ince the -.' curve intercepts the 4A/ curve at its lowest point, the monopolist produces at that point i.e., at point E%, at which Q 1 ;,, and -.' 1 4-/". 8ince P 1 6!, point A% on the "' curve" while 4A/ 1 6%, the monopolist earns a profit of A%E% 1 6; per unit and A%E%$%#% 1 6&,7,, in total.

MONOPOLISTIC COMPETITION
10.14 a" Kefine monopolistic competition and give a few examples of it. ." )dentify the competitive and monopolistic elements in monopolistic competition. c" (hy is it difficult or impossible to define the market demand curve, the market supply curve, and the e*uilibrium price under monopolistic competitionF a" -onopolistic competition refers to the market organization in which there are many sellers of a differentiated product. -onopolistic competition is very common in the retail and service sectors of our economy. 'xamples of monopolistic competition are the numerous barber shops, gasoline stations, grocery stores, li*uor stores, and drug stores located close to one another. ." The competitive element results from the presence in a monopolistically competitive market as in a perfectly competitive market" of so many firms that the activities of each have no perceptible effect on the other firms in the market. Furthermore, firms can enter or leave the market without much difficulty in the long ran. The monopolistic element results because the many firms in the market sell a differentiated rather than a homogeneous product. c" 8ince, under monopolistic competition, each firm produces a somewhat different product, we cannot define the market demand curve and the market supply curve of the product, and we do not have a single e*uilibrium price but rather a cluster of prices, each for the different product produced by each firm. Thus, the graphical analysis of monopolistic competition must be confined to the typical or representative firm. 10.15 a" Cn the demand and marginal revenue curves in Fig. !,-:, draw an alternative AT/ curve showing that at the best level of output of 5 units, the

monopolistically competitive firm incurs a loss of 6$ per unit, but P 0 A0/ by 6$. ." (hat is the total profit or loss of the firm at the best level of outputF (ill the firm produce or notF (hyF a" 8ee Fig. !,3!5. ." At the best level of output of 5 units, the firm incurs a total loss of 6!9 per time period. Lowever, since P < A0/, the firm minimizes its total losses by continuing to produce in the short ran. 8pecifically, if the firm stopped producing it would incur a total loss of 6%$ e*ual to the 6& average fixed cost at Q 1 5 units times the output of 5 units" as compared to a total loss of 6!9 by continuing to produce.

Fig. 10-1!

10.16 Kiscuss the long3run efficiency implications of monopolistic competition with respect to a" utilization of plant, ." allocation of resources, and c" advertising and product differentiation. a" (hen a monopolistically competitive market is in long3run e*uilibrium, the demand curve facing each firm is tangent to its 4A/ curve so that each firm breaks even". 8ince the demand curve is negatively sloped, the tangency point will always occur to the left of the lowest point on the firm2s 4A/ curve. Thus, the firm underutilizes a smaller3than3optimum

scale of plant when in long3ran e*uilibrium. This allows the existence of more firms in the industry than otherwise. An example of this is the GovercrowdingH of gasoline stations, barber shops, grocery stores, etc., with each business idle much of the time. ." (hen the monopolistically competitive market is in long3run e*uilibrium, the price charged by each firm exceeds the 4-/ of the last unit produced. Therefore, resources are underallocated to the firms in the market and misallocated in the economy. This misallocation of resources is not large, however, because the demand curve facing the monopolistically competitive firm, though negatively sloped, is highly elastic. c" Though some advertising is useful since it informs consumers", the amount of advertising undertaken by monopolistically competitive firms may be excessive. This only adds to costs and prices. 8imilarly, some product differentiation is beneficial since it gives the consumer a greater range of choices. Lowever, an excessive number of brands, styles, designs, etc., only serves to confuse the consumer and adds to costs and prices. 10.1 Nive the reasons why the theory of monopolistic competition has fallen somewhat into disrepute in recent years. The theory of monopolistic competition has fallen somewhat into disrepute recently because: !" )t may be difficult to define the market and determine the firms and products to include in it. For example, should moist paper tissues be included with other paper tissues or with soapsF Are toothpaste, dental floss, toothpicks, and water picks part of the same market or product groupF $" )n markets in which there are many small sellers, the demand curve facing monopolistic competitors is nearly horizontal, so that the model of perfect competition is appropriate to use. %" )n markets in which there are strong brand preferences, the product usually turns out to have only a few sellers, so that oligopoly is the relevant model. &" 'ven in markets in which there are many small sellers of a good or service say, gasoline stations" a change in price by one of them affects nearby stations significantly and evokes a response. )n such cases, the oligopoly model is the more appropriate model to use. Kespite these serious criticisms, however, the monopolistic competition model provides some important insights, such as its emphasis on product differentiation and selling exenses, that are applicable to oligopolistic markets.

OLIGOPOLY
10.1! a" Kefine oligopoly. ." (hat is the single most important characteristic of oligopolistic marketsF c" To what problem does this characteristic leadF d" (hat does oligopoly theory achieveF a" Cligopoly is the form of market organization in which there are few sellers of a product. )f there are only two sellers we have a duopoly. )f the product is homogeneous e.g., steel, cement, copper", we have a pure oligopoly. )f the product is differentiated e.g., automobiles, cigarettes", we have a differentiated oligopoly. Cligopoly is the most prevalent form of market organization in the manufacturing sector of modern economies. ." The interdependence of the firms in an oligopolistic industry is the single most important characteristic setting oligopoly apart from other market structures. This interdependence is the natural result of limited numbers. That is, since there are few firms in an oligopolistic industry, when one of them lowers its price, undertakes a successful advertising campaign, or introduces a better model, the demand curve faced by other oligopolists will shift down. Therefore, the other oligopolists react. c" There are many different reaction patterns for the other oligopolists to the actions of the first, and unless and until we assume a specific reaction pattern, we cannot define the demand curve faced by the first oligopolist. As a result, we have an indeterminate solution. =ut even if we assume a particular reaction pattern so that we may have a determinate solution, this is only one of many possible solutions. d" =ecause of the situation outlined in part c", we do not have a general theory of oligopoly. All we have are many specific cases and models. These models accomplish three things: !" they show clearly the nature of oligopolistic interdependence, $" they point out the gaps that a satisfactory theory of oligopoly must fill, and %" they give some indication of how difficult this branch of microeconomics really is. 10.17 )dentify and discuss the most important factors that give rise to oligopoly and, in the long run, also act as barriers to entry into oligopolistic industries. The most important factors that give rise to oligopoly and act as barriers to entry are these: !" 'conomies of scale may operate over a scale of outputs sufficiently large to leave only a few firms as suppliers of the entire market. $" Luge capital investments and specialized inputs are usually re*uired to enter an oligopolistic industry say automobiles, aluminum, steel, and similar industries" and this acts as an important natural barrier to entry.

%" =ecause of their patent ownership, a few firms may have the exclusive right to produce a commodity or to use a particular production process. &" 'stablished firms may have a loyal customer following based on product *uality and service that new firms would find very difficult to match. :" A few firms may own or control the entire supply of a raw material re*uired in the production of the product. 9" The government may give a franchise to only a few firms to operate in the market. 10.20 a" (hat is meant by concentration ratiosF (hat is their usefulnessF ." (hat are some of the most serious limitations in using concentration ratios as a measure of the degree of competition in an oligopolistic industryF a" /oncentration ratios give the percentage of total industry sales of the &, 5, and $, largest firms in the industry, and so measure the degree by which an industry is dominated by a few large firms. ." 8ome of the most serious limitations in using concentration ratios to measure the degree of competition in an industry are these: !" )n industries in which imports are significant, concentration ratios may greatly overestimate the relative importance of the largest firms in the industry. For example, since automobile imports are about $: percent of the domestic market in the Dnited 8tates, the real four3firm concentration ratio in the automobile industry is not 7$ percent but 97 percent i.e., 7$ percent times ,.;:". $" /oncentration ratios refer to the nation as whole, while the relevant market may be local. For example, the four3firm concentration ratio for the cement industry is %! percent, but because of very high trans3 portation costs, only two or three firms may actually compete in many local market. %" Low broadly or narrowly a product is defined is also very important. For example, concentration ratios in the computer industry as a whole are higher than in the industry2s personal computer segment. &" /oncentration ratios do not give any indication of the number of potential entrants into the market and of the degree of actual and potential competition in the industry. 0igorous competition can also take place among few sellers. )n short, concentration ratios provide only one dimension of the degree of competition in the market, and while useful, they must be used with great caution. 10.21 Assuming that an oligopolistic firm, presently selling its product at a price of 65, faced Q 1 %9, E &,P as its relevent demand function for price increases, and Q' 1 !$, E !,P for price reductions in both cases P is measured in

dollars". a" Kraw the demand curve facing this oligopolist, give an explanation for the shape of the curve, and derive the marginal revenue curve# on the same set of axes also sketch the set of c9st schedules given in the following table. ." )f the oligopolist2s cost schedules are given by -/ and A/, find how much profit this oligopolist earns. c" )f the oligopolist2s cost schedules change to -/' and A/', find the new best level of output, the price at which this output is sold, and the new level of profits for this oligopolist.

Fig. 10-17

a" 8ee Fig. !,3!7. The shape of " in Fig. !,3!7 can be explained by assuming that if the oligopolistic firm raises its price from the prevailing level of 65, the other oligopolists in the market will not raise theirs, so that the firm will lose a great deal of its sales to rivals and the firm2s demand curve will be very elastic. )f the firm lowers its price, others will also lower theirs, so our oligopolist retains more or less only its own share of the market and its demand curve becomes less elastic. ." (ith cost curves -/ and A/, the oligopolist makes a profit of 6%.:, per unit on each of the &, units it sells and thus earns a total profit of 6!&,. c" )f the oligopolist2s cost curves shift up to -/ ' and AT/', its best level of

output remains at &, units per time period since the -/ ' curve still intersects the discontinuous or vertical portion of the -. curve" and the firm will continue to sell at the price of 65. =ut now the oligopolist2s profit is only 6$.:, per unit and 6!,, in total. Aote that there is also a wide range over which the oligopolist2s demand curve, with its kink at 65, can shift and result only in a change in the oligopolist2s e*uilibrium *uantity but not in the e*uilibrium price." 10.22 a" (hat does the kinked demand curve, or 8weezy model, accomplishF ." (hat would happen if the new and higher -/ curve e.g., the -/ ' curve in Fig. !,3!7" intersected the -. curve to the left of and above its vertical or discontinuous portionF c" (hy is the oligopolist in general reluctant to lower its price even when Iustified by demand and cost considerationsF d" Ko oligopolists recognize their interdependence in the kinked demand curve modelF Ko they colludeF a" The kinked demand curve model can rationali'e price rigidity in oligopolistic markets in the face of widespread changes in cost conditions. The model is of no use, however, in explaining how the prevailing price was determined in the first place. ." )f a new and higher -/ curve intersects the -. curve to the left of and above its vertical or discontinuous portion, this and other firms would want to increase prices. An orderly price increase might then occur through price leadership. c" Cligopolists are, in general, reluctant to lower prices for fear of starting a price war. Therefore, firms prefer to compete on the basis of *uality, product design, advertising, and service. d" )n the kinked demand curve model, firms recognize their mutual dependence, but act without collusion. 10.23 Assume that !" the !, identical firms in a purely oligopolistic industry form a centralized cartel, $" the total market demand function facing the cartel is given by Q 1 $&, E l,P, where P is expressed in dollars, %" each firm2s -/ is given by 6,.l,Q for Q < & units, and factor prices remain constant. Ketermine a" the best level of output and price for this cartel, ." how the cartel can minimize production costs, and c" how much profit the cartel (ill make if the AT/ for each firm at the best level of output is 6!$. d" (hy do we study cartel models if cartels are illegal in the Dnited 8tates todayF a" 8ee Fig. !,3$,. )n the figure we see that the best level of output for this cartel is 5, units and is given by the point at which -. 1 -/. The cartel will set the price at 6!9. This is the monopoly solution. ." )f the cartel wants to minimize costs of production, it will set a *uota of 5 units of production for each firm given by the condition -/! 1 -/$

1 1 -/!, 1 -. 1 65, where the subscripts refer to the firms in the cartel". This is the same as the solution for the multiplant monopolist. c" )f AT/ 1 6!$ at Q 1 5, each firm will earn a profit of 6& per unit and 6%$ in total. The cartel as a whole will earn a profit of 6%$,. )n this case, each firm will very likely share e*ually in the cartel2s profits. )n more realistic and complicated cases, it may not be so easy to decide how to share the cartel2s profits. The bargaining strength of each firm will then become important. d" 'ven if cartels are illegal in the Dnited 8tates, cartel models give some indication of how a tightly organized oligopolistic industry might operate. The best3known international cartel today is C+'/ Crganization of +etroleum 'xporting /ountries". Aote that the greater the number of firms in the cartel, the easier it is for members to cheat on each other and thus cause the collapse of the collusive agreement.

Fig. 10-20

10.24 8uppose that only one high3cost firm firm !" and one low3cost firm firm $" are selling a homogeneous product and that they tacitly agree to share the market e*ually. )f " in Fig. !,3$! is the total market demand curve for the product, then "! 1 "$ is the half3share demand curve of firms ! and $ and -.! 1 -.$ is the corresponding marginal revenue curve. Ketermine what each firm wants to do and what it actually does.

Fig. 10-21

8ee Fig. !,3$!. )n the figure, we see that firm ! wants to sell !:, units of the product at a price of 67 given by point E!, at which -/! 1 -.!" while firm $ wants to sell $,, units of the product at a price of 65 given by point E$, at which -/$ 1 -.$". 8ince the product is homogeneous, however, firm ! will have to follow firm $ and also sell at the price of 65. Thus, only firm $ i.e., the price leader" will usually be producing and selling its best level of output. 10.25 Assume that !" in a purely oligopolistic industry there is one dominant firm, which acts as the price leader, and there are !, identical follower firms# $" the total market demand function for the commodity is " 1 $&, E l,P, where P is in dollars# and %" the -/ function for the dominant firm is 6,.$,Q for Q < !, units, while the -/ function for each of the small firms is 6lQ for Q < & units, and the A0/ for each of the small firms is 6& at Q 1 &. a" Cn the same set of axes sketch "&, the supply curve of all the follower firms combined, the demand curve of the dominant firm, its marginal revenue curve, and its marginal cost curve. ." (hat price will the dominant firm setF .ow much will all the follower firms together and the dominant firm sell at that priceF c" (hat do the cartel and price leadership models have in

commonF a" 8ee Fig. !,3$$. )n the figure, the -/ curve represents the supply curve of all the follower firms together. This is so because the followers behave as perfect competitors or price takers. 8ince the A0/ of each follower is 6& at & units of output, the followers will supply nothing at prices below 6& per unit. =y subtracting -/ from "& at each price, we get the demand curve faced by the leader or dominant firm "+". This is given by !-M (. Aote that since followers supply nothing at prices below 6&, the demand curve of the leader coincides with the market demand curve for segment (. ." The leader will set the price of 6!,, at which it can sell its best level of output of &, units given by point E, at which -.+ 1 -/+". 8ince each follower can sell all it wants to at this price, each faces an infinitely elastic demand curve which coincides with its marginal revenue curve" at the price of 6!,. 'ach follower produces at P 1 -/F 1 6!,, and all the followers combined produce !,, units point , on the -/ curve", leaving &, units segment ,# 1 )-" to be sold by the dominant firm shown by point - on its demand curve". To find the amount of profit, we need the value of AT/ at the best level of output for each firm.

Fig. 10-22
c" )n the cartel and price leadership models, the oligopolists recognize their mutual dependence and act collusively. The collusion is perfect in the cartel models and imperfect in price leadership models. 10.26 (hat are the possible a" harmful and ." beneficial effects of oligopoly in the long runF a" )n the long tun, oligopoly may lead to the following harmful effects: !" As in monopoly, price usually exceeds 4A/ in oligopolistic markets. $" The oligopolist will usually not produce at the lowest point on its 4A/ curve. %" P < 4-/, so that there is an underallocation of the economy2s resources to the firms in an ohgopolistic industry. &" (hen oligopolists produce a differentiated product, too much may he spent on advertising and model changes. ." For technological reasons economies of scale", many products such as automobiles, steel, aluminum" cannot possibly be produced under conditions of perfect competition because their costs of production would be prohibitive. )n addition, oligopolists spend a great deal of their profits on research and development, and many economists believe that this leads to much faster technological advance and higher standards of living than if the industry were organized along perfectly competitive lines. Finally, some advertising is useful since it informs consumers, and some product differentiation has the economic value of satisfying the differing tastes of consumers.