Chapter Review: Key Points. 1 Monopolistic competition occurs when entry into an industry is easy and there are large numbers of suppliers of slightly differentiated products

1 Monopolistic competition occurs when entry into an industry is easy and there are large numbers of suppliers of slightly differentiated products. Demands for a perfect competitor's products are perfectly elastic, but the demands facing monopolistic competitors are negatively-sloped but still highly elastic.

2 Product differentiation refers to differences that consumers perceive between close substitutes, which can be real or imagined. They are created by such things as advertising and promotion and/or by differences in the actual goods. Product differentiation is intended to expand the demand for a firm's output and make demand less elastic.

3 Monopolistically competitive firms produce and sell levels of output that equate marginal revenue and marginal cost. The price is then determined by demand. This is similar to pure monopoly, but the level of short run profits derived from market power is generally lower, given that numerous other firms sell close substitutes.

4 Entry is relatively easy in monopolistic competition, so profits fall to normal levels (zero economic profits) in the long run. However, equilibrium output will be less and prices will be higher under monopolistic competition than in perfectly competitive markets.

5 An oligopoly is an industry comprised of a few sellers who recognize their mutual interdependence.

6 Economies of scale are among the causes of oligopolies. Some goods require substantial plant and equipment so that efficient production requires servicing a considerable portion of total industry demand. Mergers also facilitate the creation of oligopolies by joining competitors into single firms. Finally, oligopolies may exist because of other types of entry barriers that deter new firms from entering the industry.

7 There are numerous oligopoly models, but they break down into two major categories: collusive and noncollusive. The noncollusive kinked demand curve model assumes that if one firm raises its prices, other firms will ignore the increase, while other firms in the industry will match any price cuts. The result is a demand curve for the firm that is kinked at the current equilibrium price. This irregularity leads to a discontinuity (gap) in the marginal revenue curve. Consequently, changes in costs may not lead to changes in prices. This theory forecasts "sticky" prices in oligopolistic industries, but price stickiness is not confirmed empirically. Kinked demand curve models also fail to explain how the original equilibrium price is established, how prices change, or how entry by new rivals is deterred.

8 A cartel is an organization established to facilitate collusion by firms in an industry. It sets price and output ceilings for all its members. Cartels must be concentrated in the hands of a few firms that control significant proportions of an industry's output. The product needs to be reasonably homogeneous, since agreements regarding heterogeneous products would be complex and difficult to enforce.

9 Cartels try to maximize joint profits and then allocate territories or industry output quotas. The stability of any cartel is threatened by the profitability associated with undetected price cuts, or " cheating ".

10 Industry output will be less and prices will be higher under oligopoly than in perfect or monopolistic competition..

11 Strategic behavior entails ascertaining what other people are likely to do in a specific situation, and then following tactics that maximize your gain or minimize any harm to you.

12 Game theory is the study of strategic interactions among interdependent decision makers, including those in oligopoly markets. Pay-off matrices are constructed to examine how transactors minimize their losses or maximize their gains, given the most likely decisions of other players in a game.

13 In a prisoner's dilemma, the dominant strategy of each party results in inefficiency. Cooperation would allow both to gain, but lack of cooperation is the dominant strategy.

14 Dynamic games involve sequences of choices over time and result in a wide array of possible strategies. A grim strategy entails cooperating until your opponent fails to do so, and then clobbering the opponent in every subsequent round. A tit-for-tat strategy responds in kind to whatever your opponent did in the previous round.

15 Predatory behavior involves activity by firms to drive rivals from the market or to deter entry. Once rivals disappear, predators can set prices consistent with their market power. A problem with this model is that reentry would normally occur when the high price is resumed, unless the predator firm has significant cost advantages so that potential rivals expect reentry to prompt lower prices once again.

16 Limit pricing is a strategy intended to inhibit market entry. Limit pricing techniques include low prices that make it unprofitable for new entrants, or to signal that the market is insufficient for a new entrant. Low prices also convey the message that the incumbent firm is a low cost (efficient) firm.

17 Economists have recently begun examining the role that sunk costs as precommitments to capacity have on deterring entry into markets. Game theory has opened up many avenues for future research and has changed our views on the relationship between strategic behavior and industrial structure. (5 235 digits)

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