Principles of Microeconomics Scarcity and Social Provisioning Chapter 13 Monopolistic Competition and Oligopoly

CHAPTER 13 . MONOPOLISTIC COMPETITION AND OLIGOPOLY INTRODUCTION TO MONOPOLISTIC COMPETITION AND OLIGOPOLY Figure . Competing Brands ?

The laundry detergent market is one that is characterized neither as perfect competition nor monopoly . Credit modification of work by Pixel Creative Commons ) THE TEMPTATION TO DEFY THE LAW Laundry detergent and bags of of industries that seem pretty mundane , maybe even boring , Hardly ! Both have been the center of clandestine meetings and secret deals Worthy of a spy novel , In France , between 1997 and 2004 , the top four laundry detergent producers ( Proctor Gamble , and ) controlled about 90 percent of the French soap market . Officials from the soap firms were meeting secretly , in , small around Paris . Their goals Stamp out competition and set prices . Around the same time , the top five Midwest ice makers ( Home City Ice , Lang Ice , Ice , Dairy , and Products of Ohio ) had similar goals in mind when they secretly agreed to divide up the bagged ice market . If both groups could meet their goals , it would enable each to act as though they were a single essence , a

PRINCIPLES or ECONOMICS 371 enjoy profits . The problem ?

In many parts of the world , including the European Union and the United States , it is illegal for firms to divide up markets and set prices collaboratively . These two cases provide examples of markets that are characterized neither as perfect competition nor monopoly . Instead , these firms are competing in market structures that lie between the extremes of monopoly and perfect competition . How do they behave ?

Why do they exist ?

We will revisit this case later , to find out what happened . CHAPTER OBJECTIVES Introduction to Monopolistic Competition and Oligopoly In this chapter , you will learn about Monopolistic Competition Oligopoly competition and monopoly are at opposite ends of the competition spectrum . A perfectly competitive market has many firms selling identical products , who all act as price takers in the face of the competition . If you recall , price takers are firms that have no market power . They simply have to take the market price as given . Monopoly arises when a single firm sells a product for which there are no close substitutes . for instance , has been considered a monopoly because of its domination of the operating systems ket . What about the vast majority of real world firms and organizations that fall between these extremes , firms that could be described as imperfectly competitive ?

What determines their behavior ?

They have more influence over the price they charge than perfectly competitive firms , but not as much as a monopoly would . What will they do ?

One type of imperfectly competitive market is called monopolistic competition . Monopolistically competitive markets feature a large number of competing firms , but the products that they sell are not identical . Consider , as an example , the Mall of America in Minnesota , the largest shopping mall in the United States . In 2010 , the Mall of America had 24 stores that sold women clothing ( like Ann Taylor and Urban ) another 50 stores that sold clothing for both men and women ( like Banana Republic , Crew , and ) plus 14 more stores that sold women specialty clothing ( like Motherhood Maternity and Secret ) Most of the markets that encounter at the retail level are monopolistically competitive . The other type of imperfectly competitive market is oligopoly . Oligopolistic markets are those by a small number of firms . Commercial aircraft provides a good example Boeing and each produce slightly less than 50 of the large commercial aircraft in the world . Another example is the soft drink industry , which is dominated by and Pepsi . are by high barriers to entry with firms choosing output , pricing , and other decisions strategically based on the decisions of the other firms in the market . In this chapter , we first explore how competitive firms will choose their level of output . We will then cuss oligopolistic firms , which face two conflicting temptations to collaborate as if they were a single

372 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER monopoly , or to individually compete to gain profits by expanding output levels and cutting prices . Oligopolistic markets and firms can also take on elements of monopoly and of perfect competition .

MONOPOLISTIC COMPETITION LEARNING By the end of this section , you will be able to Explain the significance of differentiated products Describe how a monopolistic competitor chooses price and quantity Discuss entry , exit , and efficiency as they pertain to monopolistic competition Analyze how advertising can impact monopolistic competition competition involves many firms competing against each other , but selling products that are distinctive in some way . Examples include stores that sell different styles of clothing restaurants or grocery stores that sell different kinds of food and even products like golf balls or beer that may be at least somewhat similar but differ in public perception because of advertising and brand names . There are over restaurants in the United States . When products are distinctive , each firm has a on its particular style or or brand name . ever , firms producing such products must also compete with other styles and flavors and brand names . The term monopolistic competition captures this mixture of and tough competition , and the following Clear It Up feature introduces its derivation . WHO INVENTED THE THEORY OF IMPERFECT COMPETITION ?

The theory of imperfect competition was developed by two economists independently but simultaneously in 1933 . The first was Edward of Harvard University who published The Economics Competition . The second Robinson of Cambridge University who published The Economics Competition . Robinson subsequently became interested in where she became a prominent , and later a economist . See the Welcome to Economics ! and The Perspective chapters for more on Keynes . DIFFERENTIATED PRODUCTS A firm can try to make its products different from those of its competitors in several ways physical aspects of the product , location from which the product is sold , intangible aspects of the product , and perceptions of the product . Products that are distinctive in one of these ways are called differentiated products . Physical aspects of a product include all the phrases you hear in advertisements unbreakable bottle ,

374 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER nonstick surface , extra spicy , newly redesigned for your comfort . The location of a firm can also create a difference between producers . For example , a gas station located at a heavily traveled intersection can probably sell more gas , because more cars drive by that corner . A supplier to an automobile manufacturer may find that it is an advantage to locate close to the car factory . Intangible aspects can differentiate a product , too . Some intangible aspects may be promises like a guarantee of satisfaction or money back , a reputation for high quality , services like free delivery , or offering a loan to purchase the product . Finally , product differentiation may occur in the minds of buyers . For example , many people could not tell the difference in taste between common varieties of beer or cigarettes if they were blindfolded but , because of past habits and advertising , they have strong preferences for certain brands . Advertising can play a role in shaping these intangible preferences . The concept of differentiated products is closely related to the degree of variety that is available . If everyone in the economy wore only blue jeans , ate only white bread , and drank only tap water , then the markets for clothing , food , and drink would be much closer to perfectly competitive . The variety of styles , locations , and characteristics creates product differentiation and monopolistic petition . PERCEIVED DEMAND FORA MONOPOLISTIC COMPETITOR A monopolistically competitive firm perceives a demand for its goods that is an intermediate case between monopoly and competition . Figure offers a reminder that the demand curve as faced by a perfectly competitive firm is perfectly elastic or , because the perfectly competitive firm can sell any quantity it wishes at the prevailing market price . In contrast , the demand curve , as faced by a monopolist , is the market demand curve , since a monopolist is the only firm in the market , and hence is downward sloping . I ) I I Quantity Quantity ( a ) Perfect ( Monopoly Figure . Perceived Demand for Firms in Different Competitive Settings . The demand curve faced by a perfectly competitive firm is perfectly elastic , meaning it can sell all the output it wishes at the prevailing market price . The demand curve faced by a monopoly is the market demand . It can sell more output only by decreasing the price it charges . The demand curve faced by a monopolistically competitive firm falls in between . The demand curve as faced by a monopolistic competitor is not , but rather , which means that the monopolistic competitor can raise its price without losing all of its customers

PRINCIPLES or ECONOMICS 375 or lower the price and gain more customers . Since there are substitutes , the demand curve facing a monopolistically competitive firm is more elastic than that of a monopoly where there are no close substitutes . If a monopolist raises its price , some consumers will choose not to purchase its they will then need to buy a completely different product . However , when a monopolistic competitor raises its price , some consumers will choose not to purchase the product at all , but others will choose to buy a similar product from another firm . If a monopolistic competitor raises its price , it will not lose as many customers as would a perfectly competitive firm , but it will lose more customers than would a monopoly that raised its prices . At a glance , the demand curves faced by a monopoly and by a monopolistic competitor look is , they both slope down . But the underlying economic meaning of these perceived demand curves is different , because a monopolist faces the market demand curve and a monopolistic tor does not . Rather , a monopolistically competitive firm demand curve is but one of many firms that make up the before market demand curve . Are you following ?

If so , how would you categorize the market for golf balls ?

Take a swing , then see the following Clear It Up feature . ARE GOLF BALLS REALLY DIFFERENTIATED PRODUCTS ?

Monopolistic competition refers to an industry that has more than a few firms , each offering a product which , from the consumer perspective , is different from its competitors . The US . Golf Association runs a laboratory that tests golf balls a year . There are strict rules for what makes a golf ball legal . The weight of a golf ball can not exceed ounces and its diameter can not be less than inches ( Which is a weight of 4593 grams and a diameter of millimeters , in case you were wondering ) The balls are also tested by being hit at different speeds . For example , the distance test involves having a mechanical golfer hit the ball with a titanium driver and a swing speed of 120 miles per hour . As the testing center explains The system then uses an array of sensors that accurately measure the of a golf ball during a short , indoor trajectory from a ball launcher . From this data , a computer calculates the lift and drag forces that are by the speed , spin , and dimple pattern of the ball . The distance limit is 317 yards . Over 1800 golf balls made by more than 100 companies meet the standards . The halls do differ in various ways , like the pattern of dimples on the ball , the types of plastic used on the cover and in the cores , and so on . Since all balls need to conform to the tests , they are much more alike than different . In other words , golf ball manufacturers are competitive . However , retail sales of are about 500 million per year , which means that a lot of large companies have a ful incentive to persuade players that golf balls are highly differentiated and that it makes a huge difference which one you choose . Sure , Tiger Woods can tell the difference . For the average duffer ( for a mediocre player ) who plays a few times a who loses a lot of golf balls to the woods and lake and needs to buy new golf balls are pretty much indistinguishable . HOW A MON COMPETITOR CHOOSES PRICE AND QUANTITY The monopolistically competitive firm decides on its quantity and price in much the same way as a monopolist . A monopolistic competitor , like a monopolist , faces a ing demand curve , and so it will choose some combination of price and quantity along its perceived demand curve . As an example of a monopolistic competitor , consider the Authentic Chinese Pizza store , which serves pizza with cheese , sweet and sour sauce , and your choice of vegetables and meats . Although Authentic Chinese Pizza must compete against other pizza businesses and

376 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER rants , it has a differentiated product . The firms perceived demand curve is downward sloping , as shown in Figure and the first two columns of Table . 35 30 Marginal cost 25 . I . Total . 20 ( 40 . 15 Average cost 10 Total cost If I I Demand . Marginal revenue ' I I I 10 20 30 40 50 70 80 90 Quantity Figure . How a Monopolistic Competitor Chooses its Profit Maximizing Output and Price . To maximize profits , the Authentic Chinese Pizza shop would choose a quantity where marginal revenue equals marginal cost , or where . Here it would choose a quantity of 40 and a price of 16 . Quantity Price 10 23 230 340 20 20 400 17 400 30 18 540 14 480 40 16 640 10 580 50 14 700 700 60 12 720 840 70 10 700 80 640 Table . Revenue and Cost Schedule 10 12 14 18 26 Total Revenue Marginal Revenue Total Cost Marginal Cost Average Cost 34 20 16 14 14 16 The combinations of price and quantity at each point on the demand curve can be multiplied to late the total revenue that the firm would receive , which is shown in the third column of Table . The fourth column , marginal revenue , is calculated as the change in total revenue divided by the change in quantity . The final columns of Table show total cost , marginal cost , and average cost . As always , marginal cost is calculated by dividing the change in total cost by the change in quantity , while age cost is calculated by dividing total cost by quantity . The following Work It Out feature shows how these firms calculate how much of its product to supply at what price .

PRINCIPLES or ECONOMICS 377 HOW A MONOPOLISTIC COMPETITOR DETERMINES HOW MUCH TO PRODUCE AND AT WHAT PRICE The process by which a monopolistic competitor chooses its quantity and price resembles closely how a monopoly makes these decisions process . First , the firm selects the quantity to produce . Then the firm decides what price to charge for that quantity . Step . The monopolistic competitor determines its level of output . In this case , the Authentic Chinese Pizza company will determine the quantity to produce by considering its marginal revenues and costs . Two scenarios are possible If the firm is producing at a quantity of output where marginal revenue exceeds marginal cost , then the firm should keep expanding production , because each marginal unit is adding to profit by bringing in more revenue than its cost . In this way , the firm will produce up to the quantity where . If the firm is producing at a quantity where marginal costs exceed marginal revenue , then each marginal unit is costing more than the revenue it brings in , and the firm will increase its profits by reducing the quantity of output until . In this example , and intersect at a quantity of 40 , which is the level of output for the firm . Step . The monopolistic competitor decides what price to charge . When the firm has determined its quantity of output , it can then look to its perceived demand curve to find out what it can charge for that quantity of output . On the graph , this process can be shown as a vertical line reaching up through the quantity until it hits the firm perceived demand curve . For Authentic Chinese Pizza , it should charge a price of 16 per pizza for a quantity of 40 . Once the firm has chosen price and quantity , it in a position to calculate total revenue , total cost , and profit . At a quantity of 40 , the price of 16 lies above the average cost curve , so the firm is making economic profits . From Table we can see that , at an output of 40 , the firm total revenue is 640 and its total cost is 580 , so profits are 60 . In Figure , the total revenues are the rectangle with the quantity of 40 on the horizontal axis and the price of 16 on the vertical axis . The firm total costs are the light shaded rectangle with the same quantity of 40 on the horizontal axis but the average cost of on the Vertical axis . Profits are total revenues minus total costs , which is the shaded area above the average cost . Although the process by which a monopolistic competitor makes decisions about quantity and price is similar to the way in which a monopolist makes such decisions , two differences are worth bering . First , although both a monopolist and a monopolistic competitor face demand curves , the monopolist perceived demand curve is the market demand curve , while the demand curve for a monopolistic competitor is based on the extent of its product tion and how many competitors it faces . Second , a monopolist is surrounded by barriers to entry and need not fear entry , but a monopolistic competitor who earns profits must expect the entry of firms with similar , but differentiated , products . MONOPOLISTIC COMPETITORS AND ENTRY If one monopolistic competitor earns positive economic profits , other firms will be tempted to enter the market . A gas station with a great location must worry that other gas stations might open across the street or down the perhaps the new gas stations will sell coffee or have a carwash or some other attraction to lure customers . A successful restaurant with a unique barbecue sauce must be concerned that other restaurants will try to copy the sauce or offer their own unique recipes . A

373 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER laundry detergent with a great reputation for quality must be concerned that other competitors may seek to build their own reputations . The entry of other firms into the same general market ( like gas , restaurants , or detergent ) shifts the demand curve faced by a monopolistically competitive firm . As more firms enter the market , the quantity demanded at a given price for any particular firm will decline , and the firms perceived demand curve will shift to the left . As a firm perceived demand curve shifts to the left , its marginal revenue curve will shift to the left , too . The shift in marginal revenue will change the ing quantity that the firm chooses to produce , since marginal revenue will then equal marginal cost at a lower quantity . Figure ( a ) shows a situation in which a monopolistic competitor was earning a profit with its nal perceived demand curve ( The intersection of the marginal revenue curve ( and marginal cost curve ( occurs at point , corresponding to quantity , which is associated on the demand curve at point with price . The combination of price Po and quantity lies above the average cost curve , which shows that the firm is earning positive economic profits . a ) Prom Induces entry , to zero ) Loss Induces , shIft to zero Figure . Monopolistic Competition , Entry , and Exit . a ) At and , the monopolistically competitive firm shown in this figure is making a positive economic profit . This is clear because if you follow the dotted line above , you can see that price is above average cost . Positive economic profits attract competing firms to the industry , driving the original firm demand down to . At the new equilibrium quantity ( the original firm is earning zero economic profits , and entry into the industry ceases . In ( the opposite occurs . At and , the firm is losing money . If you follow the dotted line above , you can see that average cost is above price . Losses induce firms to leave the industry . When they do , demand for the original firm rises to , where once again the firm is earning zero economic profit . Unlike a monopoly , with its high barriers to entry , a monopolistically competitive firm with positive economic profits will attract competition . When another competitor enters the market , the original firm perceived demand curve shifts to the left , from to , and the associated marginal revenue curve shifts from to . The new output is , because the intersection of

PRINCIPLES or ECONOMICS 379 the and now occurs at point . Moving vertically up from that quantity on the new demand curve , the optimal price is at . As long as the firm is earning positive economic profits , new competitors will continue to enter the market , reducing the original firm demand and marginal revenue curves . The equilibrium is shown in the figure at point , where the firms perceived demand curve touches the average cost curve . When price is equal to average cost , economic profits are zero . Thus , although a cally competitive firm may earn positive economic profits in the short term , the process of new entry will drive down economic profits to zero in the long run . Remember that zero economic profit is not equivalent to zero accounting profit . A zero economic profit means the firms accounting profit is equal to what its resources could earn in their next best use . Figure ( shows the reverse situation , where a monopolistically competitive firm is originally losing money . The adjustment to equilibrium is analogous to the previous example . The economic losses lead to firms exiting , which will result in increased demand for this particular firm , and consequently lower losses . Firms exit up to the point where there are no more losses in this market , for example when the demand curve touches the average cost curve , as in point Monopolistic competitors can make an economic profit or loss in the short run , but in the long run , entry and exit will drive these firms toward a zero economic profit outcome . However , the zero nomic profit outcome in monopolistic competition looks different from the zero economic profit outcome in perfect competition in several ways relating both to efficiency and to variety in the ket . MONOPOLISTIC COMPETITION AND EFFICIENCY The result of entry and exit in a perfectly competitive market is that all firms end up selling at the price level determined by the lowest point on the average cost curve . This outcome is why perfect competition displays productive efficiency goods are being produced at the lowest possible average cost . However , in monopolistic competition , the end result of entry and exit is that firms end up with a price that lies on the portion of the average cost curve , not at the very bottom of the AC curve . Thus , monopolistic competition will not be productively efficient . In a perfectly competitive market , each firm produces at a quantity where price is set equal to cost , both in the short run and in the long run . This outcome is why perfect competition displays efficiency the social benefits of additional production , as measured by the marginal benefit , which is the same as the price , equal the marginal costs to society of that production . In a competitive market , the rule for maximizing profit is to set price is higher than marginal revenue , not equal to it because the demand curve is downward sloping . When , which is the outcome in a monopolistically competitive market , the benefits to society of ing additional quantity , as measured by the price that people are willing to pay , exceed the marginal costs to society of producing those units . A monopolistically competitive firm does not produce more , which means that society loses the net benefit of those extra units . This is the same argument we made about monopoly , but in this case to a lesser degree . Thus , a monopolistically competitive industry will produce a lower quantity of a good and charge a higher price for it than would a perfectly competitive industry . See the following Clear It Up feature for more detail on the impact of demand shifts .

380 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER WHY DOES A SHIFT IN PERCEIVED DEMAND CAUSE A SHIFT IN MARGINAL REVENUE ?

The combinations of price and quantity at each point on a firm perceived demand curve are used to calculate total revenue for each combination of price and quantity . This information on total revenue is then used to calculate marginal revenue , which is the change in total revenue divided by the change in quantity . A change in perceived demand will change total revenue at every quantity of output and in turn , the change in total revenue will shift marginal revenue at each quantity of output . Thus , when entry occurs in a monopolistically competitive industry , the perceived demand curve for each firm will shift to the left , because a smaller quantity will be demanded at any given price . Another way of interpreting this shift in demand is to notice that , for each quantity sold , a lower price will be charged . Consequently , the marginal revenue will be lower for each quantity the marginal revenue curve will shift to the left as well . Conversely , exit causes the demand curve for a monopolistically competitive firm to shift to the right and the corresponding marginal revenue curve to shift right , too . A monopolistically competitive industry does not display productive and efficiency in either the short run , when firms are making economic profits and losses , nor in the long run , when firms are earning zero profits . THE BENEFITS OF VARIETY AND PRODUCT DIFFERENTIATION Even though monopolistic competition does not provide productive efficiency or , it does have benefits of its own . Product differentiation is based on variety and innovation . Many people would prefer to live in an economy with many kinds of clothes , foods , and car styles not in a world of perfect competition where everyone will always wear blue jeans and white shirts , eat only spaghetti with plain red sauce , and drive an identical model of car . Many people would prefer to live in an economy where firms are struggling to figure out ways of attracting customers by methods like friendlier service , free delivery , guarantees of quality , variations on existing products , and a better shopping experience . Economists have struggled , with only partial success , to address the question of whether a economy produces the optimal amount of variety . Critics of economies argue that society does not really need dozens of different athletic shoes or breakfast cereals or . They argue that much of the cost of creating such a high degree of product differentiation , and then of advertising and marketing this differentiation , is socially is , most people would be just as happy with a smaller range of differentiated products produced and sold at a lower price . Defenders of a economy respond that if people do not want to buy differentiated products or highly advertised brand names , no one is forcing them to do so . Moreover , they argue that consumers benefit substantially when firms seek profits by providing differentiated . This controversy may never be fully resolved , in part because deciding on the optimal amount of variety is very difficult , and in part because the two sides often place different values on what variety means for consumers . Read the following Clear It Up feature for a discussion on the role that plays in monopolistic competition . HOW DOES ADVERTISING IMPACT MONOPOLISTIC COMPETITION ?

The economy spent about billion on advertising in 2014 , according to . Roughly one third of this was television advertising , and another third was divided roughly equally between Internet , newspapers , and radio .

PRINCIPLES or ECONOMICS 381 The remaining third was divided up between direct mail , magazines , telephone directory yellow pages , and billboards . Mobile devices are increasing the opportunities for advertisers . Advertising is all about explaining to people , or making people believe , that the products of one firm are differentiated from the products of another firm . In the framework of monopolistic competition , there are two ways to conceive of how advertising works either advertising causes a firm perceived demand curve to become more inelastic ( that is , it causes the perceived demand curve to become steeper ) or advertising causes demand for the firm product to increase ( that is , it causes the firm perceived demand curve to shift to the right ) In either case , a successful advertising campaign may allow a firm to sell either a greater quantity or to charge a higher price , or both , and thus increase its profits . However , economists and business owners have also long suspected that much of the advertising may only offset other advertising . Economist wrote the following back in 1920 in his book , The Economics of Welfare It may happen that expenditures on advertisement made by competing that is , what we now call monopolistic competitors will simply neutralise one another , and leave the industrial position exactly as it would have been if neither had expended anything . For , clearly , if each of two rivals makes equal efforts to attract the favour of the public away from the other , the total result is the same as it would have been if neither had made any effort at all . KEY CONCEPTS AND SUMMARY Monopolistic competition refers to a market where many firms sell differentiated products . products can arise from characteristics of the good or service , location from which the product is sold , intangible aspects of the product , and perceptions of the product . The perceived demand curve for a monopolistically competitive firm is , which shows that it is a price maker and chooses a combination of price and quantity . However , the demand curve for a monopolistic competitor is more elastic than the perceived demand curve for a monopolist , because the monopolistic competitor has direct competition , unlike the pure monopolist . A monopolistic competitor will seek out the quantity where marginal revenue is equal to marginal cost . The monopolistic competitor will produce that level of output and charge the price that is indicated by the firms demand curve . If the firms in a monopolistically competitive industry are earning economic profits , the industry will attract entry until profits are driven down to zero in the long run . If the firms in a monopolistically competitive industry are suffering economic losses , then the industry will experience exit of firms until economic profits are driven up to zero in the long run . A monopolistically competitive firm is not productively efficient because it does not produce at the minimum of its average cost curve . A monopolistically competitive firm is not efficient because it does not produce where , but instead produces where . Thus , a competitive firm will tend to produce a lower quantity at a higher cost and to charge a higher price than a perfectly competitive firm . Monopolistically competitive industries do offer benefits to consumers in the form of greater variety and incentives for improved products and services . There is some controversy over whether a oriented economy generates too much variety .

382 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER SELF ' QUESTIONS Suppose that , due to a successful advertising campaign , a monopolistic competitor experiences an increase in demand for its product . How will that affect the price it charges and the quantity it supplies ?

Continuing with the scenario outlined in question , in the long run , the positive economic profits earned by the monopolistic competitor will attract a response either from existing firms in the industry or firms outside . As those firms capture the original firm profit , what will happen to the original firm maximizing price and output levels ?

REVIEW QUESTIONS What is the relationship between product differentiation and monopolistic competition ?

How is the perceived demand curve for a monopolistically competitive firm different from the perceived demand curve for a monopoly or a perfectly competitive firm ?

How does a monopolistic competitor choose its quantity of output and price ?

How can a monopolistic competitor tell Whether the price it is charging will cause the firm to earn profits or experience losses ?

If the firms in a monopolistically competitive market are earning economic profits or losses in the short run , would you expect them to continue doing so in the long run ?

Why ?

Is a monopolistically competitive firm productively efficient ?

Is it efficient ?

Why or why not ?

CRITICAL THINKING QUESTIONS Aside from advertising , how can monopolistically competitive firms increase demand for their products ?

Make a case for why monopolistically competitive industries never reach equilibrium . Would you rather have efficiency or variety ?

That is , one opportunity cost of the variety of products We have is that each product costs more per unit than if there were only one kind of product of a given type , like shoes . Perhaps a better question is , What is the right amount of variety ?

Can there he too many varieties of shoes , for example ?

PROBLEMS Andrea Day Spa began to offer a relaxing aromatherapy treatment . The firm asks you how much to charge to profits . The demand curve for the treatments is given by the first two columns in Table its total costs are given in the third column For each level of output , calculate total revenue , marginal revenue , average cost , and marginal cost . What is the level of output for the treatments and how much will the firm earn in profits ?

PRINCIPLES OF ECONOMICS 383 Quantity 130 10 275 20 435 30 610 40 800 50 60 REFERENCES Media . Our Insights . Advertising Year End Trends Report Accessed October 17 , 2015 . Number of Restaurants in the United States from 2011 to Accessed March 27 , differentiated product a product that is perceived by consumers as distinctive in some way imperfectly competitive firms and organizations that fall between the extremes of monopoly and perfect competition monopolistic competition many firms competing to sell similar but differentiated products oligopoly when a few large firms have all or most of the sales in an industry SOLUTIONS Answers to Questions . An increase in demand will manifest itself as a rightward shift in the demand curve , and a rightward shift in marginal revenue . The shift in marginal revenue will cause a movement up the marginal cost curve to the new intersection between and at a higher level of output . The new price can be read by drawing a line up from the new output level to the new demand curve , and then over to the vertical axis . The new price should be higher . The increase in quantity will cause a movement along the average cost curve to a possibly higher level of average cost . The price , though , will increase more , causing an increase in total profits . As long as the original firm is earning positive economic profits , other firms will respond in Ways that take away the original firm profits . This will manifest itself as a decrease in demand for the original product , a decrease in the firm price and a decrease in the firm

384 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER level of output , essentially unwinding the process described in the answer to question . In the equilibrium , all firms in monopolistically competitive markets will earn zero economic profits .

OLIGOPOLY LEARNING OBJECTIVES By the end of this section , you will be able to Explain why and how exist Contrast collusion and competition Interpret and analyze the prisoners dilemma diagram Evaluate the of imperfect competition any purchases that individuals make at the retail level are produced in markets that are perfectly competitive , monopolies , nor monopolistically competitive . Rather , they are . Oligopoly arises when a small number of large firms have all or most of the sales in an industry . Examples of oligopoly abound and include the auto industry , cable television , and commercial air travel . Oligopolistic firms are like cats in a bag . They can either scratch each other to pieces or cuddle up and get comfortable with one another . If compete hard , they may end up acting very much like perfect competitors , driving down costs and leading to zero profits for all . If collude with each other , they may effectively act like a monopoly and succeed in pushing up prices and earning consistently high levels of profit . are typically characterized by mutual interdependence where various decisions such as output , price , advertising , and so on , depend on the decisions of the other firm ( Analyzing the choices of oligopolistic firms about pricing and quantity produced involves considering the pros and cons of competition versus collusion at a given point in time . WHY DO EXIST ?

A combination of the barriers to entry that create monopolies and the product differentiation that characterizes monopolistic competition can create the setting for an oligopoly . For example , when a government grants a patent for an invention to one firm , it may create a monopoly . When the ment grants patents to , for example , three different pharmaceutical companies that each has its own drug for reducing high blood pressure , those three firms may become an oligopoly . Similarly , a natural monopoly will arise when the quantity demanded in a market is only large enough for a single firm to operate at the minimum of the average cost curve . In such a ting , the market has room for only one firm , because no smaller firm can operate at a low enough average cost to compete , and no larger firm could sell what it produced given the quantity demanded in the market .

386 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Quantity demanded in the market may also be two or three times the quantity needed to produce at the minimum of the average cost means that the market would have room for only two or three oligopoly firms ( and they need not produce differentiated products ) Again , smaller firms would have higher average costs and be unable to compete , while additional large firms would such a high quantity that they would not be able to sell it at a profitable price . This combination of economies of scale and market demand creates the barrier to entry , which led to the oligopoly for large passenger aircraft . The product differentiation at the heart of monopolistic competition can also play a role in creating oligopoly . For example , firms may need to reach a certain minimum size before they are able to spend enough on advertising and marketing to create a recognizable brand name . The problem in ing with , say , or Pepsi is not that producing fizzy drinks is technologically difficult , but rather that creating a brand name and marketing effort to equal Coke or Pepsi is an enormous task . COLLUSION OR COMPETITION ?

When oligopoly firms in a certain market decide what quantity to produce and what price to charge , they face a temptation to act as if they were a monopoly . By acting together , oligopolistic firms can hold down industry output , charge a higher price , and divide up the profit among themselves . When firms act together in this way to reduce output and keep prices high , it is called . A group of firms that have a formal agreement to collude to produce the monopoly output and sell at the oly price is called a cartel . See the following Clear It Up feature for a more analysis of the difference between the two . COLLUSION VERSUS CARTELS HOW CAN I TELL WHICH IS WHICH ?

In the United States , as well as many other countries , it is illegal for firms to collude since collusion is behavior , which is a violation of antitrust law . Both the Antitrust Division of the Justice Department and the Federal Trade Commission have responsibilities for preventing collusion in the United States . The problem of enforcement is finding hard evidence of collusion . Cartels are formal agreements to collude . Because cartel agreements provide evidence of collusion , they are rare in the United States . Instead , most collusion is tacit , where firms implicitly reach an understanding that competition is bad for profits . The desire of businesses to avoid competing so that they can instead raise the prices that they charge and earn higher profits has been well understood by economists . Adam Smith wrote in Wealth of Nations in 1776 People of the same trade seldom meet together , even for merriment and diversion , but the conversation ends in a conspiracy against the public , or in some contrivance to raise Even when recognize that they would benefit as a group by acting like a monopoly , each individual oligopoly faces a private temptation to produce just a slightly higher quantity and earn slightly higher still counting on the other to hold down their production and keep prices high . If at least some give in to this temptation and start producing more , then the market price will fall . Indeed , a small handful of oligopoly firms may end up competing so fiercely that they all end up earning zero economic if they were perfect competitors .

PRINCIPLES or ECONOMICS 387 THE DILEMMA Because of the complexity of oligopoly , which is the result of mutual interdependence among firms , there is no single , theory of how behave , in the same way that we have theories for all the other market structures . Instead , economists use game theory , a branch of that analyzes situations in which players must make decisions and then receive payoffs based on what other players decide to do . Game theory has found widespread applications in the social , as well as in business , law , and military strategy . The prisoner dilemma is a scenario in which the gains from cooperation are larger than the rewards from pursuing . It applies well to oligopoly . The story behind the prisoners dilemma goes like this Two criminals are arrested . When they are taken to the police station , they refuse to say anything and are put in separate interrogation rooms . Eventually , a police officer enters the room where Prisoner A is being held and says You know what ?

Your partner in the other room is confessing . So your partner is going to get a light prison sentence of just one year , and because you re remaining silent , the judge is going to stick you with eight years in prison . Why do you get smart ?

If you confess , too , we cut your jail time down to five years , and your partner will get five years , also . Over in the next room , another police officer is giving exactly the same speech to Prisoner . What the police officers do not say is that if both prisoners remain silent , the evidence against them is not especially strong , and the prisoners will end up with only two years in jail each . The game theory situation facing the two prisoners is shown in Table . To understand the dilemma , first consider the choices from Prisoner A point of view . If A believes that will confess , then A ought to confess , too , so as to not get stuck with the eight years in prison . But if A believes that will not confess , then A will be tempted to act selfishly and confess , so as to serve only one year . The key point is that A has an incentive to confess regardless of what choice makes ! faces the same set of choices , and thus will have an incentive to confess regardless of what choice A makes . Confess is considered the dominant strategy or the strategy an individual ( or firm ) will pursue regardless of the other individuals ( or firms ) decision . The result is that if prisoners pursue their own , both are likely to confess , and end up doing a total of 10 years ofjail time between them . Prisoner Remain Silent ( cooperate with Confess ( do not cooperate with other prisoner ) other prisoner ) Prisoner ( Cooperate with other A gets years , gets years A gets years , gets year A Confess ( do not Cooperate with A gets year gets years A gets years gets years other prisoner ) Table . The Prisoner Dilemma Problem The game is called a dilemma because if the two prisoners had cooperated by both remaining silent , they would only have had to serve a total of four years of jail time between them . If the two prisoners can work out some way of cooperating so that neither one will confess , they will both be better off than if they each follow their own individual , which in this case leads straight into longer jail terms .

383 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER THE OLIGOPOLY VERSION OF THE PRISONER DILEMMA The members of an oligopoly can face a prisoner dilemma , also . If each of the cooperates in holding down output , then high monopoly profits are possible . Each , however , must worry that while it is holding down output , other firms are taking advantage of the high price by ing output and earning higher profits . Table shows the prisoners dilemma for a as a duopoly . If Firms A and both agree to hold down output , they are acting together as a monopoly and will each earn in profits . However , both firms dominant strategy is to increase output , in which case each will earn 400 in profits . Firm Hold Down Output ( cooperate with Increase Output ( do not cooperate other firm ) with other firm ) with A ets 000 ets 000 A ets 200 ets 500 Firm other firm ) A ( A gets 500 gets 200 A gets 400 gets 400 with other firm ) Table . A Prisoner Dilemma for Can the two firms trust each other ?

Consider the situation of Firm A If A thinks that will cheat on their agreement and increase output , then A will increase output , too , because for A the profit of 400 when both firms increase output ( the bottom choice in Table ) is better than a profit of only 200 if A keeps output low and raises output ( the upper choice in the table ) If A thinks that will cooperate by holding down output , then A may seize the opportunity to earn higher profits by raising output . After all , if is going to hold down output , then A can earn in profits by expanding output ( the bottom choice in the table ) compared with only by holding down output as well ( the upper choice in the table ) Thus , firm A will reason that it makes sense to expand output if holds down output and that it also makes sense to expand output if raises output . Again , faces a parallel set of decisions . The result of this prisoner dilemma is often that even though A and could make the highest profits by cooperating in producing a lower level of output and acting like a monopolist , the two firms may well end up in a situation where they each increase output and earn only 400 each in profits . The following Clear It Up feature discusses one cartel scandal in particular . WHAT IS THE LYSINE CARTEL ?

Lysine , a 600 industry , is an amino acid used by farmers as a feed additive to ensure the proper growth of swine and poultry . The primary producer of lysine is Archer Daniels Midland ( but several other large pean firms are also in this market . For a time in the first half of the 19905 , the World major lysine producers met together in hotel conference rooms and decided exactly how much each firm would sell and what it would charge . The US . Federal Bureau of Investigation ( FBI ) however , had learned of the cartel and placed wire taps on a number of their phone calls and meetings .

PRINCIPLES or ECONOMICS 389 From FBI surveillance tapes , following is a comment that Terry Wilson , president of the corn processing division at , made to the other lysine producers at a 1994 meeting in Mona , Hawaii I wan na go back and I wan na say something very simple . If were going to trust each other , okay , and if I assured that I gon na get tons by the year end , were gon na sell it at the prices we agreed to . The only thing we need to talk about there because we are gon na get manipulated by these expletive can be smarter than us if we let them be smarter . They the customers are not your friend . They are not my friend . And we got ta have em , but they are not my friends . You are my friend . I wan na be closer to you than I am to any customer . Cause you can make us money . And all I wan na tell you again is put the prices on the board . Let all agree that what we gon na do and then walk out of here and do it . The price of lysine doubled while the cartel Was in effect . Confronted by the FBI tapes , Archer Daniels Midland pled guilty in 1996 and paid a fine of 100 million . A number of top executives , both at and other firms , later paid fines of up to and were sentenced to months in prison . In another one of the FBI recordings , the president of Archer Daniels Midland told an executive from another competing firm that had a slogan that , in his Words , had penetrated the whole company . The company president stated the slogan this way Our competitors are our friends . Our customers are the enemy . That slogan could stand as the motto of cartels everywhere . HOW TO ENFORCE COOPERATION How can parties who find themselves in a prisoner dilemma situation avoid the undesired outcome and cooperate with each other ?

The way out of a prisoners dilemma is to find a way to penalize those who do not cooperate . Perhaps the easiest approach for colluding , as you might imagine , would be to sign a tract with each other that they will hold output low and keep prices high . If a group of signed such a contract , however , it would be illegal . Certain international organizations , like the nations that are members of the Organization of Petroleum Exporting Countries ( have signed international agreements to act like a monopoly , hold down output , and keep prices high so that all of the countries can make high profits from oil exports . Such agreements , however , because they fall in a gray area of international law , are not legally enforceable . If , for example , decides to start cutting prices and selling more oil , Saudi Arabia can not sue in court and force it to stop . Visit the Organization of the Petroleum Exporting Countries Website and learn more about its history and how it defines itself . Because can not sign a legally enforceable contract to act like a monopoly , the firms may instead keep close tabs on what other firms are producing and charging . Alternatively ,

390 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER may choose to act in a way that generates pressure on each firm to stick to its agreed quantity of put . One example of the pressure these firms can exert on one another is the kinked demand curve , in which competing oligopoly firms commit to match price cuts , but not price increases . This situation is shown in Figure . Say that an oligopoly airline has agreed with the rest of a cartel to provide a of seats on the New York to Los Angeles route , at a price of 500 . This choice defines the kink in the firms perceived demand curve . The reason that the firm faces a kink in its demand curve is because of how the other react to changes in the firms price . If the oligopoly decides to produce more and cut its price , the other members of the cartel will immediately match any price therefore , a lower price brings very little increase in quantity sold . If one firm cuts its price to 300 , it will be able to sell only seats . However , if the airline seeks to raise prices , the other will not raise their prices , and so the firm that raised prices will lose a considerable share of sales . For example , if the firm raises its price to 550 , its sales drop to seats sold . Thus , if always match price cuts by other firms in the cartel , but do not match price increases , then none of the will have a strong incentive to change prices , since the potential gains are minimal . This strategy can work like a silent form of cooperation , in which the cartel successfully manages to hold down output , increase price , and share a monopoly level of profits even without any legally enforceable agreement . Many , prodded by economic changes , legal and political pressures , and the egos of their top executives , go through episodes of cooperation and competition . If could sustain cooperation with each other on output and pricing , they could earn profits as if they were a single monopoly . However , each firm in an oligopoly has an incentive to produce more and grab a ger share of the overall market when firms start behaving in this way , the market outcome in terms of prices and quantity can be similar to that of a highly competitive market . OF IMPERFECT COMPETITION Monopolistic competition is probably the single most common market structure in the economy . It provides powerful incentives for innovation , as firms seek to earn profits in the short run , while entry assures that firms do not earn economic profits in the long run . However , monopolistically competitive firms do not produce at the lowest point on their average cost curves . In addition , the endless search to impress consumers through product differentiation may lead to excessive social expenses on advertising and marketing . Oligopoly is probably the second most common market structure . When result from patented innovations or from taking advantage of economies of scale to produce at low average cost , they may provide considerable benefit to consumers . are often buffeted by significant barriers to entry , which enable the to earn sustained profits over long periods of time . also do not typically produce at the minimum of their average cost curves . When they lack vibrant competition , they may lack incentives to provide innovative products and service . The task of public policy with regard to competition is to sort through these multiple realities , attempting to encourage behavior that is beneficial to the broader society and to discourage behavior

PRINCIPLES OF ECONOMICS 391 , 550 ( 10000 . 500 500 I , III 000 5300 200 , I I 5000 20 000 Figure . A Kinked Demand Curve . Consider a member firm in an oligopoly cartel that is supposed to produce a quantity of and sell at a price of 500 . The other members of the cartel can encourage this firm to honor its commitments by acting so that the firm faces a kinked demand curve . If the attempts to expand output and reduce price slightly , other firms also cut prices if the firm expands output to , the price per unit falls dramatically , to 300 . On the other side , if the oligopoly attempts to raise its price , other firms will not do so , so if the firm raises its price to 550 , its sales decline sharply to . Thus , the members of a cartel can discipline each other to stick to the levels of quantity and price through a strategy of matching all price cuts but not matching any price increases . that only adds to the profits of a few large companies , with no corresponding benefit to consumers . Monopoly and Antitrust Policy discusses the delicate judgments that go into this task . THE TEMPTATION TO DEFY THE LAW Oligopolistic firms have been called cats in a bag , as this chapter mentioned . The French detergent makers chose to cozy up with each other . The result ?

An uneasy and tenuous relationship . When the Wall Street journal reported on the matter , it wrote According to a statement a manager made to the French commission , the detergent makers wanted to limit the intensity of the competition between them and clean up the Nevertheless , by the early , a price War had broken out among them . During the soap executives meetings , which sometimes lasted more than four hours , complex pricing structures were established . One soap executive recalled chaotic meetings as each side tried to Work out how the other had bent the rules . Like many cartels , the soap cartel disintegrated due to the very strong tion for each member to maximize its own individual profits . How did this soap opera end ?

After an investigation , French antitrust authorities fined , and Proctor Gamble a total of million ( 484 million ) A similar fate befell the . Bagged ice is a commodity , a 392 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER perfect substitute , generally sold in or bags . No one cares what label is on the bag . By agreeing to carve up the ice market , control broad geographic swaths of territory , and set prices , the moved from perfect competition to a monopoly model . After the agreements , each firm was the sole supplier of bagged ice to a region there were profits in both the long run and the short run . According to the courts These companies illegally conspired to manipulate the . Fines totaled about steep fine considering a bag of ice sells for under in most parts of the United States . Even though it is illegal in many parts of the world for firms to set prices and carve up a market , the temptation to earn higher profits makes it extremely tempting to defy the law . KEY CONCEPTS AND SUMMARY An oligopoly is a situation where a few firms sell most or all of the goods in a market . earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising price . Since each member of the oligopoly can benefit individually from expanding output , such collusion often breaks since explicit collusion is illegal . The prisoners dilemma is an example of game theory . It shows how , in certain situations , all sides can benefit from cooperative behavior rather than behavior . However , the challenge for the parties is to find ways to encourage cooperative behavior . SELF CHECK QUESTIONS . Consider the curve shown in Figure , which shows the market demand , marginal cost , and marginal revenue curve for firms in an oligopolistic industry . In this example , we assume firms have zero fixed costs . Cost Revenue Figure a . Suppose the firms collude to form a cartel . What price will the cartel charge ?

What quantity will the cartel supply ?

How much profit will the cartel earn ?

Suppose now that the cartel breaks up and the oligopolistic firms compete as vigorously as PRINCIPLES OF ECONOMICS 393 possible by cutting the price and increasing sales . What will the industry quantity and price be ?

What will the collective profits be of all firms in the industry ?

Compare the equilibrium price , quantity , and profit for the cartel and cutthroat competition outcomes . Sometimes in the same industry are very different in size . Suppose we have a duopoly Where one firm ( Firm A ) is large and the other firm ( Firm ) is small , as shown in the prisoner dilemma box in Table . Firm with Firm A Firm cheats by selling more output Firm A with Firm A gets , gets 100 A gets 800 , gets 200 Firm A cheats by selling more output A gets , gets 50 A gets 500 , gets 20 Table . Assuming that the payoffs are known to both firms , what is the likely outcome in this case ?

REVIEW QUESTIONS Will the firms in an oligopoly act more like a monopoly or more like competitors ?

explain . Does each individual in a prisoner dilemma benefit more from cooperation or from pursuing ?

Explain . What stops from acting together as a monopolist and earning the highest possible level of profits ?

CRITICAL THINKING QUESTIONS . Would you expect the kinked demand curve to be more extreme ( like a right angle ) or less extreme ( like a normal demand curve ) if each firm in the cartel produces a product like and petroleum ?

What if each firm produces a somewhat different product ?

Explain your reasoning . When raised the price of oil dramatically in the , experts said it was unlikely that the cartel could stay together over the long the incentives for individual members to cheat would become too strong . More than forty years later , still exists . Why do you think has been able to beat the odds and continue to collude ?

Hint You may wish to consider reasons . PROBLEMS . Mary and Raj are the only two growers who provide organically grown corn to a local grocery store . They know that if they cooperated and produced less corn , they could raise the price of the corn . If they work independently , they will each earn 100 . If they decide to work together and both lower their output , they

394 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER can each earn 150 . If one person lowers output and the other does not , the person who lowers output will earn and the other person will capture the entire market and will earn 200 . Table represents the choices available to Mary and Raj . What is the best choice for Raj if he is sure that Mary will cooperate ?

If Mary thinks Raj will cheat , what should Mary do and why ?

What is the prisoners dilemma result ?

What is the preferred choice if they could ensure cooperation ?

A Work independently Cooperate and Lower Output . Each results entry lists Raj earnings first , and Mary earnings second . Jane and Bill are apprehended for a bank robbery . They are taken into separate rooms and questioned by the police about their involvement in the crime . The police tell them each that if they confess and turn the other person in , they will receive a lighter sentence . If they both confess , they will be each be sentenced to 30 years . If neither confesses , they will each receive a sentence . If only one confesses , the confessor will receive 15 years and the one who stayed silent will receive 35 years . Table below represents the choices available and Bill . trusts Bill to stay silent , what should she do ?

thinks that Bill will confess , what should she do ?

have a dominant strategy ?

Does Bill have a dominant strategy ?

A Confess Stay Silent . Each results entry lists ane sentence first ( in years ) and Bill sentence second . Jane A A ( 30 , 30 ) 15 , 35 ) Bill ( 35 , 15 ) 20 , 20 ) Table . REFERENCES The United States Department of Justice . Antitrust Accessed October 17 , 2014 . Total US Ad Spending to See Largest Increase Since 2004 Mobile advertising leads growth will surpass radio , magazines and newspapers this year . Accessed March 12 , 1010982 . Federal Trade Commission . About the Federal Trade Accessed October 17 , cartel a group of firms that collude to produce the monopoly output and sell at the monopoly price when firms act together to reduce output and keep prices high duopoly an oligopoly with only two firms game theory a branch of mathematics often used by economists that analyzes situations in which players must make decisions and then receive payoffs based on what decisions the other players make kinked demand curve a perceived demand curve that arises when competing oligopoly firms commit to match price cuts , but not price increases

PRINCIPLES OF ECONOMICS 395 dilemma a game in which the gains from cooperation are larger than the rewards from pursuing SOLUTIONS Answers to Questions a . If the firms form a cartel , they will act like a monopoly , choosing the quantity of output where . Drawing a line from the monopoly quantity up to the demand curve shows the monopoly price . Assuming that fixed costs are zero , and with an understanding of cost and profit , we can infer that when the marginal cost curve is horizontal , average cost is the same as marginal cost . Thus , the cartel will earn positive economic profits equal to the area of the rectangle , with a base equal to the monopoly quantity and a height equal to the difference between price ( on the demand above the monopoly quantity ) and average cost , as shown in the following figure . Cost Average Cost , Revenue Figure . The firms will expand output and cut price as long as there are profits remaining . The equilibrium will occur at the point where average cost equals demand . As a result , the oligopoly will earn zero economic profits due to cutthroat competition , as shown in the next figure . Profit for the cartel is positive and large . Profit for cutthroat competition is ' Firm reasons that if it cheats and Firm A does not notice , it will double its money . Since Firm A profits will decline substantially , however , it is likely that Firm A will notice and if so , Firm A will cheat also , with the result that Firm will lose 90 of what it gained by cheating . Firm A will reason that Firm is unlikely to risk cheating . If neither firm cheats , Firm A earns 1000 . If Firm A cheats , assuming Firm does not cheat , A can boost its profits only a little , since Firm is so small . If both firms cheat , then Firm A loses at least 50 of what it could have earned . The possibility of a small gain ( 50 ) is probably not enough to induce Firm A to cheat , so in this case it is likely that both firms will collude .

396 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Demand Marginal Cost Average Cost Marginal Revenue Figure .