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Chapter Review Chapter 12: Monopoly, Monopolistic Competition and Oligopoly

  1. Both monopolists and firms in conditions of perfect competition maximize their profits by producing at the quantity at which marginal revenue is equal to marginal cost. However, marginal revenue for a perfect compe¬ titor is the same as the market price of an extra unit, while marginal revenue for a monopolist is less than the market price.
  2. Since in a monopoly price exceeds marginal revenue, buyers pay more for the product than the marginal cost to produce it; there is less production in a monop¬ oly than there would be if price were set equal to marginal cost.
  3. Imperfect competition occurs when a relatively small number of firms dominate the market or when firms produce goods that are differentiated in ways that reflect consumer preferences.
  4. An industry in which fixed costs are so large that only one firm can operate efficiently is called a natural monopoly. Even when there is only one firm (or a few firms), the threat of potential competition may be sufficiently strong that price is driven down to average costs; there are no monopoly profits. Such markets are said to be contestable. If, however, there are sunk costs or other barriers to entry, markets will not be contestable, and monopoly profits can persist.
  5. With monopolistic competition, barriers to entry are sufficiently weak that entry occurs until profits are driven to zero; there are few enough firms that each faces a downward-sloping demand curve, but a sufficiently large number of firms that each ignores rivals’ reaction to what it does.
  6. Oligopolists must choose whether to seek higher profits by colluding with rival firms or by competing. They must decide what their rivals will do in response to any action they take.
  7. A group of firms that have an explicit and open agreement to collude is known as a cartel. While the gains from collusion can be significant, important limits are posed by the incentives to cheat and the need to rely on self-enforcement, and by the difficulty of coordinating the responses necessitated by changing economic circumstances. Although cartels are illegal under U.S. law, firms have tried to find tacit ways of facilitating collusion—for example, by relying on price leaders and “meeting-the-competition” pricing policies.
  8. Even when they do not collude, firms attempt to restrict competition with practices such as exclusive territories, exclusive dealing, tie-ins, and resale price maintenance. In some cases, a firm’s profits may be increased by raising its rival’s costs and making the rival a less effective competitor.
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