Monopolistic competition, oligopoly and duopoly

1. Monopolistic competition: meaning

The theory was developed independently by Edward Chamberlin, The Theory of Monopolistic Competition (1933), and Joan Robinson, The Economics of Imperfect Competition (1933). Monopolistic competition is a market with many sellers selling differentiated products that are close but not perfect substitutes. Each seller has a little monopoly over his own brand but faces competition from many similar brands. Examples: toothpaste, soap, shampoo, restaurants, clothing brands.

2. Features

1. Large number of sellers, each with a small share, acting independently.
2. Product differentiation: products differ in brand, quality, design, packaging, colour or after-sales service. Differentiation may be real or imaginary (created by advertising).
3. Selling costs: expenditure on advertising and sales promotion to shift the demand curve outward. This feature is unique to this market; under perfect competition there is no need to advertise, and a monopolist has no rival.
4. Free entry and exit, so supernormal profits disappear in the long run.
5. Downward-sloping and fairly elastic demand curve: the firm can raise price and lose some, not all, customers.
6. Some control over price, limited by close substitutes.
7. Product groups instead of an industry, since products are not identical.
8. Non-price competition: firms compete through quality, service and advertising.

3. Price and output determination

Short run. Each firm, like a monopolist, produces where MR = MC and charges the price shown on its AR curve. If price exceeds AC at that output, it earns supernormal profit; if AC exceeds price, it makes a loss. In the diagram, AR slopes downward (more elastic than a monopolist’s), MR lies below it, MC cuts MR at E, and the profit rectangle lies between price and AC.

Long run. Supernormal profits attract new firms with similar brands. Each existing firm loses some customers, so its AR curve shifts to the left and becomes more elastic. Entry continues until profit is only normal. Equilibrium is where:

• MR = MC, and
• AR = AC: the AR curve is tangent to the LAC curve.

Because AR slopes downward, the tangency point lies on the falling part of the AC curve, to the left of its minimum. If losses are being made, firms leave until the same tangency is reached.

Excess capacity. Each firm produces less than the output at minimum average cost; the difference is excess capacity. Price is higher than under perfect competition, and there are too many firms, each too small. Chamberlin argued this is the cost of variety: consumers pay a little more for a choice of brands.

Selling costs. Advertising raises the AC curve but also shifts the demand curve to the right. A firm spends on advertising until the extra revenue from the last rupee of selling cost equals that rupee.

Criticism. Product groups are hard to define; firms do not know their demand curves; with few close rivals, firms do react to each other (which the theory ignores); and the excess-capacity result depends on assumptions about uniform demand and costs.

4. Oligopoly

Oligopoly (Greek oligoi, few) is a market with a few sellers, each large enough to influence the market, selling either homogeneous products (pure oligopoly: steel, cement) or differentiated products (differentiated oligopoly: cars, mobile telephone services, soft drinks).

Features.

1. Few sellers controlling most of the output.
2. Interdependence: each firm’s price and output decisions depend on how it expects its rivals to react. This is the defining feature.
3. Indeterminate demand curve: a firm cannot know its demand curve without knowing rivals’ reactions.
4. Barriers to entry: large capital, economies of scale, patents, brand loyalty.
5. Heavy advertising and non-price competition.
6. Price rigidity: prices tend to stay stable for long periods.
7. Tendency to collude: firms form cartels or follow a price leader to avoid price wars.
8. Group behaviour: no single accepted model of behaviour.

Kinked demand curve (Paul Sweezy, 1939). This explains price rigidity. At the current price, the demand curve has a kink. Above it, demand is elastic: if a firm raises its price, rivals do not follow, and it loses many customers. Below it, demand is inelastic: if it cuts price, rivals follow, and it gains few customers. So the firm keeps the price unchanged. The MR curve has a vertical gap below the kink, and MC can move up or down within that gap without changing price or output.

Collusive oligopoly. Firms may form a cartel that fixes price and output quotas (OPEC is the standard international example), or follow price leadership, where a dominant or low-cost firm sets the price and others follow. In India, cartels are prohibited as anti-competitive agreements under section 3 of the Competition Act, 2002.

5. Duopoly

Duopoly is a special case of oligopoly with two sellers. Each must take account of the other’s reaction. Features: two sellers, interdependence, homogeneous or differentiated product, possibility of collusion or a price war.

Cournot model (1838). Augustin Cournot took two sellers of mineral water from identical springs with zero cost. Each assumes the other will keep its output unchanged and supplies half of the remaining market. Through successive adjustments they reach an equilibrium in which each supplies one-third of the perfectly competitive output, and together two-thirds: more than a monopolist (one-half) but less than perfect competition.

Bertrand (1883) criticised Cournot, arguing that each duopolist would assume the other keeps its price constant and would undercut it, driving price down to cost. Edgeworth (1897), with capacity limits, showed price would oscillate without a stable equilibrium.

6. Market forms compared

How this is examined

“Explain the price and output determination under monopolistic competition” was a 10-mark essay in January 2026 (80-mark), and “What is monopolistic competition? Explain its features” in June 2025 (80-mark). “Oligopoly” was a 6-mark note in January 2026 (80-mark). For the essay, give features briefly and spend most of the answer on short-run and long-run equilibrium, with excess capacity as the conclusion.