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Introduction to Economics


This module consists of four lessons, namely:
Lesson 1 Pure Competition
Lesson 2 Monopoly
Lesson 3 Monopolistic Competition
Lesson 4 Oligopoly


This module discusses the four economic models explaining the behavior of a firm in
different market structures - perfect competition, pure monopoly, monopolistic
competition, and oligopoly - to achieve its goal of maximizing profit or minimizing loss.
Theoretical assumptions are discussed and short-run equilibrium analyses are made.


After completion of this module, you will be able to:
1. differentiate the assumptions underlying each market structure; and
2. distinguish the basis of the firm's decision as to the level of its output and
pricing, per market type.
Introduction to Economics

At the end of the lesson, the student is expected to:
1. describe a pure/perfectly competitive market structure; and
2. describe pricing and quantity decisions of a pure/perfectly competitive firm.

In Module II we developed and applied a theory of competitive markets on the

concepts of market demand and market supply. We further went behind the market
supply curve to consider the nature and costs of production. In other words, we know
that the demand curves of the individual households and the cost curves of individual
firms are the basic elements of the theory of product pricing.
But does the firm know precisely the demand curve it faces so that it can determine
the price it could charge for each rate of sales, and thus it would know its potential
revenues? No! The firm does not know its own demand curve. Why? Because
competition in business is persuasive and market structures vary greatly in the degree
of competition that they exhibit. No one firm is free from competition even if it is the only
producer of a certain variety of a good. All goods compete for the limited purchasing
power of an individual. The firm's behavior and decision on changes in its pricing and
output policies are influenced not only on demand and cost conditions but also on the
market structures such as the number of buyers and sellers, the similarities and
differences in the products bought and sold, the extent of knowledge of buyers and
sellers on market conditions, and extent of freedom of entry and exit in an industry.
Profit maximization is what motivates a firm to assume these roles. The environment
in which a firm operates is the market structure. Markets are important not only as
vehicles for the exchange of goods and services but also as tools for generating
information important to the goal of each firm.
In the four lessons of this module, we shall look into 4 types of theoretical market
structures: The perfect competition, monopoly, monopolistic competition, and oligopoly.

Assumption of Pure Competition (Pc)

A purely competitive market faces the following assumptions: (1) homogeneity of
products and resources, (2) plurality of buyers and sellers, (3) perfect knowledge of
market situations, (4) freedom of entry and exit, (5) mobility of factors of production.
Firstly, products and services sold in a purely competitive market are standardized
and identical. The outputs of all firms are indistinguishable from products of other
existing firms.
Buyers have no preferences among the many brands of a specific commodity. An
example of a homogenous product is salt. No one usually cares about what brand of
salt he is using. Salt is salt. There is no reason for him to prefer one over the other.
Secondly, a purely competitive market is made up of a very large number of firms
(sellers). When there are many sellers of the same product, a selling unit is normally a
very small fraction of the entire industry. A typical coconut farmer with 1 hectare of land,
no matter what variety of seed he might use, can produce only a small percentage of
the entire output of the coconut industry. It is obvious that no decisions of his can
possibly make a sufficient dent on total coconut supply that could influence the price of
Thus in pure competition, with so many producing or selling the product, not one can
affect the price of the good.
Since the firm cannot influence the market price of the product, it has no alternative
but to act as a price taker. The firm looks at the prevailing market price and takes it as
given. It sells any quantity of goods at the price established by the market. The market
price is determined by the intersection of the market demand and supply curve. If the
firm sells the good at a higher price, no one would buy it. On the other hand, nothing
would be accomplished by lowering the price. The demand curve of a firm operating
under pure competition assumes a horizontal line.
Figure 1.1 Demand Curve under Pure Competition

P1 D = MR

Pc Firm Pc Industry (Market)

where P1 = prevailing market price level; D1 = demand curve of Pc firm; MR =

marginal revenue of Pc firm.
Since, P1 is the price that prevails in the market, the firm can sell any quantity it can
produce at this price. The firm faces an infinitely elastic demand at this prevailing
market price.
If the Pc firm increases its price below or above P1, it would experience no sale! But
if it wants to have an additional sale (MR) or revenue (price X quantity sold) it would just
have to produce an additional output that would incur an additional cost (MC) not
exceeding P1 level, too. So that P1 D = MR1 = MC. While each individual firm faces a
straight horizontal demand, the industry demand curve is still downward-sloping. In
other words, on the whole, the demand curve behaves in the usual way - the lower the
price, the bigger the quantity demanded. Thus, as industry (the conglomeration of all the
firms producing the same product) faces a downward sloping curve.
Thirdly, full knowledge of all possible terms of sale or purchase is another
requirement of pure competition. For the benefit of the consumers, an aggressive
information dissemination campaign must exit regarding changes on prices and
qualities of consumer items. On the side of the sellers, a strong support service is
needed to market/dispose of their products at the best possible terms.
Fourthly, pure competition can exist if there are no barriers against the entry of new
products into an industry or the leaving of an existing firm from the industry when it
ceases production. Said barriers may be in the form of limited market, high
technological requirements, lack of entrepreneurial spirit and venture capital, or possible
collusion of existing producers.
Fifth, pure competition necessitates the ease transfer freely from one place to
another, from one occupation to another, from one factor use to another. Interisland
communication and transportation facilities must be synchronized and dispersed
throughout the country. The required technical, technological, and managerial skills
must be available to the area where the business firms are located.

Quantity Decisions of a Pc Firm

Given the cost curves of a Pc firm, up to what number of output should it produce so
that it can achieve its goal of profit maximization? Pc firms that select quantities where
the marginal cost equals the marginal revenue (MC = MR) are said to be maximizing
profits. But the market price must not be lower than the Pc firm's average variable cost
(P > AVC). In Figure 1.2, we can see that point A indicates where MC = MR = Price.
Figure 1.2

P1 A

O Q1
At that point, we derive that the Pc firm would produce up to Q1 if it wants to
maximize profit. What is the size of this extraordinary profit? Pi ACB where the Pc firm is
making profits in excess of all costs (i.e., as long as the price level Pi is above ATC).
Figure 1.3


In figure 1.3, the Pc firm is still maximizing profit but it is just covering all costs. In
this situation, MC = MR = Price = ATC. In Figure 1.4, the Pc firm is still maximizing
profit. But this time, it gets normal, not extraordinary, profits. Sometimes, this situation is
called the minimum loss (shaded area) level of production, P1 = MR = MC = AVC, as
long as P1 is equal to the lowest level of the AVC.
Figure 1.4


If the market price level still decreases further, below AVC level, our Pc firm should
cease production - a shutdown situation. 1.3 Short-Run Competitive Equilibrium of
the Pc Firm. A purely competitive market is in short-run equilibrium when the individual
Pc firms are maximizing profits so that MC = MR = Price. Within the short-run time
period, no new sellers enter into the market, so that quantity demanded is equal to
quantity supplied (Qd = Q8), on an industry viewpoint.
If the Pc firm's AVC < industry price, profit > 0.
If the Pc firm's AVC = industry price, profit = 0.
If the Pc firm's AVC > industry price, profit < 0.
We have discussed above how a firm in a single price system, like the purely
competitive structure, estimate an output level that would maximize its profit or minimize
its loss. The size of the Pc firm's profit would depend on the market (or industry) price
level touching the cost levels of the Pc firm. Because of the profit motive, new entrants
into the industry are attracted. With the increase in supply (Figure 1.5) the industry
supply curve shifts to the right (from S1 to S2). This results in a decrease in the industry
price (from P to P2) so that the already existing P firm's profit margin is consequently
sliced, too.
Figure 1.5
S1 S2 MC
P1 D1 = MR 1
P1 D2 = MR 2

Pc Industry Pc Firm
ECONOMICS 1A, Module 3, Lesson 1

Test I. Matching Type

Column A Column B
a. production at the lowest attainable cost
_____ 1. conditions of short-run
equilibrium output for a firm b. conditions of long-run equilibrium for
_____ 2. assumed response to short-
run profits in competitive c. P= MC; P > AVC
industry d. symptom of a declining industry
_____ 3. price taker
e. firm acting as if demand curve is
_____ 4. productive efficiency infinitely elastic
_____ 5. short-run supply curve f. horizontal summation of firm's MC
_____ 6. reduction of productive
capacity g. rate of change in total revenue with
respect to output
_____ 7. marginal revenue
h. entry of new firms
_____ 8. price equal to minimum
average total cost i. the rate of change in total cost with
respect to output
_____ 9. Marginal cost
j. acting independently through demand
_____ 10. Many buyers and sellers
and supply.

Test II. True or False

_____ 1. In the real world, there are few industries that are perfectly competitive.
_____ 2. In the real world, there are few industries that are monopolistic.
_____ 3. If price is equal to average total cost for a perfectly competitive firm, then
the firm is losing money.
_____ 4. A firm should never continue to operate - not even in the short-run, if
losses are incurred.
_____ 5. A perfectly competitive firm is able to sustain losses in the long run if price
is above the minimum point on the average variable cost curve.
_____ 6. For the perfectly competitive firm, price equals its demand curve, which
equals its marginal revenue curve.
_____ 7. In a perfectly competitive market, firms are forced to take advantage of
economies of scale.
_____ 8. The market system may not reach equilibrium as smoothly and quickly as
theory may suggest because of imperfect information.
_____ 9. As shortages are eliminated, some consumers may unfortunately be
driven out of the market.
_____ 10. As surpluses are eliminated, some firms may unfortunately be driven out
of the market.
_____ 11. If government controls prices, surpluses and shortages would not exist.
_____ 12. Perfectly competitive markets are not very efficient any yield many socially
undesirable results.
_____ 13. In a perfect competition, price is determined where the industry demand
and supply curved intersect.
_____ 14. There is no direct completion in a perfect competitive market.
_____ 15. When perfect market exists, the independent sellers are price takers.

Test III. Multiple Choice

_____ 1. Competition results from:
a. a shortage of a particular good
b. the kind of economic and political institutions a nation chooses
c. an economic model of an ideal economy
d. the scarcity imposed by nature.
_____ 2. Which of the following is an example of competition as a process:
a. providing better-quality services
b. making one firm's product more durable than the products produced by
other firms in the industry.
c. advertising a product's virtues
d. all of the above.
_____ 3. In contrast to the competitive process, pure competition is:
a. an abstract model that emphasizes the importance of industry structure
b. the most frequently observed industry structure in the real world
c. a market structure in which firms have great latitude in choosing the
price of their product
d. an unrealistic structure that serves no purpose in helping economists
explain real-world competition
_____ 4. In economic terms, a market is:
a. any geographic area in which price tends toward equality
b. the result of competing bids and offers among buyers and sellers
c. a model in which prices are determined by the forces of supply and
d. all of the above
_____ 5. In the economic model of a purely competitive market, firms are said to
produce a homogeneous product. This means that:
a. a government agency must inspect products for safety and purity
b. all producers of a good use the same technology and production
c. the product of one producer is a perfect substitute for the product of
any other producer.
d. the quality of products produced under conditions of pure competition
is lower than that of products produced in monopoly enterprises.
_____ 6. Perfect competition requires all of the following condition except:
a. free entry and exit
b. a large number of relatively small firms
c. a differentiated product
d. perfect information
_____ 7. Which of the following goods is an example of a product produced under
conditions of pure competition?
a. orange juice, because there are many orange grove owners who
produce nearly identical products
b. gasoline sold by retail gas stations, because the consumer can choose
from a very large number of brands and grades of gasoline
c. aluminum, because aluminum ingots, regardless of their manufacturers
are indistinguishable from each other
d. automobile tires, because there are large number of buyers of this
_____ 8. A perfectly elastic demand curve implies that a firm
a. can only increase sales by reducing price below the currently
prevailing amount
b. can make an infinite amount of profit if it can produce enough output
c. can sell all it wants at the going market price but would be unable to
sell anything at a higher price
d. is perfectly free to set its price because consumers are willing to buy
the same amount of the good regardless of price
_____ 9. Perfectly competitive firms face a perfectly elastic demand curve because:
a. an individual firm is too insignificant to alter the market price as a result
of a change in the amount it produces.
b. the idealized model of perfectly competitive markets that economists
have constructed would not work any other way
c. firms have a great deal of discretion in setting the price of their product
d. individual firms have so little impact on market price that most firms
simply stop producing.
_____ 10. Since perfectly competitive firms are price takers, they are powerless to
alter the market price for their product. Under these circumstances, they
decide how much output to produce by:
a. comparing the costs and benefits of producing additional units of
b. comparing total production costs with expected total benefits from
producing a given level of output
c. comparing the expected total benefit from producing a given level of
output with the average cost of producing that level of output
d. consulting with other firm owners who face the same decision.
_____ 11. If we define profit maximization as the output level that produces the
greatest difference between total revenue and total cost, then profit will be
maximized where:
a. MR is greater than MC by the biggest possible amount
b. MC is greater than MR by the biggest possible amount
c. MR does not equal MC
d. MR equals MC
_____ 12. Marginal revenue for a pure competitor is:
a. equal to total revenue
b. less than marginal cost
c. equal to the market price
d. irrelevant to the profit-maximizing decision
_____ 13. Robert Dionisio, .a pure competitor, is currently producing a level of output
at which marginal cost is less than marginal revenue. In order to improve
profitability, Mr. Dionisio should:
a. shut down
b. increase production
c. raise his price to increase profits
d. try to further increase his marginal revenue.
_____ 14. If a business executive finds that profit maximization is not possible in the
current market environment, then the next best strategy is to:
a. minimize losses
b. shut down
c. take an economics course that would provide information on how to
fool the market into yielding profit
d. make sure that revenue can cover fixed costs.
_____ 15. In the short-run, a business firm should shut down if:
a. profit is less than expected when the firm was established
b. the current profit maximization point is not expected to move
c. it cannot cover its variable costs of production
d. it cannot cover its average total costs of production
_____ 16. The short-run supply curve for a competitive firm is equal to the firm's
a. average total cost curve
b. marginal cost curve
c. average total cost curve above the average variable cost curve
d. marginal cost curve above the minimum point on the average variable
cost curve
_____ 17. The short-run supply curve is usually depicted as sloping upward to the
right and is said to reflect the rising marginal cost of production. Marginal
cost rises as output is increased because:
a. total cost always increases with additional output
b. average total cost eventually rises as output is expanded
c. of the principle of diminishing returns: rising marginal cost and
diminishing returns are two sides of the same coin
d. total fixed cost never declines no matter how much is produced.
_____ 18. Economic profits are defined as:
a. the normal rate of return that a competitive industry will generate in
long-run equilibrium
b. a return above the entire cost structure, including the opportunity cost
of the entrepreneur's time and talents
c. total revenue minus total cost, where total cost includes all explicit cost
d. the total revenue generated by a firm before costs are subtracted.
_____ 19. When economists say that purely competitive markets are efficient, they
mean that:
a. the marginal benefit of the last unit of the good consumed equals the
marginal cost of making the unit available
b. the total benefit derived from consuming the good equals the total cost
of making the good available
c. the benefit derived from consuming a good equals the amount of
consumer surplus generated by the market.
d. these markets are efficient by assumption.
_____ 20. In the real world, competition often involves non-price forms of
competition, such as:
a. quality variation
b. advertising
c. location
Introduction to Economics

At the end of the lesson, the student is expected to:
1. describe a pure monopoly market structure; and
2. describe pricing and quantity decisions of a pure monopoly.

In the previous lesson, we have analyzed how a price-taken, like the purely
competitive (Pc) firm, reacts to certain market situations as new entrants into the same
industry press down prices due to excessive supply.
In today's lesson, let's look into the other extreme case - the monopoly model.

Assumptions of Pure Monopoly (Pm)

The word monopolistic comes from mono which means one and polist which means
seller. Thus it is defined as the situation in which an entire industry is supplied by a
single seller called a monopolist. He supplies all buyers of a good that has no close
There are five basic assumptions of the monopoly model. Only three of them differ
from the Pc model.
1. There is a single seller of the commodity.
2. There are no close substitutes for the said commodity.
3. Entry into the market is blocked.
4. There is perfect knowledge concerning prices, quantities and the demand
functions of the buyers.
5. There is mobility of factors of production.
Being the sole seller, the monopolist is himself the industry. He controls the output
and price.
A monopolist produces according to his demand curve. (The demand curve of the
monopolist is the industry's demand curve which is downward sloping.) Thus the price
of his product would be at Price = Demand (P = D).
The monopolist's product has no close substitutes. The less close are the substitutes
to a particular good, the greater is the monopoly power by the producer of the
commodity. And because the monopolist is the price- maker (unlike the Pc firm as the
price-taker), his products are usually price inelastic. This situation can be shown in
Figure 2.1 where the D curve is relatively steeper (in contrast with the perfectly elastic
demand curve of a Pc firm and industry) and has a negative slope (price and quantity
demanded are inversely related).
Figure 2.1

P1 A



Q1 Q2 MR

This implies that in order to sell a larger quantity (Q1 to Q2), the monopolistic must
lower the price (P 1 to P2) on all units of the good. While it is true that the reduction in
price increases sales volume, the marginal revenue at this point would be less than its
price (MR < price).
Let us refer to the table below (Table 2.1) to illustrate this point.
Table 2.1: Hypothetical Data of a Pure Monopolist
Price Quantity Total Revenue Marginal Revenue
P8 1 P8 8
7 2 14 6
6 3 18 4
5 4 20 2

To increase sales volume from 1 to 2 units, price has to decrease to = P 7. This

increases total revenues to = P 14 while marginal revenue went down to = P 6. Now let
us compare price with marginal revenue. It can be seen that marginal revenue (=P 6) is
less than price (=P 7).
A monopoly with extraordinary profits can remain as the only producer-seller if other
firms are prevented from entering the market.
Factors that blockade other firms into entering a market called entry barriers.
Examples are patents and franchise; size and economies of scale; and control of
Patent is a grant of monopoly from the government to an inventor. This prevents
other firms from duplicating the product. On the other hand, franchise is a right granted
by a government unit to interested parties or entities of individuals to be the sole or one
of the limited supplier(s) of a product in a given geographical area. This prevents the
entry of other firms into the industry. In Dumaguete City, Negros Oriental for example,
during the 1980's CRUZTELCO was the only firm given the franchise to offer
telecommunications services.
Because of economies of scale, an established firm can produce at a lower cost
than any new competitor. This situation may retain a monopoly through a cost
advantage. On the other hand, an established firm with stable financial resources may
launch a price war with its potential competitors to prove the "survival of the fittest" into
the industry. This situation can facilitate the absence of competition.

Price Discrimination
One of the profit-maximizing strategies of a monopolized industry is price
discrimination (unlike in the Pc firm which adopts a single price system). Price
discrimination occurs when a producer sells a specific commodity to different buyers at
two or more different prices, for reasons not associated with differences in cost. Here,
the monopolist separates the market and charges different prices for the product in
each market.
However, price discrimination is only possible where the supplier(s) can control the
amount and distribution of supply and where the buyers can be separated into classes
among which resale is not possible or is very costly. The fact that consumers have
differences in income and in taste would lead us to predict that different subgroups
would have different elasticities of demand for a given commodity.
Let us illustrate the above concept.
Movie theaters charge different prices although they see the same movies.
Orchestra tickets are paid lowest rate, followed by balcony tickets. Lodge tickets are
charged the highest rate. The difference in charges is on the basis of location of the
Lawyers and physicians charge service fees on the basis of their client's ability to
pay. The more affluent clients can be charged more than the less affluent.
Prices will be higher where demand is inelastic. When markets can be segregated,
profits can be increased. The Pm will maximize profits by equating marginal cost and
marginal revenue (MC = MR) in each of the markets. The prices will depend upon the
elasticity of demand in each market. The higher the elasticity, the lower the price in a
market. Segmenting the different income groups, for example, Magnolia Ice Cream has
introduced 3 types of ice cream: the Gold Label Ice Cream (for those who have "very
discriminating taste"), the Special Flavors of the Month and the Regular Flavors. The
first classification has the highest market price. Its target clientele belong to the high-
income group. The second classification targets the middle-income households; and the
third type's price level tries to attract the ice cream "needs" of the lower-middle income
In the above argument, price discrimination is possible and profitable. But why
should a monopolist discriminate his pricing structure? Let us recall that the marginal
revenue (MR) of the monopolist is always less than the Price = Demand (P = D) level
because of the lower price that the Pm firm is forced to charge for the units previously
saleable at a higher price. Through price discrimination, this reduction in price is not
necessary and the affecting loss in revenue is not experienced.

Short-Run Equilibrium of a Pm Firm

We already have an insight into the pricing strategy of a Pm firm to maximize profit.
But at what output level? To determine the monopolist's optimal output that would give
him maximum profit, these two rules are applied:
a. If the firm produces, it should select that output for which
b. marginal revenue equals marginal cost (MR = MC);
c. The firm should produce in the short-run if price equals or exceeds average
variable cost (Price = or > AVC).
Graphically, (Figure 2.2) the MC = MR situation (point Z) gives us a starting point to
determine the optimal output (Q1). From this point Z, too, you can determine the
monopolist's price level by extending it upwards until it touches the D curve (at point B);
then to the left or the P line. Maximum profit (shaded portion) can be obtained from the
price level to the lowest portion of the ATC (point A).
Figure 2.2



Evils of Monopoly
Why are monopolies unpopular? Nobody wants the existence of monopolies.
Inasmuch as the monopolist is a price-giver and a sole supplier of a good/commodity,
he has the capacity or tendency to restrict or manipulate quantity in order to maximize
profit. Secondly, there is a possibility of degeneration of quality in of a quality of good or
service. Since the monopolist may not have any competitive spirit, there is no real
motivation for product improvement.
But there are necessary monopolies. There are industries which have relatively large
or high fixed cost inherent to technology. Examples of these are privately owned
electrical power firms, telephone companies, and natural water firms. Their MC and
ATC do not meet with a short term (Figure 2.3). Hence, entry of new firms is blocked.
Figure 2.3


To allow competition here would mean only a shift in the demand curve to the left, so
that prices would decrease. Each producer would be operating at very low capacity and,
therefore, at a very high average cost. If this situation happens, there would be a
tremendous waste of resources. Nevertheless, the National Government, through the
Board of Investments, checks on the overcrowding of industries, blocks the entry on
new firms to engage in necessary monopolies, and limits the rate of return (or profit) of
existing monopolies.
ECONOMICS 1A, Module 3, Lesson 2

Test I. Matching Type

Column A Column B
a. barriers to entry
_____ 1. Price discrimination
b. requisites for price discrimination
_____ 2. Conscious parallel action
c. tacit collusion
_____ 3. P> MC
d. concentration ratio
_____ 4. Long-continuing profits
greater than opportunity e. evidence of monopoly power
costs f. differences in prices not associated
_____ 5. Control over supply and with differences in costs.
ability to prevent resale. g. characteristics of monopoly price
_____ 6. Impediments to the h. advantage to large firms due to multi
production of a commodity product production large scale
by additional firms. distribution.
_____ 7. Fraction of total market sales i. industry where only one firm can
made by a specified number achieve available economics of scale.
of an industry’s
j. rise in price and fall in output
_____ 8. natural monopoly
_____ 9. Economics of scale
_____ 10. Effect of monopolization of a
competitive industry if costs
are not changed

Test II. True or False

_____ 1. Monopolies are often characterized by a contrived outback in production
to drive price up.
_____ 2. Monopolies cannot increase their profits by price discrimination.
_____ 3. The cost curves facing a monopoly look very similar to those of any other
_____ 4. The monopoly that does not price-discriminate will always charge a price
above marginal cost.
_____ 5. The monopoly that does not price-discriminate will always earn an
economic profit
_____ 6. If demand is great enough, the monopoly will actually produce in the range
of diseconomies of scale in the long run.
_____ 7. The dead-weight loss of monopoly shows the loss of consumer welfare of
a monopoly's output level as opposed to a competitive market's output
_____ 8. Too many resources are used in a monopolistic industry.
_____ 9. Price discrimination means the producer is selling a particular product at
different prices that do not reflect cost differences.
_____ 10. Monopoly power may result in the inefficient use of resources to build
barriers to entry and in the inefficient use of time and effort to prevent and
break it up.
_____ 11. One main feature of a monopoly market is the presence of many sellers.
_____ 12. Monopolist can always maintain profit so long as the productions costs
does not exceed production revenues.
_____ 13. In the market of monopoly, formidable barriers are in the forms pf patent
and one seller market.
_____ 14. The presence of one seller market, monopolist becomes a price maker.
_____ 15. Monopolist does not have indirect competitors.

Test III. Multiple Choice

_____ 1. Pure monopoly is an industry composed of:
a. a few firms with interdependent demand curves
b. a large number of small firms, all of which are too small to have any
influence on the equilibrium price and quantity.
c. a large number of firms that produce similar but differentiated products.
d. a single seller of a product for which there are no close substitutes.
_____ 2. In the real world, monopoly often exhibits itself as:
a. a small number of firms engaged in rivalry
b. a large number of firms that have an influence on the behavior of any
other firm in the industry
c. a small group of sellers acting together
d. all of the above.
_____ 3. Which of the following types of economic system was often characterized
by the widespread use of monopoly firms?
a. traditional societies
b. socialism
c. laissez-faire
d. mercantilism
_____ 4. A monopolist's power is never absolute. Instead a monopolist's isolation
from competition is a matter of degree. The degree of a given monopolist's
isolation from competition depends on:
a. the law of diminishing returns
b. whether the monopolist has a horizontal or downward sloping demand
c. the shape of the monopolist's marginal cost curve
d. the availability of substitutes.
_____ 5. Government licensing requirements create a type of monopoly right by:
a. requiring economies of scale as a preconditioning for a firm's
permission to complete in a given industry.
b. restricting the ability of firms to enter certain industries and occupations
c. granting bureaucrats the right to operate all licensed firms
d. granting only one firm the exclusive rights to do all licensing
_____ 6. A natural monopoly is said to exist if:
a. all of the natural resources required in the production process are
owned by a single firm
b. there is a legal restriction that prevents other firms from entering the
c. a patent has been granted giving the inventor exclusive rights to a
particular process or product for a period of 17 years
d. economies of scale are so pronounced that single firm can supply the
entire industry before exhausting its economies of scale.
_____ 7. Because of monopolist's demand curve is downward-sloping to the right,
the monopolist
a. must reduce price in order to sell additional units
b. is able to sell all the units that are produced at the prevailing
equilibrium price
c. is prevented from earning any economic profit
d. cannot raise price when his or her costs increase.
_____ 8. The monopolist's marginal revenue is defined as:
a. total revenue minus total cost
b. the change in total revenue divided by the change in output
c. the change in total revenue divided by the change in total cost
d. total revenue divided by the marginal cost.
_____ 9. Unlike a pure competitor who can sell additional output at a constant price,
a monopolist:
a. must decide on a price based on the choice between the desire to sell
fewer units at a higher price and the desire to sell more units at a lower
b. can sell additional units at a higher price than previous units
c. is unable to sell additional units of output at any price
d. finds that once price has been established, it does not pay to alter that
price as production costs change
_____ 10. If a monopolistic firm's total production costs equal zero, then:
a. it can never make a profit
b. profit maximization will be synonymous with total revenue
c. marginal revenue will be negative
d. total revenue will equal total cost
_____ 11. If the 98 demand curve of a monopolist is a straight line, then:
a. marginal revenue will be equal to marginal cost at all levels of output
b. the firm's marginal revenue curve will fall exactly twice as fast as the
demand curve
c. the demand curve should be set equal to marginal cost as the firm
attempts to maximize profits
d. the firm will be unable to find any point on the demand curve that will
be profitable
_____ 12. A monopoly firm will maximize profits at the point where:
a. marginal revenue equals marginal cost
b. marginal revenue equals price
c. marginal cost equals demand
d. total cost is minimized
_____ 13. When a monopoly firm sets MR equal to MC, what the firm has really
discovered is:
a. the profit-maximizing price to set
b. the socially efficient output level
c. the least costly combination of inputs
d. the profit-maximizing quantity of output to produce
_____ 14. The amount of profit earned by a monopoly firm is equal to:
a. the excess of price over average total cost per unit multiplied by the
number of units sold.
b. the sum of the difference between price and marginal cost for all units
c. the excess of marginal revenue over marginal cost for all units sold
d. the difference between total revenue and marginal cost.
_____ 15. Unlike the purely competitive firm, the monopolist can often earn above
normal profits in the long run because:
a. entry by new firms that would drive profits down to the normal level is
often prevented
b. consumers are unaware that excessive profits are being earned, so
they continue to pay the high profit-maximizing price
c. government anti-trust policy guarantees all monopoly firms a specific
rate of return on investment
d. once the amount of profit is set in a monopoly industry, it becomes
impossible for the monopolist to change it.
_____ 16. Which of the following is a difference between a monopolist and a pure
a. monopolists try to maximize profits, while competitors are content to
break even
b. competitors set MR greater than MC, while competitors set MR equal
to MC
c. in monopoly there is a distinction between the firm and the industry
d. competitive firm owners are more concerned with social responsibility
than are monopolists.
_____ 17. The reason that monopoly firms do not have a supply curve is that the
a. is unable to discover the profit maximizing price and quantity
b. does not set price equal to marginal cost
c. does not like others (particularly antitrust economists) to know what is
going on within the firm
d. is generally unwilling to incur the cost necessary to generate the
supply curve empirically
_____ 18. Which of the following explains why long-run competitive type adjustments
do not take place in monopoly?
a. entry is prohibited
b. exit from the industry cannot occur
c. monopolists are essentially different kinds of people than competitors
d. monopoly firms refuse to try any new techniques or innovations.
_____ 19. Both monopolists and competitors can change the scale of their plant in
the long run. However, when monopolists choose the most inefficient
scale of plant, the result will be inefficient compared to competition
because monopolists
a. charge too high a price
b. will have unit costs that exceed the minimum long run average total
c. will overproduce
d. will under price their output
_____ 20. Compared to pure competition, monopoly is inefficient because the
a. charges a price that exceeds marginal cost
b. expropriates some or all of the buyer's consumer surplus
c. produces less product than is socially ideal
d. all of the above.
Introduction to Economics

At the end of the lesson, the student is expected to:
1. describe a "monopolistic competition" market structure; and
2. describe pricing and quantity decisions of a monopolistic firm.

In our previous lessons, we have discussed two extreme models of a market

structure - pure competition and pure monopoly.
In 1930, Edward Chamberlain of Harvard University and Joan Robinson of
Cambridge University created a new market model incorporating the assumptions of
pure competition with pure monopoly. It was termed as "monopolistic competition" or
"imperfect competition".

Assumptions of a Monopolistic Competition (Mc)

Monopolistic competition is defined as the situation in which many firms selling
closely related (close substitutes) but not identical commodities. An example of this is
the many writing ballpoint pens available (e.g., Pilot, Bic, Panda, or Uni). Another
example is given by the many different makes of jeans (Levi's, Guess, Giordano,
Freego, etc.)
Monopolistic firms have succeeded in developing faithful clientele among
themselves so that some consumers would stick to their favored brands despite more
attractive features of substitute products. Monopolistic competition resembles pure
competition in the following ways:
1. There are many buyers and sellers acting independently.
2. There is perfect knowledge concerning prices, quantities, and the demand
functions of the buyers. Competition among sellers centers not solely on price
but on product differentiation. Product variation and product promotion are
highly prevalent.
3. There is freedom of entry and exit into the markets. New firms can get market
share if they offer better features of their produced.
4. There is mobility of factors of production.
The only difference is that the product is differentiated (not homogeneous). The
product of one seller is not identical, but closely related, with that of another in the
buyer's eyes. For example, Colgate toothpaste can be seen by the buyer as a close
substitute of Close-up toothpaste. Both are closely related. Both are toothpastes. One
can distinguish the difference between these two brands in terms of taste, packaging,
additional protection and whitening ingredients, and color.
Another example is Mr. Clean Kalamansi and White Tide Bar. Each claims a
different set of criteria of cleanliness, as shown in the advertisement. The former
stresses "amoy malinis" (smells clean!); the latter stresses "linis puti, parang kinula"
(looks clean, as white as sun-bleached). Thus, each seller has a limited monopoly, a
monopoly of his own production.
If the monopolist uses price discrimination to optimize output and profit, the Mc firm
uses product differentiation. This strategy gives the Mc firms a feeling that they can
have an influence or a degree of control over price, with much effort devoted to non-
price competition (like advertising and promotions) to strengthen the brand loyalty of
existing customers. Since the products are not homogeneous, prices may not be
identical, as in perfect competition. Rather, there will be a group of Mc firms selling
similar product line at different prices.
But how does an Mc firm differentiate its product with those of his competitors so
that this brand would be the consumer's choice? Product differentiation may take
several forms:
1. Product characteristics, such as design, style, durability, quality, or color of apparel
or a footwear. Which brand of shoes is your choice: Spartan Rubber, Adidas, Nike,
Kaypee, Converse, or World Balance? Why? What is your brand of body soap:
Palmolive, Jergens, Safeguard, Maxam, Lifebouy, or Ivory? Why?
2. Product imagery created by advertising. Which brand of detergent bar is most
effective in cleansing clothes: Tide, Mr. Clean, Ajax, Perla, or Superwheel? How
come? Which is a more powerful motor battery: Motolite, Oriental, Mercury or
Imarflex? Can you prove it?
3. Seller characteristics, such as store location, attitude of employment, pricing
policies, and credit policies. What's the secret behind the mushrooming of
Robinson's, Shoemart or Ayala Center? Accessibility to transportation, its credit card
system, its being a one-stop shopping complex (where one can buy her grocery
need and his personal effects, dine out with the family, see the latest movie, buy an
appliance or glassware requirement for the kitchen, try the latest craze in the
recreation centers, and buy the latest apparel and footwear needs of the family, all
under one roof!) Where do you experience the "Filipino hospitality" among the
eateries: Jollibee, McDonald's, Tropical Hut, Dunkin' Donut, Barrio Fiesta, Kamayan,
or Pinausukan? In what way?

Decisions of the Mc Firm

Each firm must determine the quantity, price, and degree of differentiation for its
product. Efforts to differentiate a product involve costs that must be offset. The higher
the cost, the higher would be the Mc price. Higher price would reduce the quantity
demanded because of the presence of close substitutes. Hence each Mc firm must
"position" itself in the market by selecting the combination of price, quantity, and product
differentiation that will maximize their profits.
The demand curve facing (Figure 3.1) an Mc Firm would be downward sloping (just
like that of a Pm firm) and very elastic (not infinitely elastic, though, just like that of a Pc
firm) since the products of other firms in the industry are close substitutes. A change in
the price by one firm that is unmatched by other firm would have a significant effect
upon the quantity demanded. Hence, the marginal revenue curve would lie below the
demand curve (MR < D) similar to that of a Pm situation. And MR would be less than
price (MR < Price).
Figure 3.1


Short-run Equilibrium of an Mc Firm
Equilibrium will occur when all firms of the same product line are simultaneously in
equilibrium. To maximize profit, each Mc firm would select quantity levels (Qmc) for
which its MR = MC. In the short run, a firm attains equilibrium when it continues to
produce as long as the industry price exceeds its average variable cost (Pmc > AVC).
Figure 3.2



ECONOMICS 1A, Module 3, Lesson 3

Test I. Multiple Choice

_____ 1. The monopolistic competition was developed by:
a. Joseph Schumpeter
b. E.H. Chamberlain
c. John Kenneth Galbraith
d. Paul Samuelson
_____ 2. Monopolistic competition is different from pure competition in that:
a. it is characterized by a small number of firms
b. entry is blocked in monopolistic competition, but it is free in pure
c. monopolistically competitive firms produce differentiated products,
while pure competitors produce identical products
d. all of the above
_____ 3. Which of the following is an example of a monopolistically, competitive
a. the steel industry
b. the tire industry
c. aluminum production
d. the production of laundry detergent
_____ 4. Product differentiation is an example of:
a. monopoly practice
b. non-price competition
c. illegal trade
d. imperfect information
_____ 5. A differentiated product permits a firm to:
a. have a degree or price control
b. drive competitors out of business
c. have a perfectly inelastic demand for its product
d. take advantage of economies of scale
_____ 6. "Product differentiation is simply part of the cost of entry under
monopolistic competition." This statement means that a new firm:
a. must offer a unique product to be successful in the market
b. will have difficulty competing with firms whose "brand name" products
are well established
c. whose product is unique will pay for it in the end
d. will not be permitted to enter the market unless it's product is unique
_____ 7. Since advertising is a vital part of the "competitive process" in
monopolistic competition, most firms in this market structure will:
a. spend too much money on advertising
b. seek to equate the marginal cost of advertising with the marginal
benefit derived from the advertising expenditures
c. spend too little money on advertising in the short run but too much
money on advertising in the long run
d. waste valuable resources trying to differentiate their products to
_____ 8. Critics of advertising argue that advertising is socially unproductive
a. it only serves to allocate demand among competitors without
increasing total demand for a particular product
b. it attempts to deceive consumers rather than inform them
c. it does not provide much high-quality information
d. the benefits received by firms which advertise are always less than the
costs they must incur.
_____ 9. Defenders of advertising argue that it offers real information about the
existence of products and their characteristics. This kind of information is
valuable because:
a. it prevents sellers from receiving short-run economic profit
b. it prevents an individual seller from charging a different price than the
advertised price of a competitor
c. it enables consumers to possess equal amounts of product information
d. it reduces the consumers' cost of searching for goods
_____ 10. For a monopolistic competitor, profits will be maximized by:
a. setting total revenue equal to total cost
b. setting marginal revenue as far above marginal cost as possible
c. setting total cost as far above marginal cost as possible
d. setting marginal revenue equal to marginal cost.
_____ 11. In the long-run, exceptionally high profits are difficult to maintain in a
monopolistically competitive market because:
a. of the inherent inefficiency of this type of market structure
b. it is easy for new firms to enter the industry
c. average variable cost rise faster in monopolistic competitive than in
any other type of market structure
d. production instability make it difficulty to maintain long term profit-
maximizing output levels.
_____ 12. Critics of monopolistic competition maintain that it is an in efficient type of
market structure because it is characterized by:
a. excessive profits
b. too many firms (all of which are too small to be economically efficient)
c. excess capacity
d. an unusually high cost structure
_____ 13. Which of the following is not true of monopolistic competition?
a. price is greater than long-run marginal costs
b. price is greater than minimum long-run average costs
c. price equals long-run marginal costs
d. total revenue equals total costs (long run).
_____ 14. An advantage of monopolistic competition over pure competition in the
production of bread is that:
a. the bread will be of higher quality of produced in a monopolistically
competitive market
b. price will be lower than in a purely competitive market
c. consumers are likely to have a wider choice of types of bread, size of
loaves, and types of packaging
d. cost structure is lower than in a purely competitive market.
_____ 15. Which of the following is an effective method for dealing with variations in
a. the carrying of inventories
b. allowing queues to form when demand temporarily exceeds capacity
c. building more capacity than is necessary to meet "normal" demand
d. all of the above.
Introduction to Economics

At the end of the lesson, the student is expected to:
1. describe an "Oligopoly" market structure; and
2. describe pricing and quantity decisions of an oligopolist.

In the previous lessons, we have seen how market power can be subjected to price-
takers and price-givers. Another shade of imperfect competition, aside from
monopolistic competition, is the oligopoly structure.

Assumptions of an Oligopoly
An oligopoly is a market structure where there are few sellers of a commodity
(competing within a given industry). Actions of each seller will affect the other sellers.
They are subject to enough rivalry that they cannot consider the market demand curve
as their own.
The following are the assumptions of an oligopoly type of market organization.
1. There are only a few sellers in the market. The action of one seller has an
effect upon the other sellers.
2. Products may be standardized (or homogeneous just like in pure competition)
or differentiated (just like in monopolistic competition).
3. There are some barriers to entry into the market.
4. There is perfect knowledge concerning prices and quantities 5. There is
mobility of factors of production.

Decisions of the Oligopolist

The quantity, price, or product characteristics that will maximize profits for one firm
depend on the choices made by the other firms in the market. This behavior can be
explained in the following forms of oligopoly models.
First, the duopoly model, a market with just two sellers. The duopolists assume that
the products are homogeneous and the demand curve for the industry is available to
either firm. Price and output decision are based on their mutual dependence and
coordinated behavior.
Secondly, cartel is a formal organization of producers within an industry that
determines policies for all the firms in the cartel, with a view to increasing total profit for
the cartel.
A cartel that determines all decisions for all member firms is called a centralized
cartel and leads to the monopoly solutions.
Another type is the market sharing cartel in which member firms agree upon the
share of the market each is to have.
An example of a cartel model is the OPEC (Organization of Petroleum Exporting
Countries). It behaves like a monopolist since it can act as a single seller facing the
demand of the industry. It maintains higher prices only by limiting the output of the
Thirdly, the Sweezy model or the kinked demand curve model, which clearly
explains apparent rigidity of prices in some oligopolistic industries. It is assumed that
oligopolists are concerned with maintaining or expanding their share of market and will
adjust their prices accordingly.
If an oligopolist increases his price, other in the industry will not raise theirs and so
he would lose most of his customers. On the other hand, an oligopolist cannot increase
his share of the market by lowering his price since the other oligopolist in the industry
will match the price out.
How does the oligopolist’s demand curve look like? It is kinked (see figure 4.1) due
to the following reactions. If the price of an oligopolist is increased to improve his profit
margin, the rival firms may follow him. Otherwise, he would lose a bigger market share
because his clients would more to the rest.
Figure 4.1


Thus, the demand curve (Di) is elastic in shape. However, if our oligopolist
decreases his price to capture a bigger share of the market, there is a bigger possibility
that the other oligarchs would follow him, or they lose their clients. Thus, the demand
curve, at times, becomes inelastic in shape (D2). Because of the above situation, the
resulting demand curve of the oligopolist is kinked in shape at the existing market price.
Consequently, the marginal revenue curve (MR) of the oligopolist becomes
truncated (Figure 4.2) below the demand curve corresponding to the latter's kink. The
gap in the MR curve implies that marginal revenue is different when rival firms match
price cuts than when they don't. It takes a larger price cut to increase output by a given
amount when rival firms march price cuts.
Figure 4.2


Short-run Equilibrium of the Oligopolist
Because of the gap in MR curve, prices may be stable even if costs change. A firm
has no reason to change its price if marginal cost shifts (MCI to MC2) are confined within
the gap (area of truncation) in the MR curve (Figure 4.3). Prices may remain stable over
extended periods in spite of changes in the MC and AVC. Within this gap, therefore, MC
= MR, a condition at which profit is maximized. The oligopolist has achieved its
Figure 4.3


With the above discussion, we end our study of Microeconomics and look forward to
Module 4.

Types of Organization of Oligopoly

a. Cartel is a formal agreement among oligopolists to peg a monopoly price on
the common product, allocate desired output and share profit among
b. Collusion is a formal and informal agreement among oligopolist to adopt
policies that will restrict or reduce the level of competition in the markets.
ECONOMICS 1A, Module 3, Lesson 4

Test I. Multiple Choice

_____ 1. Oligopolists can often:
a. charge any price they desire because there are no substitute products
from which consumers can choose
b. increase price substantially above marginal cost without invoking the
entry of new rivals
c. substantially increase output without rival firms becoming aware of
their actions
d. use deceptive advertising to control consumers' desires.
_____ 2. Oligopoly refers to a market structure which is:
a. dominated by a single seller
b. characterized by many sellers and by differentiated products
c. dominated by a few sellers
d. characterized by many sellers and by identical product.
_____ 3. Oligopoly is characterized by:
a. declining marginal cost throughout the entire production range
b. interdependent demand curves among producers
c. a large number of sellers who produce similar but differentiated
d. all of the above
_____ 4. Oligopolistic industries are characterized by mutual interdependence. This
means that:
a. oligopoly firms often engage in price-fixing agreements
b. the same individuals often serve on the board of directors of several
different firms in the industry
c. new oligopoly firms try to imitate the products of firms already
established in the industry
d. the actions of a particular firm will directly affect other firms in the
_____ 5. Which of the following are assumptions of an oligopoly type of market
a. Products may be standardized or differentiated
b. There are some barriers to entry into the market
c. few sellers in the market
d. all of the above
_____ 6. Oligopolistic industries are characterized by high barriers to entry which
can be either natural and artificial. An example of a natural barrier to entry
a. a patent
b. licensing requirements
c. economies of scale
d. exclusive ownership rights to a strategies raw materials.
_____ 7. Which of the following is not a legitimate barrier to entry into an
oligopolistic industry?
a. tariffs
b. quotas
c. licensing requirements
d. high star-up costs
_____ 8. Duopoly is a term used to refer to:
a. a competitive market in which rival firms try to duplicate the cost
structure of the most successful firms in the industry
b. a situation in which an oligopoly firm tries to duplicate the product of
another firm
c. a situation in which there are only two firms in an oligopolistic industry
d. a conspiracy between two monopolistically competitive firms to fix
_____ 9. The kinked demand curve theory of oligopolistic pricing was developed by:
a. Edward Chamberlain
b. Alfred Marshall
c. Paul Sweezy
d. Kenneth Arrow
_____ 10. The kinked demand curve model of oligopoly indicates that demand is:
a. elastic above the current market price and inelastic below the current
market price
b. inelastic above the current market price and elastic below the current
market price
c. elastic at any price other than the current market price
d. inelastic at any price other than the current market price
_____ 11. A kinked demand curve results in a discontinuous:
a. marginal cost curve
b. marginal revenue curve
c. average total cost curve
d. average variable cost curve
_____ 12. Because of the interdependence of demand in an oligopoly market, firms
are reluctant to change price for fear that rival firms will misconstrue their
action. However, when costs change, it is often necessary to change
price. This is usually accomplished by a practice known as:
a. target pricing
b. trigger pricing
c. price fixing
d. price leadership
_____ 13. A cartel can often increase the profits of its members beyond those, which
could be earned in the absence of a cartel. Nonetheless, cartels have
difficulties getting organized. This is so primarily because:
a. the costs of organizing the cartel exceed the benefits to any individual
member of the cartel
b. producers generally do not understand the benefits that can be derived
from a cartel
c. most managers have special managerial skills, but they often lack
high-level organizational skills
d. most managers feel that the rules and regulations of a cartel could
restrict their success, and they would do better on their own.
_____ 14. In order for a cartel to be effective, its members must:
a. receive at least four times the amount of profit they would as
independent producers
b. restrict their output in order to raise the price of their product
c. be willing to expand output on short notice even though it may prove
d. break the law because cartel activities are considered illegal
_____ 15. Cartel prices:
a. are usually set equal to the profit-maximizing price of a pure
b. are usually set below the profit-maximizing price of a pure monopolist
c. are usually set equal to the profit-maximizing price of a monopolistic
d. are usually set below the profit-maximizing price of a monopolistic

Lesson 1
Test I.
1. c 4. a 7. b
2. g 5. d
3. e 6. f

Test II.
1. True 5. False 9. True
2. True 6. True 10. True
3. False 7. True 11. False
4. False 8. True 12. True

Test III.
1. d 8. c 15. c
2. d 9. a 16. d
3. a 10. a 17. c
4. d 11. d 18. b
5. c 12. c 19. d
6. c 13. b 20. d
7. c 14. a

Lesson 2
Test I.
1. f 5. b 9. h
2. c 6. a 10. j
3. g 7. d
4. e 8. i
Test II.
1. True 5. False 9. True
2. False 6. True 10. True
3. True 7. True
4. True 8. False
7. a 15. a
Test III. 8. b 16. c
1. d 9. a 17. b
2. c 10. b 18. a
3. d 11. b 19. b
4. d 12. a 20. d
5. b 13. d
6. d 14. a

Lesson 3
1. b 6. b 11. b
2. c 7. b 12. c
3. d 8. a 13. c
4. b 9. d 14. c
5. a 10. d 15. d

Lesson 4
1. b 6. c 11. b
2. c 7. d 12. d
3. b 8. c 13. a
4. d 9. c 14. b
5. d 10. a 15. b