I n t h I s c h a p t e r y o u w I l L

Monopolistic competition
describes a market structure in which there are
many firms selling products that are similar but not identical. Examples include
the markets for novels, movies, CDs, and computer games. In a monopolistically
competitive market, each firm has a monopoly over the product it makes, but
many other firms make similar products that compete for the same customers.
Figure 16-1 summarizes the four types of market structure. The first question
to ask about any market is how many firms there are. If there is only one firm, the
market is a monopoly. If there are only a few firms, the market is an oligopoly. If
there are many firms, we need to ask another question: Do the firms sell identical
or differentiated products? If the many firms sell differentiated products, the mar-
ket is monopolistically competitive. If the many firms sell identical products, the
market is perfectly competitive.
o l i g o p o l y
a market structure in which only a
few sellers offer similar or identical
products
m o n o p o l i s t i c c o m p e t i t i o n
a market structure in which many
firms sell products that are similar
but not identical

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C H A P T E R 1 6
O L I G O P O LY
3 5 1
Reality, of course, is never as clear-cut as theory. In some cases, you may find
it hard to decide what structure best describes a market. There is, for instance, no
magic number that separates “few” from “many” when counting the number of
firms. (Do the approximately dozen companies that now sell cars in the United
States make this market an oligopoly or more competitive? The answer is open to
debate.) Similarly, there is no sure way to determine when products are differenti-
ated and when they are identical. (Are different brands of milk really the same?
Again, the answer is debatable.) When analyzing actual markets, economists have
to keep in mind the lessons learned from studying all types of market structure
and then apply each lesson as it seems appropriate.
Now that we understand how economists define the various types of market
structure, we can continue our analysis of them. In the next chapter we analyze
monopolistic competition. In this chapter we examine oligopoly.
Q U I C K Q U I Z :
Define 
oligopoly
and 
monopolistic competition
and give an 
example of each.
M A R K E T S W I T H O N LY A F E W S E L L E R S
Because an oligopolistic market has only a small group of sellers, a key feature
of oligopoly is the tension between cooperation and self-interest. The group of
oligopolists is best off cooperating and acting like a monopolist—producing a
• Tap water
• Cable TV
Monopoly
(Chapter 15)
• Novels
• Movies
• Wheat
• Milk
Monopolistic
Competition
(Chapter 17)
• Tennis balls
• Crude oil
Oligopoly
(Chapter 16)
Number of Firms?
Perfect
Competition
(Chapter 14)
Type of Products?
Identical
products
Differentiated
products
One
firm
Few
firms
Many
firms
F i g u r e 1 6 - 1
T
HE
F
OUR
T
YPES OF
M
ARKET
S
TRUCTURE
.
Economists who
study industrial organization
divide markets into four types—
monopoly, oligopoly,
monopolistic competition, and
perfect competition.

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3 5 2
PA R T F I V E
F I R M B E H AV I O R A N D T H E O R G A N I Z AT I O N O F I N D U S T R Y
small quantity of output and charging a price above marginal cost. Yet because
each oligopolist cares about only its own profit, there are powerful incentives at
work that hinder a group of firms from maintaining the monopoly outcome.
A D U O P O LY E X A M P L E
To understand the behavior of oligopolies, let’s consider an oligopoly with only
two members, called a 
duopoly.
Duopoly is the simplest type of oligopoly. Oligop-
olies with three or more members face the same problems as oligopolies with only
two members, so we do not lose much by starting with the case of duopoly.
Imagine a town in which only two residents—Jack and Jill—own wells that
produce water safe for drinking. Each Saturday, Jack and Jill decide how many gal-
lons of water to pump, bring the water to town, and sell it for whatever price the
market will bear. To keep things simple, suppose that Jack and Jill can pump as
much water as they want without cost. That is, the marginal cost of water equals
zero.
Table 16-1 shows the town’s demand schedule for water. The first column
shows the total quantity demanded, and the second column shows the price. If the
two well owners sell a total of 10 gallons of water, water goes for $110 a gallon. If
they sell a total of 20 gallons, the price falls to $100 a gallon. And so on. If you
graphed these two columns of numbers, you would get a standard downward-
sloping demand curve.
The last column in Table 16-1 shows the total revenue from the sale of water.
It equals the quantity sold times the price. Because there is no cost to pumping
water, the total revenue of the two producers equals their total profit.
Let’s now consider how the organization of the town’s water industry affects
the price of water and the quantity of water sold.
Ta b l e 1 6 - 1
T
HE
D
EMAND
S
CHEDULE
FOR
W
ATER