How Monopolists, Monopolistic Competitors, and Oligopolists Face Different Demand Conditions
Unlike perfectly competitive firms that face horizontal demand curves, firms with market power face downward-sloping demand curves. This fundamental difference shapes their pricing decisions and behavior. Let's examine how monopolists, monopolistic competitors, and oligopolists each face unique demand conditions.
Single seller, complete market power
A monopolist is the sole seller in the market, so the firm's demand curve IS the market demand curve. This demand curve slopes downward—to sell more output, the monopolist must lower the price.
Key Insight:
Because the monopolist must lower price to sell more units, marginal revenue from an additional unit is less than the price. Lowering price increases quantity sold but reduces revenue from all previous units.
Many firms, differentiated products, some market power
Firms in monopolistic competition also face downward-sloping demand curves due to product differentiation. Each firm has a small degree of market power because its product is unique, but faces competition from many similar substitutes.
Key Insight:
Product differentiation creates brand loyalty, giving firms limited pricing power. However, if a restaurant raises prices too high, customers will switch to competing restaurants. The demand curve is more elastic than a monopolist's because substitutes exist.
Few firms, high mutual interdependence
Oligopolists face a unique situation: their demand curve depends on how competitors react to their pricing decisions. This creates complex strategic behavior.
Key Insight:
An oligopolist must anticipate competitor reactions. If one airline lowers fares, will rivals match the cut? If one raises prices, will others follow? This interdependence makes demand uncertain and creates strategic complexity.
Most inelastic (steepest)
Moderate elasticity
More elastic (flatter)
Perfect competition would show a horizontal (perfectly elastic) demand curve for comparison
Mutual interdependence is the defining characteristic of oligopoly. Each firm's decisions directly affect its rivals, and rivals' reactions affect the original firm. This creates a strategic game where firms must anticipate and respond to competitors' moves.
In an oligopoly, firms cannot make pricing or output decisions in isolation. Each firm must consider:
When one major airline announces a fare sale, competitors often match the lower prices within hours. Why?
If competitors don't match: They lose customers to the airline with lower fares. Market share shifts dramatically.
If competitors match: All airlines earn less revenue, but market shares stay roughly stable. This is mutual interdependence in action.
Firms may cooperate (legally or illegally) to set prices or limit output, acting like a monopoly to maximize joint profits. This harms consumers but benefits the colluding firms.
Aggressive price competition can erupt when firms try to gain market share, driving prices down and potentially causing losses for all competitors until prices stabilize.
One dominant firm sets the price, and smaller firms follow. This implicit coordination avoids the risks of open collusion while maintaining stable, higher prices.
To avoid price wars, firms compete through advertising, product quality, customer service, and innovation rather than price cuts.
The kinked demand curve is a model that explains price rigidity (price stickiness) in oligopolistic markets. It suggests that oligopolists face two different demand conditions depending on whether they raise or lower prices.
Competitors do NOT follow the price increase. Why would they? They can capture market share by keeping their prices low.
Result: The firm loses many customers to rivals → Demand is highly elastic (flat) above the current price
Competitors MATCH the price cut. They don't want to lose their customers, so they lower prices too.
Result: The firm gains few new customers since everyone dropped prices → Demand is relatively inelastic (steep) below the current price
A kinked demand curve diagram would show:
The MR curve has a vertical gap (discontinuity) at the quantity where the demand curve kinks. This gap explains why prices tend to be stable—even if costs change slightly, the profit-maximizing output stays the same.
Price Rigidity: Firms have little incentive to change prices. Raising prices loses customers; lowering prices starts a price war with no gain.
Stable Prices: Even if marginal costs rise or fall somewhat, the profit-maximizing price and quantity remain unchanged due to the MR gap.
Strategic Stability: The kink reinforces the status quo, reducing aggressive competition and making markets more predictable.
The kinked demand curve helps explain why prices for products like gasoline, soft drinks, or smartphones tend to stay stable for extended periods, even when costs fluctuate:
Example: If Coca-Cola raises its price, Pepsi keeps its price low and gains customers. Coca-Cola loses sales.
Example: If Coca-Cola lowers its price, Pepsi immediately matches to protect its market share. Neither gains much.
Result: Both firms keep prices stable at the current level, creating the characteristic "kink" in the demand curve.
Now explore how monopolists use their market power to maximize profits
Next: Monopoly