452 PART • Market Structure and Competitive Strategy • monopolistic competition Market in which firms can enter freely, each producing its own brand or version of a differentiated product • oligopoly Market in which only a few firms compete with one another, and entry by new firms is impeded • cartel Market in which some or all firms explicitly collude, coordinating prices and output levels to maximize joint profits In §10.2, we explain that a seller of a product has some monopoly power if it can profitably charge a price greater than marginal cost At first glance, a cartel may seem like a pure monopoly After all, the firms in a cartel appear to operate as though they were parts of one big company But a cartel differs from a monopoly in two important respects First, because cartels rarely control the entire market, they must consider how their pricing decisions will affect noncartel production levels Second, because the members of a cartel are not part of one big company, they may be tempted to “cheat” their partners by undercutting prices and grabbing bigger shares of the market As a result, many cartels tend to be unstable and short-lived 12.1 Monopolistic Competition In many industries, the products are differentiated For one reason or another, consumers view each firm’s brand as different from other brands Crest toothpaste, for example, is perceived to be different from Colgate, Aim, and other toothpastes The difference is partly flavor, partly consistency, and partly reputation—the consumer’s image (correct or incorrect) of the relative decay-preventing efficacy of Crest As a result, some consumers (but not all) will pay more for Crest Because Procter & Gamble is the sole producer of Crest, it has monopoly power But its monopoly power is limited because consumers can easily substitute other brands if the price of Crest rises Although consumers who prefer Crest will pay more for it, most of them will not pay much more The typical Crest user might pay 25 or 50 cents a tube more, but probably not one or two dollars more For most consumers, toothpaste is toothpaste, and the differences among brands are small Therefore, the demand curve for Crest toothpaste, though downward sloping, is fairly elastic (A reasonable estimate of the elasticity of demand for Crest is −5.) Because of its limited monopoly power, Procter & Gamble will charge a price that is higher, but not much higher, than marginal cost The situation is similar for Tide detergent or Scott paper towels The Makings of Monopolistic Competition A monopolistically competitive market has two key characteristics: Firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes In other words, the crossprice elasticities of demand are large but not infinite There is free entry and exit: It is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their products become unprofitable To see why free entry is an important requirement, let’s compare the markets for toothpaste and automobiles The toothpaste market is monopolistically competitive, but the automobile market is better characterized as an oligopoly It is relatively easy for other firms to introduce new brands of toothpaste, and this limits the profitability of producing Crest or Colgate If the profits were large, other firms would spend the necessary money (for development, production, advertising, and promotion) to introduce new brands of their own, which would reduce the market shares and profitability of Crest and Colgate The automobile market is also characterized by product differentiation However, the large-scale economies involved in production make entry by new firms difficult Thus, until the mid-1970s, when Japanese producers became important competitors, the three major U.S automakers had the market largely to themselves