Explain how the long-run equilibrium under oligopoly differs from that of perfect competition.

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Firms operate at the point where marginal cost equals marginal revenue. Where that point falls below demand, there will be a shortage in the market. This shortage will cause prices (and, therefore, profits) to rise.

In a perfectly competitive market, new firms will enter the market in order to capture...

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Firms operate at the point where marginal cost equals marginal revenue. Where that point falls below demand, there will be a shortage in the market. This shortage will cause prices (and, therefore, profits) to rise.

In a perfectly competitive market, new firms will enter the market in order to capture a share of excess profits. In the long run, supply will shift outward as more firms enter. As supply increases, prices will fall along with marginal revenue. This will continue until marginal cost, marginal revenue, and demand are equal. Thus, in perfectly competitive markets, resources are allocated such that supply exactly meets demand. In other words, resource allocation is efficient.

In oligopolies, new firms are not able to easily enter the market. Therefore, no long-run shift in supply due to new firms entering will occur. If existing firms continue to operate where supply falls short of demand, prices will remain high, and excess profits will remain in the market. Because resources are not being allocated such that supply meets demand, these markets are inefficient.

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The major difference in the long run equilibrium between a market that is in perfect competition and one that is in monopoly is that there will be a lower equilibrium quantity at a higher equilibrium price in an oligopoly.  This is because of a lack of competition.

As we know, an oligopoly is a market structure in which there are only a very few companies.  There are few companies because there are high barriers to entry.  In perfect competition, there are very low barriers to entry.  This means that when firms start to make economic profit, others will enter the market.  In an oligopoly, this is not really possible.

What this means is that the industry supply will be lower than it “should” be in an oligopoly.  Simple supply and demand analysis shows us that an industry with lower supply will have (all other things being equal) a lower equilibrium quantity and a higher equilibrium price than an industry with higher supply would.  This means that economic profit can be made in an oligopoly where it cannot be in perfect competition.  It also means that there will be allocative inefficiency in an oligopoly, but not in perfect competition.

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