Setting Up The Model
Monopolies are not often found in practice, the more usual market format is oligopoly: several firms, each of whom is big enough that a change in their price will affect the price of the other firms, but none with an unchallenged monopoly. When looking at oligopolies the problem of interdependence arises. Interdependence means that the firms will, when setting their prices, consider the effect this price will have on the actions of both consumers and competitors. For their part, the competitors will consider their expectations of the firm's response to any action they may take in return. Thus, there is a complex game with each side "trying to second guess each others' strategies." The Monopolistic Competition model is used because its simplicity allows the examination of one type of oligopoly while avoiding the issue of interdependence.
Read more about this topic: Monopolistic Competition In International Trade
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