Chapter 13 - Monopolistic competition and oligopoly. In this chapter students will be able to: Explain how price and output are determined under monopolistic competition, describe the characteristics of oligopoly and the cournot model, compare several key noncooperative oligopoly models; including Stackelberg and the dominant firm;...
Prepared by Dr. Della Lee Sue, Marist College MICROECONOMICS: Theory & Applications Chapter 13: Monopolistic Competition and Oligopoly By Edgar K. Browning & Mark A. Zupan John Wiley & Sons, Inc 12th Edition, Copyright 2015 Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Learning Objectives Explain how price and output are determined under monopolistic competition Describe the characteristics of Oligopoly and the Cournot Model Compare several key noncooperative oligopoly models, including Stackelberg and the dominant firm Show how price and output are determined under the cooperative oligopoly model of cartels Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Explain how price and output are determined under monopolistic competition 13.1 PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Price and Output Under Monopolistic Competition Monopolistic competition – a market characterized by: unrestricted entry and exit a large number of independent sellers producing differentiated products Differentiated product – a product that consumers view as different from other similar products Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Determination of Market Equilibrium The demand curve facing each firm is downwardsloping but fairly elastic, reflecting a firm’s market power Differs from a monopoly: Firm demand curve is not the market demand Entry into the market is not restricted Firms compete on product differentiation as well as price Longrun equilibrium: attained as a result of firms entering (or leaving) the industry in response to profit incentives Price > MC zero economic profit Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Figure 13.1 – Monopolistic Competition Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Monopolistic Competition and Efficiency Excess capacity – the result of firms failing to produce at lowest possible average cost The firm does not operate at the minimum point on the LR average cost curve Total output is wrong from a social perspective due to deadweight loss Deadweight loss is analytically reduced if the interdependence between individual firms’ demand is taken into account Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Figure 132 – Alleged Deadweight Loss of Monopolistic Competition Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Is Government Intervention Warranted? Three reasons why government intervention is probably not warranted: Any deadweight loss is likely to be small, due to the presence of competing firms and free entry Any possible inefficiency cost must be weighed against the product variety produced and the benefits of such variety to consumers The costs of intervention must be balanced against the potential gain from expanding output Copyright © 2015 John Wiley & Sons, Inc. All rights reserved Describe the characteristics of Oligopoly and the Cournot Model 13.2 OLIGOPOLY AND THE COURNOT MODEL Copyright © 2015 John Wiley & Sons, Inc. All rights reserved 10 Other Oligopoly Models The Stackelberg Model – a model of oligopoly in which a leader firm selects its output first, taking the reactions of follower firms into account Dominant Firm Model – a model of oligopoly in which the leader or dominant firm assumes its rivals behave like competitive firms in determining their output Copyright © 2015 John Wiley & Sons, Inc. All rights reserved 18 The Stackelberg Model Residual demand curve – a firm’s demand curve based on the assumption that the firm knows how much output rivals will produce for each output the firm may choose Key point: a firm’s conjectures in an oligopoly about how rivals will respond can affect firms’ outputs, profits, and total industry output Which model is better, the Stackelberg model or the Cournot model? It depends upon the particular market under examination Copyright © 2015 John Wiley & Sons, Inc. All rights reserved 19 Figure 13.5 The Stackelberg Model Copyright © 2015 John Wiley & Sons, Inc. All rights reserved 20 The Dominant Firm Model The leader assumes its rivals behave like competitive firms in determining their output Also known as “the dominant firm with a competitive fringe” model At any price, the dominant firm can sell an amount equal to the total quantity demanded at that price minus the quantity the fringe firms produce At equilibrium, price > MC for the dominant firm but price = MC for the fringe firm Total output