After reading this chapter, you should be able to: List the characteristics of monopolistic competition, explain why monopolistic competitors earn only a normal profit in the long run, describe the characteristics of oligopoly, discuss how game theory relates to oligopoly,...
11 Monopolistic Competition and Oligopoly McGrawHill/Irwin Copyright © 2012 by The McGrawHill Companies, Inc. All rights reserved Four Market Models Characteristics of the Four Basic Market Models Characteristic Pure Competition Monopolistic Competition Oligopoly Monopoly Number of firms A very large number Many Few One Type of product Standardized Differentiated Standardized or differentiated Unique; no close subs Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Considerable Conditions of entry Very easy, no obstacles Relatively easy Significant obstacles Blocked Nonprice competition None Considerable emphasis on advertising, brand names, trademarks Typically a great deal, particularly with product differentiation Mostly public relation advertising Examples Agriculture Retail trade, dresses, shoes Steel, auto, farm implements Local utilities LO1 11-2 Monopolistic Competition • Relatively large number of sellers • Differentiated products • Easy entry and exit • Advertising LO1 11-3 Monopolistically Competitive • Industry concentration • Measured by: • Four-firm concentration ratios • Percentage of largest firms 4-Firm CR = Output of four largest firms Total output in the industry • Herfindahl index • Sum of squared market shares HI = (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2 LO1 11-4 Price and Output in Monopolistic Comp • Demand is highly elastic • Short run profit or loss • Produce where MR=MC • Long run normal profit • Entry and exit • Inefficient • Product variety LO2 11-5 The Short Run: Profit or Loss Price and Costs MC ATC P1 A1 Economic Profit D1 MR = MC MR Q1 Quantity LO2 11-6 The Short Run: Profit or Loss Price and Costs MC ATC A2 P2 Loss D2 MR = MC MR Q2 Quantity LO2 11-7 The Long Run: Only a Normal Profit MC Price and Costs ATC P3= A3 D3 MR = MC MR Q3 Quantity LO2 11-8 Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO2 11-9 Monopolistic Competition: Efficiency P=MC=Min ATC for pure competition (recall) P4 Price is Lower Excess Capacity at Minimum ATC Q4 Monopolistic competition is not efficient LO2 11-10 Oligopoly • A few large producers • Homogeneous or differentiated • • • LO3 products Limited control over price • Mutual interdependence • Strategic behavior Entry barriers Mergers 11-12 Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be oligopoly • Shortcomings • Localized markets • Inter-industry competition • World price • Dominant firms LO3 11-13 Game Theory Overview • Oligopolies display strategic pricing behavior • Mutual interdependence • Collusion • Incentive to cheat • Prisoner’s dilemma LO4 11-14 Game Theory Overview RareAir’s Price Strategy LO4 High Uptown’s Price Strategy • competitors • price strategies • Each strategy has a payoff matrix • Greatest combined profit • Independent actions stimulate a response A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 11-15 Game Theory Overview RareAir’s Price Strategy LO4 High Uptown’s Price Strategy • Independently lowered prices in expectation of greater profit leads to worst combined outcome • Eventually low outcomes make firms return to higher prices A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 11-16 Three Oligopoly Models • Kinked-demand curve • Collusive pricing • Price leadership • Reasons for models • Diversity of oligopolies • Complications of interdependence LO5 11-17 KinkedDemand Curve P0 e f D2 Q0 Quantity LO5 P0 MR2 e f MC2 MR2 Rivals Match g Price Decrease MC1 D2 Price Price Rivals Ignore Price Increase g D1 MR1 D1 Q0 MR1 Quantity 11-18 KinkedDemand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6 11-19 Cartels and Other Collusion MC P0 ATC A0 Economic Profit MR=MC MR D Q0 LO6 11-20 Overt Collusion • Cartels - a group of firms or nations • • LO6 that collude • Formally agreeing to the price • Sets output levels for members Collusion is illegal in the United States OPEC 11-21 Obstacles to Collusion • Demand and cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles LO6 11-22 Price Leadership Model • Price Leadership • Dominant firm initiates price • • LO6 changes • Other firms follow the leader Use limit pricing to block entry of new firms Possible price war 11-23 Oligopoly and Advertising • Prevalent to compete with product development and advertising • Less easily duplicated than a price change • Financially able to advertise LO7 11-24 Advertising Positive Effects Low-cost way of providing information to consumers Negative Effects Can be manipulative Enhances competition Contains misleading claims that confuse consumers Speeds up technological progress Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product Can help firms obtain economies of scale LO7 11-25 Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > minATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7 11-26 ... LO2 1 1-9 Monopolistic Competition: Efficiency P=MC=Min ATC for pure competition (recall) P4 Price is Lower Excess Capacity at Minimum ATC Q4 Monopolistic competition is not efficient LO2 1 1-1 0... product, and advertising • Better product differentiation • Better advertising The consumer benefits by greater array of choices and better products • Types and styles • Brands and quality 1 1-1 1 Oligopoly. .. Characteristic Pure Competition Monopolistic Competition Oligopoly Monopoly Number of firms A very large number Many Few One Type of product Standardized Differentiated Standardized or differentiated