PRINCIPLES OF ECONOMICS Chapter 10 Monopolistic Competition and Oligopoly PowerPoint Image Slideshow

IMPERFECT COMPETITION The laundry detergent market is one that is characterized neither as perfect competition nor monopoly as there are a few big firms supplying the good.

MONOPOLISTIC COMPETITION A market in which there are many firms producing similar, but not identical goods and services. Example: fast-food restaurants; gas stations; grocery stores; travel agencies

OLIGOPOLY A market in which there are a few large firms. Examples Domestic Oil (e.g., Chevron, Texaco, Exxon) Airlines (e.g., American, Delta, Alaska) Automobile (e.g., General Motors, Ford, Chrysler)

EXAMPLES OF MARKETS Perfect Competition Monopolistic Competition OligopolyMonopoly 1)Agriculture 2)Lumber 1)Fast Food 2)Long Distance Phone Service 1)Cars and Trucks 2)Soft Drinks 1)Windows Operating system 2)PG & E 3)The Gas Company

MARKET CHARACTERISTICS Perfect Competition Monopolistic Competition OligopolyMonopoly Number of Firms Many-often thousands or even millions ManyFewOne Barriers to Entry NoneFewSubstantialInsurmountable, at least in the short run Product Similarity IdenticalSimilar but not identical Similar or Identical Unique * The line between “several” and “few” is not definite

WHICH MODEL FITS REALITY? Perfect competition is rare outside agriculture though it fits some labor markets. Monopolies are common in public utilities like electricity and water. Major branded companies are typically either oligopolistic (automobile) or monopolistically competitive (McDonalds).

MONOPOLISTIC COMPETITION The demand curve facing a perfectly competitive firm is a horizontal line, meaning it can sell all the output it produces at the market price. The demand curve facing a monopoly is the market demand. It can sell more output only by decreasing the price. The demand curve facing a monopolistically competitive firm is downward sloping because of products are differentiated.

MONOPOLISTIC COMPETITION

Profit making depends on the P-AC margin. To maximize profits, the Authentic Chinese Pizza shop would choose a quantity where MR = MC. Here it would choose Q = 40 and P = $16 with AC = $15. TR = 16*40 = $640 TC = 15*40 = $600 Profit = $640 – $600 = $40

MONOPOLISTIC COMPETITION

With profit of $40, new firms enter to market to share it. Demand for the existing firm’s product declines, reducing its profit. Entry into the market continue until the firm breaks-even with normal profit (TR covers both explicit and implicit costs).

MONOPOLISTIC COMPETITION

OLIGOPOLY A few big firms produce almost the entire market output. Products are usually differentiated. Effective entry barriers protect firm profitability. Price fixing is illegal in the industry. They follow price changes and compete with advertisement. 6-14

OLIGOPOLY - CARTELS A few big firms that jointly maximize profit. They agree to set price and output levels. Generally illegal in the U.S., but common internationally (e.g., The OPEC) Self-interest results in failure of the cartel as some members cheat by cutting the price Repeated interaction increase the incentives to cooperate. 6-15

OLIGOPOLY – THE KINKED DEMAND CURVE The cartel faces two demand curves: 1.Rivals follow a price cut 2.Rivals do not follow a price hick The combined firm’s demand is kinked at the intersection of the two demand curves to set the price and quantity. 6-16

OLIGOPOLY – THE KINKED DEMAND CURVE

THE GAME THEORY - NASH EQUILIBRIUM An oligopolist does the best it can, given expectations of rival behavior Behavior is non-cooperative Duopolists considering a low price or a high price must consider rival’s response Nash equilibrium occurs when each firm does the best it can given rival’s actions 6-18

THE PRISONERS‘ DILEMMA 2 years A—No confession A—Confession 8 year 8 years 1 year 5 years B—No confession B—Confession 6-19

THE CARTEL’S DILEMMA $1,000 $500 A-Low output A—Low output A—High output $200 $1,500 $400 B-Low output B—High output 6-20