MANAGERIAL ECONOMICS 12 th Edition By Mark Hirschey

Monopolistic Competition and Oligopoly Chapter 13

Chapter 13 OVERVIEW   Contrast Between Monopolistic Competition and Oligopoly   Monopolistic Competition   Monopolistic Competition Process   Oligopoly   Cartels and Collusion   Oligopoly Output-Setting Models   Oligopoly Price-Setting Models   Market Structure Measurement   Census Measures of Market Concentration

Chapter 13 KEY CONCEPTS   monopolistic competition   oligopoly   high-price/low-output equilibrium   low-price/high-output equilibrium   cartel   collusion   Cournot model   output-reaction curve   Stackelberg model   first-mover advantage   price signaling   price leadership   barometric price leadership   Bertrand model   price-reaction curve   contestable markets theory   Sweezy model   kinked demand curve   oligopoly theory   economic census   North American Industry Classification System (NAICS)   concentration ratios   Herfindahl-Hirschmann Index (HHI)

Contrast Between Monopolistic Competition and Oligopoly   Monopolistic Competition Large number of sellers that offer differentiated products. Normal profit opportunity in long-run equilibrium.   Oligopoly Few sellers. Economic profits are possible in long-run equilibrium.   Dynamic Nature of Competition Timely market structure information is required for optimal investment decisions

Monopolistic Competition   Monopolistic Competition Characteristics Many buyers and sellers. Product heterogeneity. Free entry and exit. Perfect information. Opportunity for normal profits in long-run equilibrium.   Monopolistic Competition Price/Output Decisions Set M π = MR - MC = 0 to maximize profits, MR=MC. No durable economic profits because P=AR=AC.

Monopolistic Competition Process   Short-run Monopoly Equilibrium Monopolistically competitive firms take full advantage of short- run monopoly. In short run, MR = MC, P > AC, and π > 0.   Long-run High-price/Low-output Equilibrium With differentiated products, MR = MC and P = AR = AC at a point above minimum LRAC. No excess profits exist, so π = 0.   Long-run Low-price/High-output Equilibrium With homogenous products, MR = MC and P=AC at minimum LRAC. No excess profits exist, so π = 0. This is a competitive market equilibrium.

Oligopoly   Oligopoly Market Characteristics Few sellers. Homogenous or unique products. Blockaded entry and exit. Imperfect dissemination of information. Opportunity for above-normal (economic) profits in long-run equilibrium.   Examples of Oligopoly National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc. Local retail markets for gasoline, food, professional services, etc.

Cartels and Collusion   Overt and Covert Agreements Overt agreements create cartels that operate like monopoly. Collusion exists when firms reach secret, covert agreements.   Enforcement Problem Cartels are typically short-lived because coordination problems often lead to cheating. Cartel subversion can be extremely profitable. Detecting the source of secret price concessions can be extremely difficult.

Oligopoly Output-Setting Models   Cournot Oligopoly Cournot equilibrium output is found by simultaneously solving output-reaction curves for both competitors. Cournot equilibrium output exceeds monopoly output but is less than competitive output.

Stackelberg Oligopoly   Stackelberg model posits a first-mover advantage. Price wars severely undermine profitability for both leading and following firms. Price signaling can reduce uncertainty in oligopoly markets. Price leadership occurs when firms follow the industry leader’s pricing policy.

Oligopoly Price-Setting Models   Bertrand Oligopoly: Identical Products The Bertrand model focuses on price reactions. The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.   Bertrand Oligopoly: Differentiated Products The Bertrand model demonstrates how price-setting oligopolies profit with differentiated products.

Sweezy Oligopoly   Sweezy model predicts “sticky” prices. Price increases are sometimes ignored. Price decreases are sometimes followed Uncertainty creates sticky prices.   “Kinked” Demand Curve If competitors expect price increases to be ignored but price decreases to be followed, a kink in the demand curve results. Sweezy model explains why prices in oligopoly markets sometimes fail to respond to marginal cost changes.

Oligopoly Model Comparison   Modeling Oligopoly is Difficult Cournot model does not incorporate output reactions. Bertrand model does not incorporate price reactions. Stackelberg model explains first-mover advantages, but does not explain countermoves. Sweezy model is incomplete.   Oligopoly markets differ. Competition among the few can be intense. Competition among the few can resemble a competitive game.

Market Structure Measurement   Economic Markets Economic markets consists of all individuals and firms willing and able to buy or sell a given product. When cross-price elasticities are large and positive, competing products are indicated.   Economic Census The economic census provides a comprehensive statistical profile of the economy. Industry statistics are classified using the North American Industry Classification System (NAICS).

Census Measures of Market Concentration   Concentration ratios measure the combined market share percentage of the ith leading firms, CR i = ∑ X i. CR i = 100 for monopoly. CR i ≈ 0 for a perfectly competitive industry.   The Herfindahl-Hirschmann Index is the sum of squared market share percentage for all competitors, HHI = ∑ X i 2. HHI = 10,000 for monopoly. HHI ≈ 0 for a perfectly competitive industry.   Limitations of Census Information Slow reports hinder usefulness. National statistics obscure local markets.