Chapter 13 Monopolistic Competition and Oligopoly Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

13-2 Monopolistic Competition Monopolistic competition Relatively large number of sellers Product differentiation Easy entry and exit Nonprice competition like advertising LO1

13-3 Monopolistically Competitive Industries Industry concentration Measured by 4-firm concentration ratio Percentage of sales by 4 largest firms Herfindahl index Sum of squared market shares 4-firm CR = output of four largest firms total output in the industry HI = (%S 1 ) 2 + (%S 2 ) 2 + (%S 3 ) 2 + …. + (%S n ) 2 LO1

13-4 Price and Output in Monopolistic Competition Demand is highly elastic Short run profit or loss Produce where MR = MC Long run only a normal profit Entry and exit LO2

13-5 Monopolistic Competition and Efficiency Monopolistic competition inefficient Productive inefficiency because P > min ATC Allocative inefficiency because P > MC Excess capacity LO3

13-6 Product Variety The firm constantly manages price, 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 LO4

13-7 Oligopoly A few large producers Homogeneous oligopoly Differentiated oligopoly Limited control over price Entry barriers Mergers LO5

13-8 Oligopolistic Industries Four-firm concentration ratio 40% or more to be an oligopoly Shortcomings Localized markets Interindustry competition Import competition Dominant firms LO5

13-9 Oligopoly Behavior Oligopolies display strategic behavior Mutual interdependence Collusion Incentive to cheat Game theory Prisoner’s dilemma LO6

13-10 Game Theory Overview RareAir’s price strategy Uptown’s price strategy AB CD $12 $15 $6 $8 $6 $15 High Low 2 competitors 2 price strategies Each strategy has a payoff matrix Greatest combined profit Independent actions stimulate a response LO6

13-11 Game Theory Overview RareAir’s price strategy Uptown’s price strategy AB CD $12 $15 $6 $8 $6 $15 High Low Independently lowered prices in expectation of greater profit leads to worst combined outcome Eventually low outcomes make firms return to higher prices. LO6

13-12 Three Oligopoly Models Kinked-demand curve Collusive pricing Price leadership Reasons for 3 models Diversity of oligopolies Complications of interdependence LO7

13-13 Kinked-Demand Theory Noncollusive oligopoly Uncertainty about rivals reactions Rivals match any price change Rivals ignore any price change Assume combined strategy Match price reductions Ignore price increases LO7

13-14 Cartels and Other Collusion Price and costs Quantity D MR=MC ATC MC MR P0P0 A0A0 Q0Q0 Economic profit LO7

13-15 Overt Collusion A cartel is a group of firms or nations that collude Formally agreeing to the price Sets output levels for members Collusion is illegal in the United States OPEC LO7

13-16 Obstacles to Collusion Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles LO7

13-17 Price Leadership Model Price leadership Dominant firm initiates price changes Other firms follow the leader Use limit pricing to block entry of new firms Possible price war LO7

13-18 Oligopoly and Advertising Oligopolies commonly compete though product development and advertising Less easily duplicated than a price change Financially able to advertise LO8

13-19 Positive Effects of Advertising Low-cost way of providing information to consumers Enhances competition Speeds up technological progress Can help firms obtain economies of scale LO8

13-20 Oligopoly and Efficiency Oligopolies are inefficient Productively inefficient because P > min ATC Allocatively inefficient because P > MC Qualifications Increased foreign competition Limit pricing Technological advance LO9