Monopolistic Competition and Oligopoly

Somewhere between the two extremes of monopoly and perfect competition Two forms – Monopolistic Competition – Oligopoly Monopolistic Competition – Many sellers, but – Product Differentiation – So face a downward sloping demand curve – Not Price Takers Oligopoly – Only a few seller – Offer similar or identical products

Monopolistic Competition Key Points Like a monopoly – Faces a downward sloping demand curve – Sets its own price – Marks up price over quantity But not – Not really a monopoly – Almost because it tries to make its product different – But its not different, so cant push the monopoly mindset too far, because people will go to other close substitutes

Profit in the long run? – If firms making lots of profit maybe more firms come in with close substitutes – This would lower the firms demand and MR curve and also profits – Could this lead then to zero LR profits? – If they havent sufficiently differentiated their product, yes – But if they have, no – Because consumers might feel there are no real substitutes – Think Athletic Shoes

Monopolistic Competition and Advertising If a firm is selling a differentiated product and making a profit (price > MC) Then there is an incentive to advertise – To attract more buyers (increase demand and MR curve) – And to keep their product differentiated

Is advertising bad? – Manipulates peoples tastes – Psychological, not informative – Impedes competition – Differentiating products that are really the same (brand loyalty) Is it good? – Gives information – Fosters competition (consumers take advantage of price differences among similar products) – Allows new firms to enter easier

Does it make sense that consumers buy brand names? Essentially the same product as store brands, but cost more, partly because they advertise But maybe they are higher quality, and they have an incentive to keep higher quality to defend the brand

Oligopoly Only a few sellers Similar or identical products Interdependent Game Theory – How people behave in strategic situations – If only a few, I need to consider how theyll respond to my actions

Tension between cooperating and competing Best off cooperating and acting like a monopoly – Produce small amount – P > MC But each only cares about own self interest – Incentive to compete

Duopoly Example Only two firms Same product Each decides quantity to sell Price is set by the market demand Thus the combination of both sellers choice of Q leads to the price and so their profits

They could collude and act as a monopoly – Come to an agreement on price or quantity – But generally explicit collusion is illegal (but can still act strategically) Thus forming a Cartel – Think of OPEC

Economics of Cooperation Prisoners Dilemma – A game – Illustrates why cooperation can be hard even if both would benefit Dominant Strategy – A strategy that is best for a player in a game regardless of what others do

Confess Dont A B A gets 8 yrs prison B gets 8 yrs prison A gets 20 yrs prison A gets 1 yrs prison B gets 8 yrs prison B goes free B gets 20 yrs prison A goes free

Regardless of what A does it is better for B to confess – Dominant Strategy Regardless of what B does if is better for A to confess – Dominant Strategy So they both confess and both get 8 yrs instead of both getting off Of course this is if they cant collude This is similar to the situation face by two firms in a duopoly

Two firms in a duopoly face a similar game If colluded could reach higher profits But cant directly collude Becomes a strategic game

GallonsMarket PriceTotal Revenue (Total Profit) 0$120$ , , , , , , , , , ,000 Demand Schedule and Profit

High Production 40 Gallons High P 40 G Low Production 30 Gallons Low P 30 G A B A gets $1.6K profit B gets $1.6K profit A gets $1.5K profit A gets $1.8K profit B gets $1.8K profit B gets $2K profit B gets $1.5K profit A gets $2K profit Duopoly Game

Application to OPEC Organization of Petroleum Exporting Countries Control about ¾ of worlds oil reserves Tries to set production limits to keep price of oil sufficiently high (but not too high to cause long term shift in demand) Each country then has incentive to deviate a bit – Because still get benefit of higher price but also get to sell more, but if all do this then price falls – Success at setting high price in 70s and early 80s but since then not so much

Arms Race Example Cold war arms race between US and Soviet Union Two strategies – Arm – Disarm Dominant Strategy – Arm

Arm Disarm US Soviet US at risk Soviet at risk US at risk and weak US safe Soviet safe Soviet safe and strong Soviet at risk and weak US safe and strong Cold War Game

Games implication for welfare Noncooperative Equilibrium – Dominant Strategy – Could be good for society Gets away from monopoly production – Could be bad Gets us a world full of nuclear warheads

How to Still Get Cooperation Repeated Games – Dominant strategy is such because game only played once Start out at best position Penalize players for deviating – Tit for Tat

Public Policy Anti Trust Laws Sherman Act, 1890 – Made agreements between oligopolists a crime Clayton Act, 1914 – Strengthened anti trust laws Prevent Certain Mergers Prevent Collusion

Predatory Pricing Selling below cost in order to drive out a competitor Then when competitor gone can act as a monopoly Illegal under anti trust policies Deemed anticompetitive Rockefeller strategy in oil (Cincinnati/Chicago) Lower price in Cincinnati to drive out competition, but raise price in Chicago where competition had already been driven out