Principles of Microeconomics: Econ102

Monopolistic Competition: A market structure in which barriers to entry are low, and many firms compete by selling similar, but not identical, products. Oligopoly: A market structure in which a small number of firms compete.

Demand and Marginal Revenue at a Starbucks CAFFÈ LATTES SOLD PER WEEK (Q) PRICE (P) TOTAL REVENUE (TR = P x Q) AVERAGE REVENUE (AR – TR/Q) MARGINAL REVENUE (MR = ΔTR/ΔQ) $ $ $ $

A firm’s profits will be eliminated in the long run only if the firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product.

Allocative Efficiency: The situation where every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. For allocative efficiency to hold, firms must charge a price equal to marginal cost. Productive Efficiency: The situation where every good or service is produced at the lowest possible cost. For productive efficiency to hold, firms must produce at the minimum point of average total cost.

The profit-maximizing level of output for a monopolistically competitive firm comes at a level of output where MR=MC, and where price is greater than marginal cost and the firm is not at the minimum point of its average total cost curve. Excess Capacity under Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes. How Consumers Benefit from Monopolistic Competition

Oligopoly:  A market structure dominated by a few large producers with considerable control over prices.  Homogeneous (standardized) or differentiated  Strategic behavior  Self-interested behavior that takes into account the reactions of others.  Mutual Interdependence  A situation in which each firm’s profit depends not just on its own price and sales strategies but also on those of other firms in its highly concentrated industry.

RETAIL TRADEMANUFACTURING INDUSTRY FOUR-FIRM CONCENTRATION RATIO INDUSTRY FOUR-FIRM CONCENTRATION RATIO Warehouse Clubs and Superstores 90%Cigarettes99% Discount Department Stores88%Beer90% Hobby, Toy, and Game Stores 70%Aircraft85% Radio, Television, and Other Electronic Stores 62%Breakfast Cereal83% Athletic Footwear Stores62%Automobiles80% College Bookstores58%Dog and Cat Food58% Pharmacies and Drugstores47%Computers45%

Economies of Scale Help Determine the Extent of Competition in an Industry

In addition to economies of scale, other barriers to entry include:  Ownership of a key input  Government–Imposed Barriers  Patent: The exclusive right to a product for a period of 20 years from the date the product was invented.

 Kinked-demand curve  Collusive pricing  Price leadership  Reasons for 3 models  Diversity of oligopolies  Tight & loose oligopoly  Differentiated & standardized  Collusive & non-collusive (independently)  Strong and not so-strong barriers  Complications of interdependence  Inability to estimate demand & MR data because of uncertainty of rivals’ reactions

P0 MR2 D2 D1 MR1 e f g Rivals Ignore Price Increase Rivals Match Price Decrease Q0 MR2 D2 D1 MR1 Q0 MC1 MC2 P0 e f g Price Quantity  Criticisms  Explains inflexibility, not price  Prices are not that rigid when macroeconomy is unstable.  Price wars  During downturns, some firms cut prices setting off price wars in attempt to maintain market share.

Price and Costs Quantity D MR=MC ATC MC MR P0 A0 Q0 Economic Profit Obstacles to Collusion  Demand & cost differences  Number of firms  Cheating  Recession  New entrants  Legal obstacles

 Price Leadership  Dominant firm initiates price changes  Other firms follow the leader  Use limit pricing to block entry of new firms  Possible price war 11-18

Game theory: The study of how people make decisions in situations where attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms.

Payoff matrix: A table that shows the payoffs that each firm earns from every combination of strategies by the firms. Collusion: An agreement among firms to charge the same price, or to otherwise not compete. A Duopoly Game Dominant Strategy: A strategy that is the best for a firm, no matter what strategies other firms use. Nash equilibrium: A situation where each firm chooses the best strategy, given the strategies chosen by other firms.

Cooperative Equilibrium: An equilibrium in a game in which players cooperate to increase their mutual payoff. Non-cooperative Equilibrium: An equilibrium in a game in which players do not cooperate but pursue their own self-interest. Prisoners’ Dilemma: A game where pursuing dominant strategies results in noncooperation that leaves everyone worse off.

If Coca-Cola wants to maximize profits, will it advertise? Explain. If Pepsi wants to maximize profits, will it advertise? Explain. Is there a Nash Equilibrium to this advertising game? If so, what is it?

Cartel: A group of firms that colludes by agreeing to restrict output to increase prices and profits. Does a cartel guarantee that collusion would be successful?

The equilibrium of this game will occur with Saudi Arabia producing a low output and Nigeria producing a high output. Does a cartel guarantee that collusion would be successful?