Monopolistic Competition and Oligopolies

Monopolistic Competition Companies offer differentiated products yet face competition Companies face downward sloping demand curve Companies produce where MC=MR, set price and quantity according to demand curve In short run, economic profits exist In long run, competitors move into industry and economic profits tend to zero Where is the deadweight loss to society? Monopolistic compertition leads firms to produce where they have “excess capacity” What does society gain/lose in this situation

Oligopoly: Cartel or Collusion Oligopoly: –market dominated by a few firms –Actions of each firm affect the other firms How many cellular carriers in US? How many major TV networks (but why is this increasing lately?) No single model explains profit-seeking behavior in oligopoly

Oligopolies By acting as if they were a single monopolist, oligopolists can maximize their combined profits. So there is an incentive to form a cartel. Each firm has motive to cheat— to produce more than agreed Two principal outcomes: successful collusion or behaving non-cooperatively by cheating When firms ignore the effects of their actions on each others’ profits, they engage in non- cooperative behavior Likely to be easier to achieve informal collusion when firms in an industry face capacity constraints

Concentration and Collusion “Concentration” describes amount of market controlled by oligopoly Concentration Ratio: % of industry controlled by top 4 firms, top 8, top 20, etc. Herfindahl-Hirschman Index calculated by summing the squares of each firm’s % control of the industry HHI = (S 1 ) 2 + (S 2 ) 2 + (S 3 ) 2 + … (S n ) 2

Canadian food production concentration ratios. Note that decimals are used rather than percents. CR4 is the concentration ratio of the largest 4 firms in each industry.

Game Theory Strategic choice = choice based on recognition that actions of others will affect outcome of the choice Game theory = analytical approach to assess strategic choices Payoff = outcome of a strategic choice Dominant strategy = player’s best choice regardless of choice of other player If clear dominant strategy exists for each player, game is in a dominant strategy equilibrium

Price Discrimination Companies can try to set different prices for different customers Effort to charge more to buyers willing to pay more than equilibrium price Requirements for firm: –Must have “monopoly power” (be price setter) –Must be able to distinguish between buyers –Must be able to prevent resale of product