By: Adrian Morales and Angelica Morgan

Characterized by (1) Relatively large number of sellers; competitive aspect (2) Differentiated products; monopolistic aspect (3) Easy entry/exit to industry; competitive aspect In general, monopolistically competitive industries are more competitive than they are monopolistic Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly

Fairly large number of firms but less then pure competition. Therefore, 1.Small market shares 2.No collusion 3.Independent action

Product differentiation- Monopolistic competitive firms turn out variations of a particular product. Product differentiation may occur through: Product Attributes Service Location Brand Names and Packaging

Easy entry and exit is easy. Financial barriers such as copyrights trademarks makes it difficult/costly to imitate their products. Nothing keeps monopolistic competitor from shutting down. Advertising- goal of product differentiation and advertising is non-price competition Monopolistic Competitive Industries- Retail establishments: grocery stores, gas stations, barbershops, clothing stores, and restaurants. Professional services: medical care, legal assistance, and real estate sales.

Assumptions: each firm in an industry is producing a specific differentiated product and engaging in a particular amount of advertising. The Firms Demand Curve- monopolistic competitor’s demand is more elastic than demand faced by a pure monopolists Not perfectly elastic for two reasons: 1) Monopolistic competitor has fewer rivals, 2)Product differentiation

D MR P1P1 Price and Costs Q1Q1 Short-Run Economic Profits Quantity A1A1 MC ATC

D MR MC P2P2 ATC Price and Costs Q2Q2 Short-Run Economic Losses Quantity A2A2

D MR MC P 3 = A 3 Price and Costs Q3Q3 Quantity Normal Profit Only ATC

Some firms may have sufficient product differentiation such that firms cannot duplicate them even in the long run. Example: Well known brand names. Product differentiation can lead to financial barriers making entry more difficult than if the product where standardized. This suggests some monopoly power with small economic profits continuing even in the long run.

D MR MC P 3 = A 3 Price and Costs Q3Q3 Long-Run Equilibrium Price is ≠ Minimum ATC Price  MC ATC

D MR MC P 3 = A 3 Price and Costs Q3Q3 ATC Q4Q4 Excess Capacity

(1) In the eyes of monopolistic competitors: A firm can attempt to stay ahead of competitors and keep profits through further product differentiation and better advertising. Rivals must imitate/improve on the product or lose business If demand ↑ by more than enough cover advertising costs, then the firm has improved financial position. (2) In the eyes of consumers: Consumers are offered a wide range of types, styles brands and quality gradations of a product. Product differentiation creates a tradeoff between consumer choice and product efficiency. Stronger product differentiation = greater excess capacity (product inefficiency) = greater satisfaction of diverse consumer tastes.

Assumptions: a constant given product and given level of advertising expenditures. However, monopolistic competitors must determine what variety of a product, at what price, and what level of advertising will result in the greatest profit. Moreover, this optimal combo can only be found through trial and error.

Characterized by: A market demanded by a few large producers Selling either a homogenous or differentiated product Considerable control over prices Strategic behavior or self interested behavior that takes into account the reactions of other firms Mutual interdependence or a situation where a firm’s profit depends on not only their own price and sales strategies but also that of other firms. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly

Entry Barriers: New firms tend to be high-cost producers Large expenditures for capital Ownership of raw materials Patents, copyrights, and trademarks Retaliatory pricing and advertising strategies Mergers: Increase market share Greater economies of scale, greater control over market supply and thus the price of it product.

Concentration Ratio Percentage total output produced and sold by an industry’s largest firms Example: Four largest U.S. producers of breakfast cereal account for 83% of cereals made in the U.S. If the four largest firms control 40% of the market than the industry is considered oligopolistic. Shortcomings: 1.Localized Markets 2.Interindustry Competition 3.World Trade

Herfindahl Index The sum of the squared percentage market shares of all the firms in industry. Formula: (%S 1 ) 2 + (%S 2 ) 2 + (%S 3 ) 2 + … + (%S n ) 2 Problem: Suppose you have industry X and Y. X is pure monopoly with a 100% concentration ratio. Y is an oligopoly with 100% as well but each firm has a 25% market share. Which has a a greater market share? Herfindahl Index is the solution: Industry X → = 100,000 Industry Y → = 25,000

The Game Theory is the study of how people behave in strategic situations Game Theory model assumptions: (1) Duopoly; (2) Price high or Price low

HighLow Nike’s Price Strategy High Low Reebok’s Price Strategy Greatest Combined Profit

HighLow Nike’s Price Strategy High Low Reebok’s Price Strategy Independent Actions increases the profits at the expense of the other Independent Actions increases the profits at the expense of the other

HighLow Nike’s Price Strategy High Low Reebok’s Price Strategy Collusion increases the profits of both firms

HighLow Nike’s Price Strategy High Low Reebok’s Price Strategy The incentive to cheat becomes very tempting

Three distinct models for oligopolistic pricing and output behavior: 1.The Kinked Demand Curve 2.Collusive Pricing 3.Price Leadership Why not a single model, as in our discussions of the other market structures? Diversity of oligopolies Complications of Interdependence The diversity of oligopolies and the presence of mutual interdependence are reflected in the models that follow…

D1D1 MR 1 Quantity The Anheuser’s demand and marginal revenue curves when rivals match price changes Price Q0Q0 P0P0

MR 2 D1D1 D2D2 MR 1 Quantity The Anheuser’s demand and marginal revenue curves when rivals ignore price changes Price Q0Q0 P0P0

MR 2 D1D1 D2D2 MR 1 Quantity Price Rivals Follow any price cuts Q0Q0 P0P0

MR 2 D1D1 D2D2 MR 1 Quantity Price Rivals ignore price any increase Q0Q0 P0P0

MR 2 D1D1 D2D2 MR 1 Quantity Price Behold! The Kinked Demand Curve Q0Q0 P0P0

D Price Anheuser Busch’s Demand Curve Q0Q0 P0P0

D MR 1 Quantity Price MC 2 MC 1 MR 2 Prices are generally stable in noncollusive oligopolies for both demand and cost reasons Q0Q0 P0P0

D Quantity Profit maximization at the kink Price MC 2 MC 1 MR 2 MR 1 Q0Q0 P0P0

D Quantity This behavior can set off a price war. Price MC 2 MC 1 MR 2 MR 1 Q0Q0 P0P0

Colluding Oligopolists Will Split the Monopoly Profits. D MC ATC MR Economic Profit MR = MC Price and costs Q0Q0 P0P0 A0A0 Price ≠ Minimum ATC Price ≠ MC

Demand and Cost Differences Number of Firms Cheating Recession Potential Entry Legal Obstacles

An understanding by which oligopolists can coordinate prices without outright collusion Most efficient firm initiates price changes and all the other firms follow the leader Leadership tactics include: Infrequent Price Changes Communications Limit Pricing

Increased foreign competition Limit Pricing Advances in Technology