Monopolistic Competition & Oligopoly

Characteristics of Monopolistic Competition A relatively large number of sellers (Small Market Share, No Collusion, Independent Action) Differentiated products (Product Attributes, Service, Location, Brands) Easy entry and exit from the industry (Entry Eliminates Profits, Exits Eliminate Losses) Advertising & Non Price Competition

Monopolistically Competitive Industries Clothing Industry Restaurants Jewelry Consumer Electronics

Price and Output in Monopolistic Competition (SR vs. LR)

Monopolistic Competition and Efficiency Productive efficiency is P= min ATC Allocative efficiency is P= MC Not productive or allocative efficiency P>MC, meaning that resources are underallocated; not allocatively efficient Firms do not produce where P= min ATC; therefore, not productively efficient Marginal revenue curve will never coincide with D=AR=P

Monopolistic Competition& Excess Capacity Product differentiation creates excess capacity means that fewer firms operating at capacity could supply the industry output Excess capacity is the gap between the minimum ATC output and the profit- maximization output

Monopolistic Competition & Product Variety Firms are able to have profit from differentiation in the long run because no exact substitute). Advertising may increase costs, but also demand, and help maintain long-run profit. Satisfies a wide range of consumer tastes and encourages innovation to differentiate. Max Profit is Price x Product x Advertising

Characteristics of Oligopoly 1) A few large producers (Oil, Telecom, Soda). 2) Homogenous OR differentiated products (Oil and Gasoline versus Automobiles) 3) Price maker, but still mutually interdependent (Strategic Behaviour & Interdependance KEY!!) 4) Relatively high entry barriers

Mergers Merging of two or more competing firms is beneficial in that it may increase their market share significantly, and thus achieve greater economies of scale. The larger firm that results from a merger would have greater control over market supply and price.

Measures of Industry Concentration Price Leadership The Four Firm Concentration Ratio (determines whether a industry is monopolistic competition or oligopoly, magic number is 40%) Herfindahl Index (Herfindahl-Hirschman Index or HHI) (the sum of the squares of the market shares of each individual firm)

Oligopoly Behavior: A Game Theory Overview Game Theory: study of how people/firms behave in strategic situations. Game Theory Model: can be used to analyse the behaviour of oligopolists. The “Payoff Matrix” and Collusive Behaviour. Often the “Payoff Matrix” is represented by the Prisoner’s Dilemma, which is used to explain ologopoly behaviour.

Prisoner’s Dilemma

Mutual Interdependence Revisited Oligopolistic firms can influence rival's profits by changing pricing strategies Each firm's profit depends on their pricing strategy in relation to their rival's Firms make decisions based on how they think other firms will react. They anticipate the next move Collusion is best, but firms cheat : (

Oligopoly and Advertising Positive Effects of Ads: > Low-cost means to obtain info on product > Diminishes monopoly power by providing info on competing goods Negative Effects of Ads: > Manipulate or persuade consumers > May create a barrier to entry with costs of advertising

Oligopoly and Efficiency Remember the triple equality for economic efficiency: (P = MC = minimum ATC), Oligopolists do not achieve this. Produce where P > minimum ATC so they are not productively efficient. Produce where P > MC so they are not alocatively efficient. Oligopolies can be less desirable than monopolies because no regulation.