1. Chapter 8 Monopolistic Competition and Oligopoly
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

2. Learning Objectives
Discuss the nature and prevalence of monopolistic competition.
Analyse and evaluate the price–output behaviour of monopolistically competitive firms.
Discuss the implications of monopolistic competition for economic efficiency.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

3. Learning Objectives (cont.)
Explain and assess the role of non-price competition.
Define oligopoly, assess its occurrence, and note the reasons for its existence.
Examine the behaviour of oligopoly in terms of a simple game theory framework.
Survey four models of the possible courses of price–output behaviour that oligopolistic industries might follow.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

4. Learning Objectives (cont.)
Discuss the role of non-price competition, that is, competition on the basis of product development and advertising in oligopolistic industries.
Provide some comments on the economic efficiency and social desirability of oligopoly.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

5. Monopolistic Competition Described
Relatively large numbers of firms
small market share
no collusion
independent actions
Product differentiation
competition based not just on price
quality, brands, services, location, promotion and packaging
Ease of entry
low economies of scale
low set-up costs
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

6. Price and Output Determination
The Firm’s Demand Curve
Highly elastic, Why?
More close substitutes than a pure monopolist
Not perfect substitutes (as is the case with perfect competition)
Elasticity depends on:
number of rivals
degree of product differentiation
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

7. Short-Run Price and Output Determination
How much to produce?
MR = MC
Profits or losses in the short run
Profits: When AC > AR (D )—entry of new firms
Losses: When AC < AR (D )—exit of existing firms
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

8. Short-Run Price and Output Determination: Short-Run ProfitsMC AC D MR
Economic
Profits
Price and Costs Q Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

9. Short-Run Price and Output Determination: Short-Run LossesMC AC D MR
Losses
Price and Costs Q Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

10. Long Run How much to produce?
MR = MC
Firms tend to break even, i.e. normal profit
Tangency solution: profit-maximising firm will produce an output when its demand curve is at a tangent to its AC curve
When AC = AR (D )
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

11. Long-Run Equilibrium
Why do monopolistically competitive firms tend to break even in the long run?
Profits attract new entrants
Losses encourage exits
Complications
Some product differentiation
Some entry is partially restricted
Some economic losses may be tolerated by firms in the long run
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

12. Long-Run Equilibrium (cont.)AC P D MR
Price and Costs Q Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

13. Monopolistic Competition & Economic Efficiency
Productive inefficiency: Minimum ATC is not necessarily chosen
excess capacity
Allocative inefficiency:
price does not necessarily equal MC
Redeeming features
product variety
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

14. Non-Price Competition
Assists firms to improve their long-run equilibrium position
Product differentiation and product development
at a point in time
over time
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

15. The Economics of Advertising
The case for advertising
information and efficiency
competition
communication support
The case against advertising
persuasion and wastage
concentration
media bias
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

16. Characteristics of Oligopoly
‘Fewness’: few firms dominate the market
Firms are mutually interdependent and must consider the possible reactions of rivals to their price and product development decisions
Firms may collude or act independently
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

17. Characteristics of Oligopoly (cont.)
Product differentiation?
Homogeneous or differentiated product
Examples:
Petroleum products
Aluminium
Insurance
Motor vehicles
Concentration ratios: the percentage of total industry sales accounted for by a given number of the largest firms in each industry
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

18. Characteristics of Oligopoly (cont.)
High Barriers to Entry
Causes
Economies of scale
Mergers
Give firms more market power, influence, etc.
Ownership of patents, copyrights
Control of strategic raw materials
Technological progress
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

19. Oligopoly Behaviour: A Game Theory Overview
Compare the behaviour of oligopolists to a simple duopoly game of strategy, actions and pay-offs as shown in the profit pay-off matrix
Mutual interdependence
the fate of one firm lies partially or wholly with the performance or decisions of other firms in that same industry
Incentives to collude
Incentive to cheat
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

20. Profit Pay-offs for a Duopoly
Giant’s pricing strategy
High
Low A B
$12m
$15m
High
Big’s pricing strategy
$12m
$6m C D
$6m
$8m
Low
$15m
$8m
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

21. Maximin Strategies and Optimal Pricing Strategy
Strategies chosen by players in a game to maximise their minimum expected pay-off from the game
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

22. Price–Output Behaviour in Four Models
Four Models of Oligopoly
the kinked demand curve
collusive pricing
price leadership models
cost-plus pricing
No standard model of oligopoly due to:
diversity
interdependence
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

23. Kinked Demand: Non-Collusive Oligopoly Model
Output occurs where MR = MC
Price remains stable over a variety of cost scenarios
Avoiding price wars
Firms ignore price increases
Firms match price decreases
Criticisms
How is the current price set?
Prices may not be as inflexible as model suggests
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

24. The Kinked Demand CurveP
The firm’s demand
and marginal
revenue curves D1
MR1 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

25. The Kinked Demand Curve (cont.)P
The rival’s demand
and marginal
revenue curves
MR2 D2 D1
MR1 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

26. The Kinked Demand Curve (cont.)P
Rivals tend to
follow a price cut
MR2 D2 D1
MR1 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

27. The Kinked Demand Curve (cont.)P
Rivals tend to
follow a price cut
or ignore a
price increase
MR2 D2 D1
MR1 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

28. The Kinked Demand Curve (cont.)P
Effectively creating…
MR2 D2 D1
MR1 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

29. The Kinked Demand Curve (cont.)P
Effectively creating
a kinked demand curve D2
MC2
MC1 P
MR2 X D1
MR1 Q Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

30. Collusion and Cartels
Overt or covert agreements to fix prices, divide up or share the market or limit competition between firms
Output and price: same as a monopolist
Forms:
Cartels
groups of firms that agree either formally or informally to set prices and output levels of a product among members
‘Gentlemen’s agreements’
groups of firms agree verbally to set prices and output levels, usually in an informal setting such as a golf course
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

31. Collusion and Profit MaximisationMC
Price
ATC MR P
Economic
Profit D
MR = MC Q Q
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

32. Obstacles to Collusion
Demand and cost differences between firms
Numbers of firms
Cheating
Recession
Legislative obstacles: Trade Practices Law
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

33. Price Leadership: Tacit Collusion Model
A type of gentlemen’s agreement in which oligopolists automatically follow the price initiatives of the dominant firm in an industry
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

34. Price Leadership: Tacit Collusion Model (cont.)
Infrequent price changes by price leader
Price announcements often made through indirect channels such as trade publications
Price leader may choose strategies to block potential entrants: limit-pricing or price blocking
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

35. Cost-Plus Pricing Model
An oligopolist uses a standard formula to estimate cost per unit of output and adds a mark-up to determine price
Advantages for multi-product firms
Consistent with outright collusion
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

36. Non-Price Competition
Oligopolists dislike competing on price
Oligopolists must rely on non-price competition
advertising
product development
Oligopolists typically have substantial resources to support non-price competition
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

37. Oligopoly and Economic Efficiency
Productive inefficiency
Minimum ATC is not necessarily chosen
under-allocation of resources
Allocative inefficiency:
Price does not necessary equal MC
output is restricted
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

38. Oligopoly and Economic Efficiency (cont.)
Dynamic efficiency:
Long-term improvements in product quality and production methods may occur
competitive view
Schumpeter–Galbraith view
Technical progress: the evidence
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University

39. Next Chapter: Market Failure and Resource Allocation
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa
Slides prepared by Muni Perumal, University of Canberra
and Jay Bandaralage, Griffith University