1. Monopolistic Competition & Oligopoly1

2. Where Does Monopolistic Competition “fit in?”
Perfect Competition Monopoly
Monopolistic
Competition 6

3. Monopolistic Competition
Characteristics:
Many buyers and sellers (no firm has a significant share of the market)
Firms produces a similar, yet differentiated product (gives us downward sloping, elastic demand)
Ease of entry and exit
Nonprice Competition 7

4. Monopolistic Competition
Characteristics:
Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
Product Differentiation
Product Attributes (quality or gimmicks)
Services
Location
Brand Names and Packaging
Some Control Over Price

5. Product Differentiation
The more that a Firm can Differentiate their product, the more Inelastic the Demand becomes.
Thus, firms may Advertise, improve quality or service, or find better locations. 17

6. Examples of Monopolistically Competitive Markets
Book Publishers
Paperboard Boxes
Sawmills
Light Fixtures
Wood Furniture
Kitchen Cabinets
Pizza Places (Pizza Hut, Dominos)
Hairdressers
Grocery Stores (Ramey, Price Chopper Richards Brothers 8

7. Monopolistic Competition in the Short Run
Looks and Acts Like Monopoly
Faces Downward Sloping Demand and MR
Produces where MR=MC and may make a profit. 9

8. Monopolistic Competition in the Short Run
Economic
Profit
Firms will
Enter
$10 MC 8
ATC p* 6
atc* 4 2 D MR Q 1 2 3 4 5 10

9. Monopolistic Competition in the Long Run
Firm Demand Shifts In and Gets More Elastic.
Demand Shifts Back Because More Firms Enter the Industry, So There is Less Demand Per Firm.
Demand Gets More Elastic Because More Firms Means More Substitutes and More Substitutes Means More Elastic 11

10. Monopolistic Competition in the Long Run
Like Perfect Competition, Firms Will Continue to Enter Until There are No More Profits to Attract Them. 12

11. Monopolistic Competition in the Short Run
Economic
Profit
Firms will
Enter
$10 MC 8
ATC p* 6
atc* 4 2 D MR Q 1 2 3 4 5

12. Monopolistic Competition in the Long Run
Zero Economic
Profit
$10 MC
ATC 8 6
p*=
atc* 4 D1 2 MR D2 Q 1 2 3 4 5 13

13. Monopolistic Competition in the Short Run
ATC MC
ATC P
Firms will
Exit
Economic
Losses
Price and Costs D MR Q Q

14. Monopolistic Competition in the Long Run
ATC MC
ATC P
Zero Economic
Profit D2
Price and Costs D1 MR Q Q

15. Long Run Conditions of Monopolistic Competition
Excess Capacity
Inefficiency 14

16. Excess Capacity
Excess Capacity is the Difference Between The Long Run Perfectly Competitive Quantity Produced and the Long Run Monopolistically Competitive Quantity Produced.
Generally Speaking, There Will be Excess Capacity in the Long Run of Monopolistic Competition. 15

17. Excess Capacity P Q Zero Economic Profit MC ATC P* D MR Q QQ Q Q
Excess Capacity 16

18. Comparison of Perfect Competition and Monopolistic

19. Efficiency Productive Efficiency Allocative Efficiency
Generally, A Monopolistically Competitive Firm is not Productively Efficient, since it is not producing at the bottom of it’s ATC curve
Allocative Efficiency
Generally, A Monopolistically Competitive Firm is not Allocatively Efficient, since MR > MC and there is excess capacity. 18

20. Oligopoly
For a Market to be Described as Oligopolistic, it must satisfy the following conditions:
Few Sellers
Mutual Interdependence
The Firm’s products may be identical or unique (Homogeneous or Differentiated)
The are Barriers to Entry (like monopoly)
non-price competition 19

21. Where Does Oligopoly “fit in?”
Perfect Competition Monopoly
Monopolistic
Competition
Oligopoly 20

22. Oligopoly Model
Oligopoly is a market in which a small number of firms supply the entire market and where natural barriers to entry prevent other firms from entering
Examples: beer, breakfast cereals, automobiles, long-distance telephones, airplanes, database software,...

23. Concentration Ratios
One Way to Determine Whether a Market is Oligopolistic is to look at a Concentration Ratio
A Concentration Ratio Let’s Us Know if the Whole Industry’s Sales are Dominated by the Sales of a Few Firms. 21

24. The X-Firm Concentration Ratio
The X-Firm (usually X = 4) Concentration Ratio is the
Percentage of Industry Sales Accounted for by the Sales of the Top X (4) Firms in the Industry:
Sales of the Top 4 Firms
Total Industry Sales 22

25. Herfindahl Index
This index ix the sum of the squared percentages of all firms in the industry.
Hindex =  (%Si)2
Suppose firms have 50%, 30%, 10% and 10% respectively the Herfindahl Index would be:
Hindex = (50)2 + (30)2 + (10)2 + (10)2
Hindex = 2, = 3,600

26. Herfindahl Index
Hindex = (25)2 + (20)2 + (15)2 + (10)2 + (10)2 + (10)2 + (10)2
Hindex = = 1,650
A Herfindahl Index below 1000 is not considered a concentrated market.
Industries with a Herfindahl Index between 1000 and 1800 have some degree of concentration.
If the Herfindahl Index is greater than , the degree of monopoly power potentially exists

27. Mutual Interdependence
The oligopoly problem is that the demand curve facing one oligopolist depends on actions (price and advertising) of other firms.
If one firm lowers price it will reduce other firms demand.
The quantity that combined firms produce will influence the market price.
So we all must restrict combined output and cooperate to make maximum profit.

28. Oligopolies and Collusion
Overt Collusion
OPEC Cartel
Covert Collusion
Electrical Equipment
Price Fixing
Tacit Collusion
Price Leadership

29. Game Theory
Game Theory is a Technique That Allows Us to Examine The Strategies of Oligopolists
This Technique Allows Us to Determine the Best Strategy for a Oligopolist if the Other Oligopolists are Aware of the All of Avaliable Strategies

30. The Prisoner’s Dilemma
Consider the Following Story:
Bill and Jill Have Cheated on an Exam
They are Both Caught
Bill in Prof. Martin’s Office and Jill is Prof. White’s Office
Each Are Told That Their Punishment Will Be Somewhat Lighter if They Confess

31. The Prisoner’s Dilemma
Jill and Bill cheat on an Exam
Jill is Silent
Jill Confesses
They Fail The Class
and Their Transcript
is Noted
Bill is
Silent
Jill Fails,
Bill is Expelled
They Are Both
Suspended For a Year,
Fail the Class and
Transcipts are Noted.
Bill
Confesses
Bill Fails,
Jill is Expelled

32. Oligopoly Behavior A C B D Mutual Interdependence $12 $15 $6 $4
RareAir’s Price Strategy
High
Low A C B
$12
$15 $6 $4 D
High
Uptown’s Price Strategy
Low

33. Game Theory A C B D Greatest Combined Profit $12 $15 $6 $4
RareAir’s Price Strategy
High
Low A C B
$12
$15 $6 $4 D
Greatest
Combined
Profit
High
Uptown’s Price Strategy
Low

34. Game Theory A C B D $12 $15 $6 $4 Independent Actions Stimulate
RareAir’s Price Strategy
High
Low A C B
$12
$15 $6 $4 D
Independent
Actions
Stimulate
Response
High
Uptown’s Price Strategy
Low

35. Game Theory A C B D $12 $15 $6 $4 Independent Actions Stimulate
RareAir’s Price Strategy
High
Low A C B
$12
$15 $6 $4 D
Independent
Actions
Stimulate
Response
Gravitating
to the
Worst Case
High
Uptown’s Price Strategy
Low

36. Game Theory A C B D Mutual Interdependence Collusion Invites a
RareAir’s Price Strategy
High
Low A C B
$12
$15 $6 $4 D
Collusion
Invites a
Different
Solution
High
Uptown’s Price Strategy
Low

37. The Payoff Matrix
You’ve now seen the four possible outcomes. They are:
both collude and make an economic profit of $12 million a week each
one cheats and makes an economic profit of $15 million a week while the other complies and earns a profit of $6 million a week
both cheat and make $4 million a week.

38. Models of Oligopoly 1 - Kinked Demand Curve 2 - Collusive Pricing
No Standard Model due to...
Diversity
Interdependence
1 - Kinked Demand Curve
2 - Collusive Pricing
3 - Price Leadership
4 - Break-Even Model

39. Kinked Demand Curve
Each Oligopolist believes that if it raises its price, other firms will keep their prices constant, so the quantity demanded will fall by a large amount (demand is elastic).
Each firm also believes that if it cuts its price, other firms will cut their prices too, so the quantity demanded will rise by a small amount (demand is inelastic).

40. Kinked Demand Curve Effectively creating P a kinked demand curve
This is an attempt to explain the “sticky prices” in oligopoly industries. P P D2 D1 Q
Quantity

41. The Kinked Demand Curve Theory
The current price is P
And at this price, the firm is selling the quantity Q P

42. The Kinked Demand Curve Theory
The marginal revenue curve from “b” down.
The marginal revenue curve for a price increase runs from “a” up.

43. The Kinked Demand Curve Theory
Between a and b, there is no marginal revenue curve
Cost can increase considerably without causing the firm to increase price.
So long as the MC curve passes through the break in the MR curve, the firms keeps its price and quantity constant.

44. The Kinked Demand Curve Theory
Summary:
The demand curve has a kink at the current price
The marginal revenue curve is discontinuous
Price is sticky and remains at the kink point unless a large enough change in marginal cost occurs
The elasticity of demand indicates a decrease in TR for any price change.

45. Cartels and Collusion Oligopoly is conducive to collusion
If a few firms face identical or
highly similar demand and costs...
They will seek joint profit
maximization...

46. Collusive Pricing Model
The Cartel Model:
The Oligopolists Get Together (Since There are So Few of Them) and Act As If They Were One Monopolist.
Collectively Produce the Monopolistic Quantity (establish quotas) - Thus Maximizing Profit as a group.
Example: OPEC 23

47. Cartel Model
Collusive agreement --a cartel--is an agreement between two (or more) producers to restrict output in order to raise prices and make bigger profits (act like a monopoly).
Strategies for a firm in a cartel
comply with the agreement
cheat on the agreement

48. Cartel Model M C P r i c e A T C
If the firms compete the price would fall to the minimum of the ATC A P C P R O F I T S C B P 1 D M R Q Q Q u a n t i t y C 1 a

49. Problems With Cartels Generally, They Are Not Legal (Price Fixing)
They Are Difficult to Organize and Monitor
Can’t Force New Firms to Join
Usually there is Cheating 24

50. The Incentive to Cheat On A Cartel
If the Cartel Maintains the Monopoly Price, The Individual Member of the Cartel Can Act Like a Price Taker (They Can Sell the Quota amount at the Market Price)
As a Price Taker, They Maximize Profit Where MC = MR.
This Quantity is Greater Than the Cartel Wants the Individual Firm to Produce.
All Firms in the Cartel Do This and the Cartel Falls Apart 25

51. The Incentive to Cheat On A Cartel$ $
If I lower the price,
MR > MC. Profit. MC MC
ATC P MR MR D Q Q
Qcheater
Market
Qquota
Firm 27

52. A Duopoly Model
determine the profit maximizing output for the industry.
assign a production quota to each firm.

53. Duopoly Model
One firm cheats on the agreement and increases production to 3,000 units a week.
With 5,000 units supplied, the price falls to $7,500 a unit.

54. Duopoly Model
Despite the fall in price, the cheat makes a bigger profit, because its average total cost falls.
The cheat’s profit becomes $4.5 million a week.

55. Duopoly Model
Here, both firms cheat and increase production to 3,000 units a week.
With 6,000 units on offer for sale, the price falls to $6,000 a unit (zero economic profit).

56. Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Potential Entry (or new)Entry
Legal Obstacles: Antitrust