1. 23
Monopolistic Competition and Oligopoly

2. Chapter Objectives Characteristics of Monopolistic Competition
Why Monopolistic Competitors Earn Only a Normal Profit in the Long-Run
Characteristics of Oligopoly
How Game Theory Relates to Oligopoly
Why the Demand Curve of the Oligopolist May Be Kinked
Incentives and Obstacles to Collusion Among Oligopolists
Potential Positive and Negative Effects of Advertising

3. Monopolistic Competition
Characteristics
Small Market Shares
No Collusion
Independent Action
Differentiated Products
Product Attributes
Service
Location
Brand Names and Packaging
Some Control Over Price

4. Monopolistic Competition
Easy Entry and Exit
Advertising
Nonprice Competition
Monopolistically Competitive Industries

5. Price and Output Determination
In Monopolistic Competition
The Firm’s Demand Curve
The Short Run:
Profit or Loss
The Long Run:
Only a Normal Profit
Profits: Firms Enter
Losses: Firm’s Leave
Complications
Product Variety
G 23.1

6. Price and Output Determination
In Monopolistic Competition
Short-Run Profits
ATC MC P1 A1
Price and Costs
Economic
Profit D1
MR = MC MR Q1
Quantity

7. Price and Output Determination
In Monopolistic Competition
Short-Run Losses
ATC MC A2 P2
Loss
Price and Costs D2
MR = MC MR Q2
Quantity

8. Price and Output Determination
In Monopolistic Competition
Long-Run Equilibrium MC
ATC
P3= A3
Price and Costs D3
MR = MC MR Q3
Quantity

9. Monopolistic Competition and Efficiency
Recall: P=MC=Minimum ATC
Quantity
Price and Costs
MR = MC MC MR D3
ATC Q3
P3= A3 P4
Price is Higher
Excess Capacity at
Minimum ATC Q4
Monopolistic Competition is Not Efficient

10. Oligopoly Characteristics A Few Large Producers
Homogeneous or Differentiated Products
Homogeneous Oligopoly
Differentiated Oligopoly
Control Over Price, But Mutual Interdependence
Strategic Behavior
Entry Barriers
Mergers

11. Measures of Concentration
Concentration Ratio
Localized Markets
Interindustry Competition
World Trade
Import Competition
Herfindahl Index
(%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2
W 23.1

12. Game Theory Game Theory Model to Analyze Behavior
RareAir’s Price Strategy
2 Competitors
2 Price Strategies
Each Strategy Has a Payoff Matrix
Greatest Combined
Profit
Independent Actions
Stimulate a Response
High
Low A B
$12
$15
High
$12 $6
Uptown’s Price Strategy C D $6 $8
Low
$15 $8
O 23.2

13. Game Theory Game Theory Model to Analyze Behavior
RareAir’s Price Strategy
Independently Lowered Prices in Expectation of Greater Profit Leads to the Worst Combined Outcome
Eventually Low Outcomes Make Firms Return to Higher Prices
High
Low A B
$12
$15
High
$12 $6
Uptown’s Price Strategy C D $6 $8
Low
$15 $8
O 23.2

14. Game Theory Role of Mutual Interdependence Collusive Tendencies
Collusion
Incentive to Cheat
G 23.2

15. Three Oligopoly Models
Kinked Demand Curve
Collusive Pricing
Price Leadership
Diversity of Oligopolies
Complications of Interdependence

16. Kinked-Demand Curve Strategies A Combined Strategy Price Inflexibility
Noncollusive Oligopoly
Strategies
Match Price Changes
Ignore Price Changes
A Combined Strategy
Price Inflexibility
The Kinked-Demand Curve
Graphically…

17. Competitor and Rivals Strategize Versus Each Other
Kinked-Demand Curve
Noncollusive Oligopoly
Competitor and Rivals Strategize Versus Each Other
Consumers Effectively Have 2 Partial Demand Curves and Each Part Has Its Own Marginal Revenue Part
Price
Price and Costs
Quantity
Rivals Ignore
Price Increase D2
MC1 e e P0 P0
MR2 f f D2
MC2
MR2
Rivals Match
Price Decrease g g D1 D1 Q0
MR1 Q0
MR1
Resulting in a Kinked-Demand Curve to the Consumer – Price and Output Are Optimized at the Kink

18. Kinked-Demand Curve Criticisms of the Model
Noncollusive Oligopoly
Criticisms of the Model
Doesn’t Explain How Price Gets to the Kink (P0)
Oligopoly Prices Are Not As Rigid During Instability as the Model Indicates
Possibility of Price Wars

19. Cartels and Other Collusion
Price and Output
Collusion and Tendency Toward Joint-Profit Maximization
Price and Costs
Quantity
Effectively Sharing
The Monopoly Profit MC P0
ATC A0
MR=MC
Economic
Profit D MR Q0

20. Cartels and Other Collusion
Overt Collusion
Cartels
The OPEC Cartel
GLOBAL PERSPECTIVE
The 11 OPEC Nations Daily Oil Production, May 2006
Saudi Arabia
Iran
Venezuela
UAE
Nigeria
Kuwait
Iraq
Libya
Indonesia
Algeria
Qatar
Source: OPEC
Country
Barrels of Oil
9,099,000
4,110,000
3,233,000
2,444,000
2,306,000
2,247,000
1,903,000
1,500,000
1,451,000
894,000
726,000

21. Cartels and Other Collusion
Covert Collusion
Tacit Understandings
Obstacles to Collusion
Demand and Cost Differences
Number of Firms
Cheating
Recession
Potential Entry
Legal Obstacles:
Antitrust Law

22. Price Leadership Model
Leadership Tactics
Infrequent Price Changes
Communications
Limit Pricing
Breakdowns in Price Leadership:
Price Wars

23. Oligopoly and Advertising
Advertising Prevalent in Monopolistic Competition and Oligopoly
Positive Effects of Advertising
Potential Negative Effects of Advertising

24. Oligopoly and Advertising
The Largest U.S. Advertisers, 2005
Company
Advertising Spending
Millions of $
Proctor and Gamble
General Motors
Time Warner
Verizon
AT&T
Ford Motor
Walt Disney
Johnson & Johnson
GlaxoSmithKline
DaimlerChrysler
$4609
4353
3494
2484
2471
2398
2279
2209
2194
2179
Source: Advertising Age

25. Oligopoly and Advertising
World’s Top 10 Brand Names
GLOBAL PERSPECTIVE
Source: Interbrand
Coca-Cola
Microsoft
IBM
General Electric
Intel
Nokia
Toyota
Disney
McDonalds
Mercedes-Benz

26. Oligopoly and Efficiency
Productive and Allocative Efficiency
P = MC = Minimum ATC
Neither Exists
Tendency to Share the Monopoly Profit
Qualifications
Increased Foreign Competition
Limit Pricing
Technological Advance

27. Oligopoly in the Beer Industry
Last
Word
Once Hundreds of Firms Now a Very Small Group
Demand Side Changes
Taste Shifts to Lighter Beers of Large Breweries
Shift From Tavern-Tap Consumption to Can or Bottles
Supply Side Changes
Technology Increased Minimum Efficient Scale Creating a Barrier to Entry
National Brands Enjoy Cost Advantages
Consolidation of Firms into Oligopoly

28. Key Terms monopolistic competition product differentiation
nonprice competition
excess capacity
oligopoly
homogeneous oligopoly
differentiated oligopoly
strategic behavior
mutual interdependence
concentration ratio
interindustry competition
import competition
Herfindahl index
game-theory model
collusion
kinked-demand curve
price war
cartel
tacit understandings
price leadership

29. Next Chapter Preview…
Technology, R&D,
And Efficiency
Chapter 24!