1. Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Monopolistic Competition Relatively large number of sellers Differentiated products Easy entry and exit Advertising LO1 11-2

3. Monopolistically Competitive Industry concentration Measured by: Four-firm concentration ratios Percentage of 4 largest firms Herfindahl index Sum of squared market shares LO1 4-Firm CR = Output of four largest firms Total output in the industry HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2 11-3

4. Low Concentration Industries (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index Asphalt paving25207 Metal windows and doors14114 Plastic pipe24262Women’s dresses1384 Textile bags24263Ready mix concrete1163 Bolts, nuts, and rivets24205Wood trusses1050 Plastic bags23240Stone products1059 Quick printing22319Metal stamping831 Textile machinery20206Wood pallets724 Sawmills18117Sheet metal work625 Jewelry16117Signs519 Curtains and draperies16111Retail bakeries47 LO1 11-4

5. Price and Output in Monopolistic Comp Demand is highly elastic Short run profit or loss Produce where MR=MC Long run normal profit Entry and exit Inefficient Product variety LO2 11-5

6. The Short Run: Profit or Loss LO2 Quantity Price and Costs MR = MC MC MR D1D1 ATC Economic Profit Q1Q1 A1A1 P1P1 0 11-6

7. The Short Run: Profit or Loss LO2 Quantity Price and Costs MC MR D2D2 ATC Loss Q2Q2 A2A2 P2P2 0 MR = MC 11-7

8. The Long Run: Only a Normal Profit LO2 Quantity Price and Costs MC MR D3D3 ATC Q3Q3 P 3 = A 3 0 MR = MC 11-8

9. Monopolistic Competition: Efficiency Inefficient Productive inefficiency P > ATC Allocative inefficiency P > MC LO2 11-9

10. Monopolistic Competition: Efficiency LO2 Quantity Price and Costs MR = MC MC MR D3D3 ATC Q3Q3 0 P 3 = A 3 P=MC=Min ATC for pure competition (recall) P4P4 Q4Q4 Price is Lower Excess Capacity at Minimum ATC Monopolistic competition is not efficient 11-10

11. Product Variety The firm constantly manages price, product, and advertising. Better product differentiation Better advertising The consumer benefits by greater array of choices and better products. Types and Styles Brands and Quality LO2 11-11

12. Oligopoly A few large producers Homogeneous or differentiated products Limited control over price Mutual interdependence Strategic behavior Entry barriers Mergers LO3 11-12

13. Oligopolistic Industries Four-firm concentration ratio 40% or more to be oligopoly Shortcomings Localized markets Inter-industry competition World price Dominant firms LO3 11-13

14. High Concentration Industries (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index Primary copper99NDPetrochemicals852662 Cane sugar refining99ND Small arms ammunition831901 Cigarettes95NDMotor vehicles812321 Household laundry equipment93ND Men’s slacks and jeans802515 Beer91NDAircraft81ND Electric light bulbs892582Breakfast cereals782521 Glass containers882582 Household vacuum cleaners782096 Turbines and generators88NDPhosphate fertilizers781853 Household refrigerators and freezers851986 Tires77 1807 Electronic computers76 2662 Primary aluminum85NDAlcohol distilleries711609 LO1 11-14

15. Game Theory Overview Oligopolies display strategic pricing behavior Mutual interdependence Collusion Incentive to cheat Prisoner’s dilemma LO4 11-15

16. Game Theory Overview LO4 RareAir’s Price Strategy Uptown’s Price Strategy AB CD $12 $15 $6 $8 $6 $15 High Low 2 competitors 2 price strategies Each strategy has a payoff matrix Greatest combined profit Independent actions stimulate a response 11-16

17. Game Theory Overview LO4 RareAir’s Price Strategy Uptown’s Price Strategy AB CD $12 $15 $6 $8 $6 $15 High Low Independently lowered prices in expectation of greater profit leads to worst combined outcome Eventually low outcomes make firms return to higher prices. 11-17

18. 3 Oligopoly Models Kinked Demand Curve Collusive Pricing Price Leadership Reasons for 3 models Diversity of oligopolies Complications of interdependence LO5 11-18

19. Kinked-Demand Theory Noncollusive oligopoly Uncertainty about rivals reactions Rivals match any price change Rivals ignore any price change Assume combined strategy Match price reductions Ignore price increases LO5 11-19

20. Kinked Demand Curve LO5 Price Price and Costs Quantity 0 0 P0P0 MR 2 D2D2 D1D1 MR 1 e f g Rivals Ignore Price Increase Rivals Match Price Decrease Q0Q0 MR 2 D2D2 D1D1 MR 1 Q0Q0 MC 1 MC 2 P0P0 e f g 11-20

21. Kinked Demand Curve Criticisms Explains inflexibility, not price Prices are not that rigid Price wars LO6 11-21

22. Cartels and Other Collusion LO6 Price and Costs Quantity D MR=MC ATC MC MR P0P0 A0A0 Q0Q0 Economic Profit 11-22

23. Global Perspective LO6 11-23

24. Overt Collusion Cartels - a group of firms or nations that collude Formally agreeing to the price Sets output levels for members Collusion is illegal in the United States OPEC LO6 11-24

25. Obstacles to Collusion Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles LO6 11-25

26. Price Leadership Model Price Leadership Dominant firm initiates price changes Other firms follow the leader Use limit pricing to block entry of new firms Possible price war LO6 11-26

27. Oligopoly and Advertising Prevalent to compete with product development and advertising Less easily duplicated than a price change Financially able to advertise LO7 11-27

28. Positive Effects of Advertising Low-cost way of providing information to consumers Enhances competition Speeds up technological progress Can help firms obtain economies of scale LO7 11-28

29. Oligopoly and Advertising LO7 The Largest U.S. Advertisers, 2008 Company Advertising Spending Millions of $ Procter & Gamble$4831 Verizon$3700 AT&T$3073 General Motors$2901 Johnson & Johnson$2529 Unilever$2423 Walt Disney$2218 Time Warner$2208 General Electric$2019 Sears$1865 Source: Advertising Age http://www.adage.comhttp://www.adage.com 11-29

30. Negative Effects of Advertising Can be manipulative Contains misleading claims that confuse consumers Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product. LO7 11-30

31. Global Perspective LO7 11-31

32. Oligopoly and Efficiency Oligopolies are inefficient Productively inefficient P > minATC Allocatively inefficient P > MC Qualifications Increased foreign competition Limit pricing Technological advance LO7 11-32

33. Oligopoly in the Beer Industry The beer industry is now an oligopoly. Changes in demand Change in tastes Consumed at home and mass produced Changes in supply Technological advance Economies of scale 11-33