Download presentation
Presentation is loading. Please wait.
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
Recall the Four Market Models
Pure Competition Pure Monopoly Monopolistic Competition Oligopoly We have covered the extremes, pure competition and monopoly: most real world markets are in the middle, namely monopolistic competition and oligopoly. Pure Competition Monopolistic Competition Pure Monopoly Oligopoly
4
Monopolistic Competition
Characteristics Large number of firms with small market shares No Collusion Independent Action Differentiated Products Product Attributes Service Location Brand Names and Packaging Some Control Over Price due to product differentiation
5
Monopolistic Competition
Easy Entry and Exit Advertising Nonprice Competition Examples of Monopolistically Competitive Industries, see page 446
6
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 with the normal profit conclusion Product Variety G 23.1
7
What does the graphic model look like for Monopolistic Competition compared to Monopoly?
It looks very similar because both face a downward sloping demand curve—possibly more elastic in monopolistic competition due to more close substitutes.
8
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
9
Price and Output Determination
In Monopolistic Competition Short-Run Losses ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR Q2 Quantity
10
Price and Output Determination
In Monopolistic Competition Long-Run Equilibrium MC ATC P3= A3 Price and Costs D3 MR = MC MR Q3 Quantity
11
Pure competition vs. Monopolistic competition
Since both pure competition and monopolistic competition tend to result in zero economic profits, are the models equal in efficiency? NO, as can be seen by comparing the two.
12
Zero Profits in Perfect Competition
MC ATC P P = MR P = ATC Q1 12
13
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
14
Excess capacity Firms in MC tend to produce less output than the minimum ATC level of output: the difference is called excess capacity. “Too many firms, each producing too little output” is a phrase to characterize this: towns with many gas stations, restaurants, etc, that tend to operate below their optimal capacity.
15
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 and oligopoly
16
Measures of Concentration
Concentration Ratio: percent of sales accounted for by the top 4 firms Problems with concentration ratios 1)Localized Markets 2)Interindustry Competition 3)World Trade Import Competition W 23.1
17
Measures of Concentration
Herfindahl Index (HI) (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2
18
Problems: For an industry with only 1 firm, (monopoly), what would be the HI?
19
Suppose the industry has 10 equal size firms, what is the HI?
What if the industry has 100 equal size firms?
20
Answers: Monopoly, HI = 10,000 10 equal size firms, HI = 1,000
21
Game Theory Approach to Oligopoly
Is Oligopoly best analyzed as a strategic game like chess?
22
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
23
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
24
Game Theory: Payoff matrix shows several things, including:
Mutual Interdependence of firms in oligopoly The temptation to collude The incentive to Cheat on a collusive arrangement G 23.2
25
Three Oligopoly Models
Kinked Demand Curve Collusive Pricing Price Leadership Why no single model? due to the Diversity of Oligopolies and the complications of Interdependence
26
Kinked demand curve model of oligopoly: assumption, rivals will match all price cuts but not price increases. Under this assumption, its as if each firm faces a “kinked” demand curve, with 2 sections to it: more elastic above the existing price, since rivals won’t match a price increase, and less elastic below the existing price, since rivals quickly match price cuts.
27
Kinked-Demand Curve Noncollusive Oligopoly Possible Strategies
Match Price Changes Ignore Price Changes Kinked model uses a Combined Strategy: match price cuts but not price increases Price Inflexibility The Kinked-Demand Curve Graphically…
28
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
29
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
30
Second model of oligopoly: Cartels and Other Collusion
What is a Cartel? A group of firms that collude to limit competition in a market by negotiating and accepting agreed-upon price and market shares
31
Collusion and Tendency Toward Joint-Profit Maximization
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
32
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
33
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
34
Price leadership in Oligopoly
One firm, the dominant firm, sets the price, others follow the leader Often the dominant firm is the low cost producer in the industry Is this a form of “tacit” collusion?
35
Price Leadership Model
Leadership Tactics of the price leader may well include: 1) Infrequent Price Changes 2) Forms of Communications to the other firms, such as press releases, etc. 3) Limit Pricing: perhaps do not choose the monopoly price for fear of enticing entry to your industry Breakdowns in Price Leadership: Price Wars
36
Oligopoly and Advertising
Advertising Prevalent in Monopolistic Competition and Oligopoly Positive Effects of Advertising Potential Negative Effects of Advertising
37
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
38
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
39
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
40
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
41
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
42
Next Chapter Preview… Technology, R&D, And Efficiency Chapter 24!
Similar presentations
