Monopolistic Competition and Oligopoly

1
Chapter 7.1 Monopolistic Competition and Oligopoly
2
The Continuum of the Market Structure
Perfect Competition
Monopoly
ninfinity
No of firms, n
n1
n small Oligopoly
n large Monopolistic Competition
3
MONOPOLISTIC COMPETITION

• Assumptions of monopolistic competition
• Each firm sells a different variety or brand
  (think of coke or restaurants)
• There are many firms
• Act independently ignore others reactions
• Freedom of Entry and Exit
• There is Symmetry
• New firms affect all old ones equally

4
MONOPOLISTIC COMPETITION

• Equilibrium
• short run

5
Suppose we consider the case of demand for eating
out.
The Industry Demand Curve looks like this

Ps
O
Q
Qs
6
Suppose we consider the case of demand for eating
out.

What about an individual restaurant?
It is further in and flatter Why?
Ps
O
Q
Qs
7
Suppose we consider the case of demand for eating
out.
Each restaurant type has a share of the industry
But knows that it can only vary its price a little
Ps

O
Q
Qs
8
Suppose we consider the case of demand for eating
out.

What if a new competitor appears?
Demand line shifts in more and flattens more
Getting closer and closer to Perfect Competition
Ps
O
Q
Qs
9
So now suppose we have a firm like the blue line
and this restaurant is doing well in the
short-run

Ps
O
Q
Qs
10
Lets make the picture bigger

Ps
AR D
MR
O
Q
Qs
11
Lets make the picture bigger

MC
AC
Ps
AR D
MR
O
Q
Qs
12
Short-run equilibrium of the firm under
monopolistic competition

MC
AC
Ps
ACs
AR D
MR
O
Q
Qs
13
Short-run equilibrium

MC
AC
Ps
ACs
AR D
MR
O
Q
Qs
14
What happens now?
New Firms enter What happens to D?

MC
So P and Q down
AC
P1
ACs
D
MR
O
Q
Qs
15
What happens now?
New Firms enter What happens to D?

MC
So P and Q down
AC
And Super-normal Profits down
ACs
D
MR
O
Q
Qs
16
What happens now?
New Firms enter What happens to D?

MC
So P and Q down And Super-normal Profits down
AC
ACs
D
MR
O
Q
Qs
17
What Happens Next?

• Still Super-Normal Profits
• So firms keep entering
• P keeps falling and Super-normal profits keep
  falling until.
• In the LR
• AR AC and there are no supernormal profits

18
Long-run equilibrium of the firm under
monopolistic competition

LRMC
LRAC
PL
ARL DL
MRL
O
Q
QL
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NOTICE

• AR (D) curve still slopes down
• So not in perfectly competitive case
• Firms have market power (can choose price and
  quantity), but.
• Competition is such that this power is illusory
  (in the long run)

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MONOPOLISTIC COMPETITION

• Limitations of the model
• imperfect information about profits and demand
• difficulty in identifying industry demand curve
• indivisibilities/local monopolies
• importance of non-price competition
• Variety
• Advertising

21
MONOPOLISTIC COMPETITION

• The public interest
• comparison with perfect competition
• PRODUCTION WILL NOT OCCUR WHERE LRAC IS AT ITS
  MINIMUM (unlike perfect competition which is
  efficient)

22
Long run equilibrium under perfect
andmonopolistic competition (with decreasing or
constant returns to scale)

LRAC
P1
DL under perfect competition
O
Q1
Q
23
Long run equilibrium under perfect
andmonopolistic competition (with decreasing or
constant returns to scale)

LRAC
P2
P1
DL under perfect competition
DL under monopolistic competition
O
Q2
Q1
Q
24
The Continuum of the Market Structure
Perfect Competition
Monopoly
ninfinity
No of firms, n
n1
n small Oligopoly
n large Monopolistic Competition
25
OLIGOPOLY

• Key features of oligopoly
• barriers to entry
• interdependence of firms
• Whats he up to?
• incentives to compete versus incentives to collude

26
Day 1 Suppose initially Monopoly firm in the
Industry

To make life simple suppose P200-Q is the demand
curve
D
O
Q
27
Suppose initially Monopoly firm in the Industry

To make life simple suppose P200-Q is the demand
curve, And MC are zero
200
What is the MR curve?
D
O
200
Q
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Suppose initially Monopoly firm in the Industry

P200-Q TR PQ TR200-QQ TR200Q-Q2 MR200-2Q
200
D
O
200
Q
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Suppose initially Monopoly firm in the Industry

P200-Q TR PQ TR200-QQ TR200Q-Q2 MR200-2Q
200
If MR 0, 2002Q
D
MR
MC
O
200
100
Q
30
Suppose initially Monopoly firm in the Industry
What quantity will this firm supply to the
market MRMC at 100 Q100 P200-Q P200-100 100

200
P100
MR
D
MC
O
200
100
Q
31
Suppose initially Monopoly firm in the Industry
So monopolist supplies half the market in this
case (Linear demand, MC0)

200
P100
MR
D
MC
O
200
100
Q
32
Day 2 Harmony is broken! Suppose now a new firm
notices there are unfulfilled customers

200
What will new firm do?
P100
MR
D
MC
O
200
100
Q
33
Suppose now a new firm notices there are
unfulfilled customers

200
What will new firm do?
It thinks it has demand P100-Q MR100-2Q
P100
MR
D
MC
O
MC2
200
100
Q
34
Suppose now a new firm notices there are
unfulfilled customers
It is just looking at this bit of the
market Setting MC MR 0 1002Q Q50
What will new firm do?
200
It thinks it has demand P100-Q MR100-2Q
P100
MR
D
MC
MC2
100
0
Q
35

• So now firm 1 is supplying 100 units
• And firm 2 is supplying 50 Units
• Will firm 1 accept that?
• How will it react?

36
Day 3 The reckoning

200
Firm 1 sees that 50 people are already being
supplied. So its market is P200-Q 50 P150-Q
P100
MR
D
MC
O
MC2
200
100
Q
37
Day 3 The reckoning

200
Firm 1 sees that 50 people are already being
supplied. So its market is P200-Q 50 P150-Q
150
P100
MR
D
MC
O
150
200
100
Q
38
Day 3 The reckoning

200
And MR is now MR150-2Q So when MRMC0 Q75
150
P100
D
MR
MC
O
200
100
Q
75
39

• Firm 1 was supplying 100 units
• Is Now Supply 75 units
• Firm 2 is still producing 50 units
• How will firm 2 react to the cut in firm 1s
  production?

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This is essentially the story now

200
Firm 1 Supplies 75 Firm 2 Supplies 50 But now
Firm 2 sees that there are 125 unsatisfied
consumers
P100
MR1
Market D
D1
D1
D2
MR2
MC
O
MC2
200
100
Q
41
Day 4 The Mob Strikes BACK

200
Firm 2 sees that 75 people are already being
supplied. So its market now is P200-Q
75 P125-Q
125
P100
MR
D
MC
O
200
125
100
Q
42
Day 4 The Mob Strikes BACK

200
And MR is now MR125-2Q So when MRMC0 Q62.5
125
P100
D
MR2
MC
O
62.5
200
100
Q
125
43

• Firm 1 was supplying 100 units
• Firm 1 Is Now producing 75 units
• Firm 2 was producing 50 units
• Firm 2 is now Producing 62.5 units
• Firm 1s Q is going down as Firm 2 goes Up
• Firm 2s Q is going Up as Firm 1 goes down
• When will equilibrium occur?

44
Armageddon

If each firm sees that 66.66 people are already
being supplied, then it sees its market
as P200-Q 66.66 P133.33-Q
200
133.3
P100
D
MC
O
200
100
Q
133.33
45
Armageddon

If each firm sees that 66.66 people are already
being supplied, then P133.33-Q
200
133.3
And MR is now MR133.33-2Q So when
MRMC0 Q66.66
P100
D1D2
D
MR1 MR2
MC
O
66.66
200
100
Q
133.33
46

• Firm 1 fall from supplying 100 units to 66.66
  units
• Firm 2 rises from supplying 0 units to 66.66
  units
• Given that firm 1 is supplying 66.66 units firm
  2s best response is 66.66 units
• Given that firm 2 is supplying 66.66 units firm
  1s best response is 66.66 units
• EQUILIBRIUM (Cournot equilibrium)

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• What do we learn from this story?
• With a small number of firms, one firms actions
  directly affects the other.
• Where the number of firms are small, the firms
  will think strategically!!
• What is the other guy (male or female) up to ?
• How will they react to my actions

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• Indeed
• Firms wouldnt go through this tortuous process,
  they would figure out the situation pretty
  quickly and if firm 1 couldnt stop 2 entering
  they would go to final equilibrium.
• Called Cournot Competition (competing over market
  share - Quantities)
• Can also model price competition- Bertrand

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Comparison of Cournot with Perfect Compt. and
Monopoly

• Under Monopoly Firm 1 with a linear demand curve
  Zero MC supplied half the market, that is Q1 1/2
  of 200100
• Here with 2 firms each supply 1/3 of 200, that
  is, 66.66 and total output 133.33
• Under perfect competition MC 0 would produce at
  Q 200
• So oligopoly moves the economy closer to perfect
  competition as compared with monopoly

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Cournot

• 1 firm supplies ½ of market
• 2 firms supply 1/3 market each, 2/3 overall.
• What about 3 firms?
• 3 firms supply 1/4 market each, 3/4 overall.
• ..and 4 firms?
• 4 firms supply 1/5 market each, 4/5 overall.
• n firms, supply 1/(n1) of market each, n/(n1)
  overall
• So more firms getting closer and closer to
  perfect competition

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Profits Under Cournot P 200-2(66.66)
200-133.33 66.66 Industry Profits2(TR-TC) 266.
66(66.66)8887.7 But under Monopoly p100 Q100
and Profits 100100 10,000

200
133.3
P100
D1D2
D
MR1 MR2
MC
O
66.66
200
100
Q
133.33
52

So two firms would be better off if they could
get together and agree to limit market Collusion

200
Profits Under Cournot 8,888 Profits under
monopoly 10,000
133.3
P100
D1D2
D
MR1 MR2
MC
O
66.66
200
100
Q
133.33
53
OLIGOPOLY

• Key features of oligopoly
• barriers to entry
• interdependence of firmsWhats s/he up to?
• incentives to compete versus incentives to
  collude
• Factors favouring collusion
• Collusive oligopoly cartels
• equilibrium of the industry

54
OLIGOPOLY

• Key features of oligopoly
• barriers to entry
• interdependence of firms
• incentives to compete versus incentives to
  collude
• Factors favouring collusion
• Collusive oligopoly cartels
• Join forces and act collectively as a monopoly
• allocating and enforcing quotas