Most Industries

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Most Industries
Pure Competition
Monopoly
Market Structures
2
100
50
Percent share of the market
0
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Monopolistic Competition

• Defining characteristics
• 1. A relatively large number of sellers
• 2. Easy entry to, and exit from, the industry
• 3. Product differentiation

• The first and second characteristics provide the
  competitive aspect of monopolistic competition.
• The third characteristic contributes the
  monopolistic aspect.

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A Prevalent Market Structure

• From mattresses to mens suits, from book
  publishing to paperboard boxes, and from
  upholstered furniture to fur goods, all these
  industries are monopolistically competitive.
• So are the industries producing the several
  hundred magazines on a newsstand rack and the
  fifty or so competing brands of personal
  computers.

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Other Industries

• Numerous brands of gasoline

• Several grocery stores in a neighborhood
  competing on the basis of location and brand
  name.

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Monopolistic Competition Versus Oligopoly

• Perhaps the best way to understand monopolistic
  competition is to focus on the differences
  between monopolistic competition and oligopoly on
  the one hand and monopolistic competition and
  perfect competition on the other hand.
• There are three key differences between oligopoly
  and monopolistic competition.

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Small Market Share

• First, a monopolistically competitive industry is
  relatively unconcentrated.
• Each firm in a monopolistically competitive
  industry has a comparatively small percentage of
  the total market so that each has limited control
  over market price.

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In Contrast

• Market concentration in an oligopoly is
  relatively high and so, too, is the oligopolists
  price making power.
• This is because there are only a small number of
  firms in concentrated oligopoly so that each has
  a relatively large share of the market.

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The Concentration Ratio

• The four-firm concentration ratio is defined as
  the percent of total industry output accounted
  for by the four largest firms.

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The Widget Industry

• Firm Output
• Firm 1 25
• Firm 2 20
• Firm 3 15
• Firm 4 10
• Firm 5 8
• Firm 6 7
• Firm 7 5
• Firm 8 5
• Firm 9 3
• Firm 10 2

• Concentration Ratios
• (Percent of industry output supplied by the
  largest few firms)
• c4

q1 q2 q3 q4 Q
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The Widget Industry

• Firm Output
• Firm 1 25
• Firm 2 20
• Firm 3 15
• Firm 4 10
• Firm 5 8
• Firm 6 7
• Firm 7 5
• Firm 8 5
• Firm 9 3
• Firm 10 2

• Concentration Ratios
• (Percent of industry output supplied by the
  largest few firms)
• c4

70
q1 q2 q3 q4 Q
25201510_ 100
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Percentage of industry output produced by the
Industry four largest firms.
Chewing Gum 96 Household laundry
equipment 93 Cigarettes 92 Electric lamps
(bulbs) 91 Motor vehicles 90 Small arms
ammunition 88 Primary copper 87 Breakfast
cereals 87 Beer and malt beverages 87 Household
refrigerators 85 Greeting card publishing 85 Book
publishing 24 Upholstered furniture 24 Wood
furniture 20 Metal house furniture 18 Paperboard
boxes 16 Bolts, nuts, and rivets 16 Fur
goods 16 Womens and misses suits and
coats 13 Metal doors 13 Womens and misses
dresses 6
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Percentage of industry output produced by the
Industry four largest firms.
Chewing Gum 96 Household laundry
equipment 93 Cigarettes 92 Electric lamps
(bulbs) 91 Motor vehicles 90 Small arms
ammunition 88 Primary copper 87 Breakfast
cereals 87 Beer and malt beverages 87 Household
refrigerators 85 Greeting card publishing 85 Book
publishing 24 Upholstered furniture 24 Wood
furniture 20 Metal house furniture 18 Paperboard
boxes 16 Bolts, nuts, and rivets 16 Fur
goods 16 Womens and misses suits and
coats 13 Metal doors 13 Womens and misses
dresses 6
An indicator of strategic interaction.
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Strategic Interaction

• Describes how each firms business strategy
  depends on their rivals strategies.
• As the number of firms in an industry shrinks and
  industry concentration grows, each firm is more
  likely to base pricing and output decisions on
  how other firms in the industry are likely to
  respond.

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Mutual Interdependence

• Each firm is more likely to want to collude with
  the others when setting price and quantity, where
  collusion may be defined as the concerted action
  by firms to restrict output and fix price.
• This observation leads to two additional
  important distinctions between oligopoly and
  monopolistic competition.

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Collusion

• Because of the small number of firms in an
  oligopoly, collusion is possible.
• However, the relatively large number of firms in
  a monopolistically competitive industry ensures
  that collusion is all but impossible.

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Independent Action

• At the same time, with numerous firms in the
  industry, there is no feeling of mutual
  interdependence among them.
• Each firm determines its policies without
  considering possible reactions of its rivals.
• This a very reasonable way to act in a market in
  which there are numerous rivals.

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For Example

• The 10 or 15 percent increase in sales which a
  firm may realize by cutting prices will be spread
  so thinly over its 20, 40, or 100 rivals that,
  for all practical purposes, the impact on their
  sales will be imperceptible.
• Rivals reactions can be ignored because the
  impact of one firms actions on each of its many
  rivals is so small that these rivals will have no
  reason to react.
• This is certainly not the case with oligopoly.

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Monopolistic Competition Versus Perfect
Competition

• Now that we know some of the ways that oligopoly
  and monopolistic competition differ, what can we
  say about the difference between monopolistic
  competition and perfect competition?

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Monopolistic Competition

• Resembles perfect competition in three ways
• there are numerous buyers and sellers
• entry and exit are easy
• and firms are price takers
• The big difference, however, is that with
  monopolistic competition, there is product
  differentiation.

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Price Competition

• Purely competitive firms produce a standardized
  or homogeneous product.
• This means that consumers will have no basis
  other than price for preferring one firms
  product over anothers and price competition is
  the norm.

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Nonprice Competition

• Monopolistically competitive producers turn out
  many variations of a particular product.
• Because of such product differentiation,
  consumers have reasons other than price to prefer
  one product over another so that economic rivalry
  typically takes the form of nonprice competition.

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Put Another Way

• Competition comes primarily in the way that firms
  differentiate their products, and such
  differentiation can be accomplished in many ways
• From product quality and conditions of sale and
  service to location and advertising and packaging.

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1 Differences in Actual Quality

• Product differentiation may take the form of
  differences in actual product quality due to
  engineering, processing, or styling differences.

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• Personal computers differ in terms of hardware
  capacity, software, graphics, and how user
  friendly they are.

• Burgers differ on leanness of beef, size of bun,
  and whether it is broiled or fried.

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• Plain old aspirin may be enhanced by buffered
  compounds to prevent stomach aches or caffeine to
  keep you awake.

• Detergents may be specially formulated for use in
  cold or hard water.
• Beer might have less alcohol or more malt.

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With Durable Goods

• Different brands can differ in hundreds if not
  thousands of ways -- from styling and horsepower
  to airbags, gas mileage, and stereo systems.

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2 Conditions Of Sale And Service

• Beyond physical characteristics and product
  quality, products may also be differentiated in
  other ways such as the amount of service and the
  conditions of sale.

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For Example

• One auto dealer might offer low interest
  financing and free service while another might
  feature multi-year warranties.
• One grocery store may stress the helpfulness of
  the clerks that bag your groceries while a
  warehouse may leave the bagging and carrying to
  you but offer lower prices.
• And one pizza restaurant might tout its fast
  delivery while another touts its fat mushrooms
  and thick crust.

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3 Location And Accessability

• Small mini-groceries or convenience stores
  successfully compete with the big supermarkets
  even though they offer much less choice and much
  higher prices.
• But they can do so because they are often closer
  to customers and stay open for 24 hours.

• A gas stations proximity to a freeway or busy
  intersection gives it a locational advantage
  which may allow it to sell gas at a higher price
  than could a gas station several miles away.

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4 Advertising And Packaging

• While product quality, conditions of sale, and
  location are all important sources of product
  differentiation based on real differences between
  products, such is not always the case with the
  fourth major source of product differentiation
  advertising and packaging and the use of brand
  names and trademarks.

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• While there are many aspirin-type products,
  promotion and advertising may convince headache
  sufferers that Bayer or Anacin are superior and
  worth a higher price than a generic substitute.

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• A celebritys name associated with jeans or
  perfume may enhance those products while a
  tobacco or auto company that associates their
  product with greater sex appeal may get a leg up
  on its competitors.

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Product Differentiation
S
p1
Price
D
q1
quantity
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Product Differentiation
S
p1
Price
q1
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quantity
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Product Differentiation
S
Price
Demand curve facing seller of an undifferentiated
product
q1
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quantity
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Strategic Opportunities

• Increased inelasticity increases the strategic
  opportunities of the firm.
• Rather than being a price taker, the
  monopolistically competitive firm becomes a price
  maker, albeit with less flexibility than a pure
  monopolist.
• Because the firm can now react to changing market
  conditions by changing the traits of its product,
  it can also engage in nonprice competition.

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Monopolistic Competition And Market Conduct

• So how, then, can we expect monopolistically
  competitive firms to behave?
• Lets first rule out the prospect of any
  collusion among firms in the industry to fix
  prices.
• This is for two reasons.

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Why Collusion is Difficult

• First, by definition, there is a very large
  number of firms in the industry so collusion is
  very difficult.
• Second, even if the large number of firms in an
  industry were to successfully collude, they
  wouldnt be able to stop a flood of new firms
  from entering the market to take advantage of any
  collusive monopoly pricing.
• This is because, again by definition, with
  monopolistic competition, entry is easy.

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Noncollusive olligopoly

• For these two reasons, monopolistic competition
  is sometimes called noncollusive oligopoly.
• Market conduct is very different in the presence
  versus the absence of collusion.

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The Short Vs. Long Run

• In the short run, monopolistic competitors may
  well earn monopoly profits under certain
  circumstances.
• In long run equilibrium, economic profits in the
  industry will be driven to zero just as in
  perfect competition.

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An Important Difference

• Nonetheless, there is an important difference
  between perfect competition and monopolistic
  competition in the long run and it is this
  Under monopolistic competition, prices will be
  above marginal cost, indicating a deadweight
  efficiency loss.

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The Computer Industry

• And you may already know this story about two
  American business heroes.

• Steve Jobs and Steve Wozniak started off in their
  garage making what turned out to be the Apple I
  computer, and they grew fabulously wealthy doing
  it.

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d
MC
Monopolistic competition before entry
G
P2
AC
Price
H
P1
B
d
MR
Q1
Q2
Quantity

• What is the price and quantity in this industry
  and what are the economic profits?
• a) Price is P1, quantity is Q1 and economic
  profits are BHG. Price is set where MC
  intersects dd.
• b) Price is P2 , quantity is Q2 , and economic
  profits are P1P2GB. Price is set where MR equals
  MC.
• c) If I had a computer, I could figure it out.

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d
MC
Monopolistic competition before entry
G
P2
AC
Price
H
P1
B
d
MR
Q1
Q2
Quantity

• What is the price and quantity in this industry
  and why and what are the economic profits?
• a) Price is P1, quantity is Q1 and economic
  profits are BHG. Price is set where MC
  intersects dd.
• b) Price is P2 , quantity is Q2 , and economic
  profits are P1P2GB. Price is set where MR equals
  MC.
• c) If I had a computer, I could figure it out.

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d
MC
Monopolistic competition after entry
AC
Price
G
d
MR
Quantity

• At what point will entry cease?
• a) Entry will cease when each seller has been
  forced into a long-run, no-profit tangency such
  as at G'.
• b) Entry will cease where MC equals AC.
• c) Entry will cease when Bill Gates says it will.

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d
MC
Monopolistic competition after entry
AC
Price
G
d
MR
Quantity

• At what point will entry cease?
• a) Entry will cease when each seller has been
  forced into a long-run, no-profit tangency such
  as at G'.
• b) Entry will cease where MC equals AC.
• c) Entry will cease when Bill Gates says it will.

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d
MC
Monopolistic competition after entry
AC
Price
G
P1
d
PMC
MR
Quantity

• Each producer is on the left-hand declining
  branch of its long run average cost curve.
• What do you think this means for market
  performance.

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d
MC
Monopolistic competition after entry
AC
Price
G
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P1
A
d
PMC
MR
Quantity

• In the long run, monopolistic competition is
  neither allocatively or productively efficient.
• An underallocation of resources occurs in the
  industry because the product price exceeds
  marginal cost.
• Productive efficiency is not realized because
  production occurs at point G' where the average
  total cost exceeds the minimum attainable cost at
  Point A.

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Nonprice Competition And Excessive Advertising

• The fact that that monopolistic competition is
  both allocatively and productively inefficient
  relative to the perfect competition result is not
  the only problem with market performance.
• At least some economists argue that monopolistic
  competition leads to both excessive advertising
  and needless brand proliferation.

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Increased Profits

• This possibility follows directly from the fact
  that in the long run, economic profits are zero.
  
• Firms will engage in additional product
  differentiation and development and rely upon
  advertising to create real or perceived
  differences in their product with consumers.
• While it is true that these efforts will cost
  money, they also increase demand and demand
  inelasticity so that in some circumstances, a
  firm can improve its profit position.

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Brand Proliferation

• Such market conduct is not always graded as a
  plus by economists.
• Economists usually have to point no further than
  the cereal aisle at their local supermarket where
  a dizzying array of brands proliferate.

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In Fact

• It is hard to argue that being able to choose
  over 50 different ways to eat sugared grain adds
  significantly to societal welfare.

• Or having a different brand of gasoline available
  on every corner of an intersection .

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Diversity Can Be Good

• Reducing the number of monopolistic competitors,
  while cutting costs, might well end up lowering
  consumer welfare because it would reduce the
  diversity of available goods and services.

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The Communist Example

• To bolster this argument, economists need point
  no further than the globes centrally planned,
  socialist and communist economies which have
  tried to standardize output on a small number of
  varieties and, in the process, left consumers
  highly unsatisfied.

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In Conclusion

• Of course, we will not settle this debate here.
• Instead, I will simply end this lesson by asking
  you to reflect on this economic food for thought.
  

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End Of Lesson
Lecturer Peter Navarro Multimedia Designer Ron
Kahr Female Voiceover Ashley West Leonard