Product differentiation

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Chapter 11 Product differentiation Monopolistic
competition Oligopoly
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Monopolistic Competition many firms free
entry slightly differentiated products EX Ebony
Magazine Liz Clairborne clothes line Fast food
chains Brand Names important
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Oligopoly 1. Pure few firms each has market
power (substantial barriers to entry) Action
in one firm can effect another Consider each
firms action homogeneous product price
leaders Some nonprice competition EX time EX
steel aluminum industries
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2. Differentiated oligopoly few
firms differentiated product substantial
barriers to entry possible price
leaders Extensive nonprice competition EX
cereals, beer, soft drinks, toothpaste, soap
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Over time firms can move from one type of market
to another/ because of the of firms in the
market
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Product Differentiation the effect by firms to
produce goods that are slightly different from
other types Homogeneous product no
differentiation Variety of Goods in the Market
Table 11.1 one way for firms to improve
performance not the same as inventing something
new Ex Vanilla Coke Differences in capital
goods Ex extent of spare parts repair service
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Puzzles explained by product differentiation 1.
Intraindustry trade between countries in goods
from the same or similar industries
Interindustry trade between countries of goods
from different industries because of comparative
advantage Ex Budweiser sells beer to
Canada Moslon(made in Canada) sells to US

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Advertising 1. the attempt by firms to tell
consumers what is good about their products 2.
Way to provide information to consumers about
how products differ 3. Waste associated with
advertising 4. Advertising will not sell an
inferior product Ex FedEx and Zip mail fax
around the world in hours 5. Can produce a
perception of difference
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• Consumer Information
• Consumer Reports is the result of
• product differentiation
• How are Products Differentiated?
• Physically
• Ex calorie in sport drinks
• 2. Location
• the grocery store on the other side of town
• 3. Time 24 hour grocery stores

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• Optimal Amount of Product Diff at a firm
• product diff is costly BUT can add revenue
• Profit max requires will attempt to diff.
• their product IF the additional revenue is
• Greater than the additional cost
• Had to determine where that pt. Is
• because of what other firms are doing.

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Monopolistic Competition
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Like a monopoly faces dowward sloping demand
curve Like perfect competition many firms free
entry and exit very important Idea developed by
Edward Chamberlain
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Typical Monopolistic Competitor Table 11.3 not
the demand curve for all BUT specific new firms
cause a shift to the left Reason more firms take
some of the q.d. Differences in LR MC and ATC
D curves meet TRTC zero profit In SR either
or profit (loss) P is gt of lt AVC
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More on short run like a monopoly make
decisions like a monopolist produce where
MRMC Ex Pearle Vision stores all have eye
doctors BUT like a monopoly because only 1 in a
Mall Unlike a monopoly because other types
of glass stores in mall

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Entry exit Like competition Positive profits
attract new firms D shifts to the left Because
they have to share their sales Negative profits
leave the market D shifts to the right
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Long Run Monopolistic Competition 2 difference in
the LR from Competition 1. Pgt MC This means it
is inefficient mainly because of restricted
output dead weight loss 2. Production is at
the minimum on the ATC curve
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SO they operate at EXCESS COST And EXCESS
CAPICITY they COULD increase production
reduce ATC (if they so desired) They choose
not to because they would lose market power
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profit Comparing Price dead
w LR Competitive PMC no NO Monopolistic PgtMC yes
NO Monopoly Pgt MC yes YES Product variety V
deadweight loss Variety is valued by
consumers So consumers accept deadweight loss.
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Oligopoly
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Homogeneous product Depend on other
producers Market power Game Theory firm
behavior that takes into account the market
power and reactions of other firms
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Over view of Game Theory assumes people make
purposeful choices Players in the game try to
maximize payoffs Prisoners Dilemma individual
incentives lead to a nonoptimal outcome if
people agree to agree/everyone wins
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Both have to agree on their action for both to
mutually gain Cooperative outcome Noncooperative
outcome everyone for themselves
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Applying Game Theory duopoly 2
oligopolists Both work to maximize profits 3 ways
firms can act 1. Explicit collusion managers
meet and agree on an action EX
CARTEL OPEC 2. Tacit collusion dont openly
meet BUT follow one firm to set prices PRICE
LEADER
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3. Could merge illegal in US Incentive to
Defect (cheat) needs to have a way to bind each
firm to cooperategt this causes a reduction in
dead weight Incentive to Cooperate future
interaction possible game is played repeatedly
reputation
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Tit-for-tat strategy encourages
cooperation Secret Defections firms defect more
IF they wont get caught Problem with oil and
coffee cartels Dango (collusion scheme)begun in
Japan bids are offered and firms take turns
under cutting the others This is why bids for
govt services are done in private.
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Measures of Market Power 1. Price Cost Margins
the greater the price is above MC the more market
power.
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2.Concentration Ratio Collusive activities
easier Four-firm concentration ratio the the
top firms have the market Varies for 50 to
90
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3. Structure-conduct-performance method Infer
conduct by the structure of the industry