Monopolistic Competition and Oligopoly

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Monopolistic Competition and Oligopoly
Principles of Microeconomics Econ102
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Monopolistic Competition and Oligopoly
Monopolistic Competition A market structure
in which barriers to entry are low, and many
firms compete by selling similar, but not
identical, products. Oligopoly A market
structure in which a small number of firms
compete.
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Marginal Revenue for a Firm with a
Downward-Sloping Demand Curve
CAFFÈ LATTES SOLD PER WEEK (Q) CAFFÈ LATTES SOLD PER WEEK (Q) PRICE(P) TOTAL REVENUE(TR P x Q) AVERAGEREVENUE(AR TR/Q) MARGINAL REVENUE(MR ?TR/?Q)
0 1 2 3 4 5 6 7 8 9 10 6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.00 5.50 10.00 13.50 16.00 17.50 18.00 17.50 16.00 13.50 10.00 - 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 - 5.50 4.50 3.50 2.50 1.50 0.50 -0.50 -1.50 -2.50 -3.50
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Demand Marginal Revenue Curves for a
Monopolistically Competitive Firm
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Maximizing Profit in a Monopolistically
Competitive Market
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How Does Entry of New Firms Affect the Profits of
Existing Firms?
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Is Zero Economic Profit Inevitable in the Long
Run?

• A firms profits will be eliminated in the long
  run only if the firm stands still and fails to
  find new ways of differentiating its product or
  fails to find new ways of lowering the cost of
  producing its product.

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Allocative Productive Efficiency

• Allocative Efficiency
• The situation where every good or service is
  produced up to the point where the last unit
  provides a marginal benefit to consumers equal to
  the marginal cost of producing it. For allocative
  efficiency to hold, firms must charge a price
  equal to marginal cost.

Productive Efficiency The situation where every
good or service is produced at the lowest
possible cost. For productive efficiency to hold,
firms must produce at the minimum point of
average total cost.
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Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition
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Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition
Excess Capacity under Monopolistic Competition

• The profit-maximizing level of output for a
  monopolistically competitive firm comes at a
  level of output where MRMC, and where price is
  greater than marginal cost and the firm is not at
  the minimum point of its average total cost
  curve.

How Consumers Benefit from Monopolistic
Competition
Consumers benefit from being able to purchase a
product that is differentiated and more closely
suited to their tastes.
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Oligopolies

• Oligopoly
• A market structure dominated by a few large
  producers with considerable control over prices.
• Homogeneous (standardized) or differentiated
• Strategic behavior
• Self-interested behavior that takes into account
  the reactions of others.
• Mutual Interdependence
• A situation in which each firms profit depends
  not just on its own price and sales strategies
  but also on those of other firms in its highly
  concentrated industry.

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Oligopolies
RETAIL TRADE RETAIL TRADE RETAIL TRADE MANUFACTURING MANUFACTURING
INDUSTRY FOUR-FIRM CONCENTRATION RATIO FOUR-FIRM CONCENTRATION RATIO INDUSTRY FOUR-FIRM CONCENTRATION RATIO
Warehouse Clubs and Superstores Warehouse Clubs and Superstores 90 Cigarettes 99
Discount Department Stores Discount Department Stores 88 Beer 90
Hobby, Toy, and Game Stores Hobby, Toy, and Game Stores 70 Aircraft 85
Radio, Television, and Other Electronic Stores Radio, Television, and Other Electronic Stores 62 Breakfast Cereal 83
Athletic Footwear Stores Athletic Footwear Stores 62 Automobiles 80
College Bookstores College Bookstores 58 Dog and Cat Food 58
Pharmacies and Drugstores Pharmacies and Drugstores 47 Computers 45
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Oligopolies Economies of Scale as a Barrier to
Entry
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Oligopolies Barriers to Entry

• In addition to economies of scale, other barriers
  to entry include
• Ownership of a key input
• GovernmentImposed Barriers
• Patent
• The exclusive right to a product for a period of
  20 years from the date the product was invented.

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Three Oligopoly Models

• Kinked-demand curve
• Collusive pricing
• Price leadership
• Reasons for 3 models
• Diversity of oligopolies
• Tight loose oligopoly
• Differentiated standardized
• Collusive non-collusive (independently)
• Strong and not so-strong barriers
• Complications of interdependence
• Inability to estimate demand MR data because of
  uncertainty of rivals reactions.

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Kinked-Demand Curve
Rivals Ignore Price Increase
MC1
D2
e
e
Price
Price
P0
P0
MR2
f
f
D2
MC2
MR2
g
Rivals Match Price Decrease
g
D1
D1
0
Q0
0
Q0
MR1
MR1
Quantity
Quantity

• Criticisms
• Explains inflexibility, not price
• Prices are not that rigid when macroeconomy is
  unstable.
• Price wars
• During downturns, some firms cut prices setting
  off price wars in attempt to maintain market
  share.

11-16
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Cartels and Other Collusion
MC
ATC
P0
A0

• Obstacles to Collusion
• Demand cost differences
• Number of firms
• Cheating
• Recession
• New entrants
• Legal obstacles

MRMC
Economic Profit
D
MR
Q0
11-17
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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

11-18
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Using Game Theory to Analyze Oligopoly
Game theory The study of how people make
decisions in situations where attaining their
goals depends on their interactions with others
in economics, the study of the decisions of firms
in industries where the profits of each firm
depend on its interactions with other firms.
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A Duopoly Game Price Competition Between Two
Firms

• Payoff matrix
• A table that shows the payoffs that each firm
  earns from every combination of strategies by the
  firms.

Collusion An agreement among firms to charge
the same price, or to otherwise not compete.
Dominant Strategy A strategy that is the best
for a firm, no matter what strategies other firms
use.
Nash equilibrium A situation where each firm
chooses the best strategy, given the strategies
chosen by other firms.
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Firm Behavior and the Prisoners Dilemma

• Cooperative Equilibrium
• An equilibrium in a game in which players
  cooperate to increase their mutual payoff.

Non-cooperative Equilibrium An equilibrium in
a game in which players do not cooperate but
pursue their own self-interest.
Prisoners Dilemma A game where pursuing
dominant strategies results in noncooperation
that leaves everyone worse off.
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Is Advertising a Prisoners Dilemma for Coca-Cola
and Pepsi?
If Coca-Cola wants to maximize profits, will it
advertise? Explain. If Pepsi wants to maximize
profits, will it advertise? Explain. Is there a
Nash Equilibrium to this advertising game? If so,
what is it?
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Cartels The Case of OPEC
Cartel A group of firms that colludes by
agreeing to restrict output to increase prices
and profits. Does a cartel guarantee that
collusion would be successful?
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Cartels The Case of OPEC
Does a cartel guarantee that collusion would be
successful?

• The equilibrium of this game will occur with
  Saudi Arabia producing a low output and Nigeria
  producing a high output.