Chapter 12 Monopolistic Competition and Oligopoly DERYA GÜLTEKİN KARAKAŞ.
-
Upload
olivia-copeland -
Category
Documents
-
view
222 -
download
5
Transcript of Chapter 12 Monopolistic Competition and Oligopoly DERYA GÜLTEKİN KARAKAŞ.
Chapter 12
Monopolistic Competition and
Oligopoly
Monopolistic Competition and
OligopolyDERYA GÜLTEKİN KARAKAŞ
Chapter 12 Slide 2
Topics to be Discussed Monopolistic Competition
Oligopoly
Price Competition
Competition Versus Collusion: The Prisoners’ Dilemma
Implications of the Prisoners’ Dilemma for Oligopolistic Pricing
Cartels
Chapter 12 Slide 3
Monopolistic Competition
Characteristics
1) Many firms
2) Differentiated but highly substitutable products
3) Free entry and exit
Chapter 12 Slide 4
Monopolistic Competition
Examples of this very common market structure include:ToothpasteSoapShampoo
Chapter 12 Slide 5
Monopolistic Competition The amount of monopoly power depends on the degree of
differentiation.
Toothpaste Crest and monopoly power
Procter & Gamble is the sole producer of Crest Consumers can have a preference for Crest---taste,
reputation, decay preventing efficacy The greater the preference (differentiation) the higher
the price.
Question? Does Procter & Gamble have much monopoly power in the market for Crest?
A Monopolistically CompetitiveFirm in the Short and Long Run
Quantity
$/Q
Quantity
$/QMC
AC
MC
AC
DSR
MRSR
DLR
MRLR
QSR
PSR
QLR
PLR
Short Run Long Run
Chapter 12 Slide 7
Observations (short-run)Downward sloping demand--differentiated
productDemand is relatively elastic--good
substitutesMR < PProfits are maximized when MR = MCThis firm is making economic profits
A Monopolistically CompetitiveFirm in the Short and Long Run
Chapter 12 Slide 8
Observations (long-run)Profits will attract new firms to the industry
(no barriers to entry)The old firm’s demand will decrease to DLR
Firm’s output and price will fallIndustry output will riseNo economic profit (P = AC)P > MC -- some monopoly power
A Monopolistically CompetitiveFirm in the Short and Long Run
Chapter 12 Slide 9
Monopolistic Competition Questions
1) If the market became competitive, what would happen to output and price?
2) Should monopolistic competition be regulated?
3) What is the degree of monopoly power?
4) What is the benefit of product diversity?
Deadweight lossMC AC
Comparison of Monopolistically CompetitiveEquilibrium and Perfectly Competitive Equilibrium
$/Q
Quantity
$/Q
D = MR
QC
PC
MC AC
DLR
MRLR
QMC
P
Quantity
Perfect Competition Monopolistic Competition
Chapter 12 Slide 11
Monopolistic Competition Monopolistic Competition and Economic
EfficiencyThe monopoly power (differentiation) yields
a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle.
With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists.
Chapter 12 Slide 12
Oligopoly
CharacteristicsSmall number of firmsProduct differentiation may or may not existBarriers to entry
Chapter 12 Slide 13
Oligopoly
ExamplesAutomobilesSteelAluminumPetrochemicalsElectrical equipmentComputers
Chapter 12 Slide 14
Oligopoly The barriers to entry are:
NaturalScale economiesPatentsTechnologyName recognition
Strategic actionFlooding the marketControlling an essential input
Chapter 12 Slide 15
Oligopoly
Management ChallengesStrategic actionsRival behavior
QuestionWhat are the possible rival responses to a
10% price cut by Ford?
Chapter 12 Slide 16
Oligopoly Defining Equilibrium:
Firms doing the best they can and have no incentive to change their output or price
Equilibrium in an Oligopolistic Market In perfect competition, monopoly, and monopolistic
competition the producers did not have to consider a rival’s response when choosing output and price.
In oligopoly the producers must consider the response of competitors when choosing output and price.
Chapter 12 Slide 17
Oligopoly
Nash EquilibriumEach firm is doing the best it can given
what its competitors are doing.
Chapter 12 Slide 18
Oligopoly
The Cournot ModelDuopoly
Two firms competing with each otherHomogenous goodThe output of the other firm is assumed
to be fixed
Chapter 12 Slide 19
MC1
50
MR1(75)
D1(75)
12.5
If Firm 1 thinks Firm 2 will produce 75 units, its demand curve is
shifted to the left by this amount.
Firm 1’s Output Decision
Q1
P1
What is the output of Firm 1if Firm 2 produces 100 units?
D1(0)
MR1(0)
If Firm 1 thinks Firm 2 will produce nothing, its demand
curve, D1(0), is the market demand curve.
D1(50)MR1(50)
25
If Firm 1 thinks Firm 2 will produce 50 units, its demand curve is
shifted to the left by this amount.
Chapter 12 Slide 20
Oligopoly
The Reaction CurveA firm’s profit-maximizing output is a
decreasing schedule of the expected output of Firm 2.
Chapter 12 Slide 21
Firm 2’s ReactionCurve Q*2(Q2)
Firm 2’s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 1 will produce.
Reaction Curves and Cournot Equilibrium
Q2
Q1
25 50 75 100
25
50
75
100
Firm 1’s ReactionCurve Q*1(Q2)
x
x
x
x
Firm 1’s reaction curve shows how much itwill produce as a function of how much it thinks Firm 2 will produce. The x’s
correspond to the previous model.
In Cournot equilibrium, eachfirm correctly assumes how
much its competitors willproduce and thereby
maximize its own profits.
CournotEquilibrium
Chapter 12 Slide 22
Oligopoly
Questions
1) If the firms are not producing at the Cournot equilibrium, will they
adjust until the Cournot equilibrium is reached?
2) When is it rational to assume that its competitor’s output is fixed?
Chapter 12 Slide 23
Oligopoly
An Example of the Cournot EquilibriumDuopoly
Market demand is P = 30 - Q where Q = Q1 + Q2
MC1 = MC2 = 0
The Linear Demand CurveThe Linear Demand Curve
Chapter 12 Slide 24
Oligopoly
An Example of the Cournot EquilibriumFirm 1’s Reaction Curve
111 )30( Revenue, Total QQPQR
122
11
1211
30
)(30
QQQQ
QQQQ
The Linear Demand CurveThe Linear Demand Curve
Chapter 12 Slide 25
Oligopoly
An Example of the Cournot Equilibrium
12
21
11
21111
2115
2115
0
230
MCMR
QQQRMR
Curve Reaction s2' Firm
Curve Reaction s1' Firm
The Linear Demand CurveThe Linear Demand Curve
Chapter 12 Slide 26
Oligopoly
An Example of the Cournot Equilibrium
1030
20
102,101
1)2115(2115
:mEquilibriuCournot
21
1
21
QP
QQQ
The Linear Demand CurveThe Linear Demand Curve
Chapter 12 Slide 27
Duopoly Example
Q1
Q2
Firm 2’sReaction Curve
30
15
Firm 1’sReaction Curve
15
30
10
10
Cournot Equilibrium
The demand curve is P = 30 - Q andboth firms have 0 marginal cost.
Chapter 12 Slide 28
Oligopoly
MCMRMR
QQRMR
QQQQPQR
and 15 Q when 0
230
30)30( 2
Profit Maximization with CollusionProfit Maximization with Collusion
Chapter 12 Slide 29
Oligopoly
Collusion CurveQ1 + Q2 = 15
Shows all pairs of output Q1 and Q2 that maximizes total profits
Q1 = Q2 = 7.5
Less output and higher profits than the Cournot equilibrium
Profit Maximization with CollusionProfit Maximization with Collusion
Chapter 12 Slide 30
Firm 1’sReaction Curve
Firm 2’sReaction Curve
Duopoly Example
Q1
Q2
30
30
10
10
Cournot Equilibrium15
15
Competitive Equilibrium (P = MC; Profit = 0)
CollusionCurve
7.5
7.5
Collusive Equilibrium
For the firm, collusion is the bestoutcome followed by the Cournot
Equilibrium and then the competitive equilibrium
Chapter 12 Slide 31
First Mover Advantage--The Stackelberg Model
AssumptionsOne firm can set output firstMC = 0Market demand is P = 30 - Q where Q =
total outputFirm 1 sets output first and Firm 2 then
makes an output decision
Chapter 12 Slide 32
Firm 1Must consider the reaction of Firm 2
Firm 2Takes Firm 1’s output as fixed and
therefore determines output with the Cournot reaction curve: Q2 = 15 - 1/2Q1
First Mover Advantage--The Stackelberg Model
Chapter 12 Slide 33
Firm 1
Choose Q1 so that:
122
1111 30
0
Q - Q - QQ PQ R
MC, MC MR
0 MR therefore
First Mover Advantage--The Stackelberg Model
Chapter 12 Slide 34
Substituting Firm 2’s Reaction Curve for Q2:
5.7 and 15:0
15
21
1111
QQMR
QQRMR
211
112
111
2115
)2115(30
QQQQR
First Mover Advantage--The Stackelberg Model
Chapter 12 Slide 35
ConclusionFirm 1’s output is twice as large as firm 2’sFirm 1’s profit is twice as large as firm 2’s
QuestionsWhy is it more profitable to be the first
mover?Which model (Cournot or Shackelberg) is
more appropriate?
First Mover Advantage--The Stackelberg Model
Chapter 12 Slide 36
Price Competition
Competition in an oligopolistic industry may occur with price instead of output.
The Bertrand Model is used to illustrate price competition in an oligopolistic industry with homogenous goods.
Chapter 12 Slide 37
Price Competition
AssumptionsHomogenous goodMarket demand is P = 30 - Q where
Q = Q1 + Q2
MC = $3 for both firms and MC1 = MC2 = $3
Bertrand ModelBertrand Model
Chapter 12 Slide 38
Price Competition
AssumptionsThe Cournot equilibrium:
Assume the firms compete with price, not quantity.
Bertrand ModelBertrand Model
$81 firms both for
12$P
Chapter 12 Slide 39
Price Competition
How will consumers respond to a price differential? (Hint: Consider homogeneity)The Nash equilibrium:
P = MC; P1 = P2 = $3Q = 27; Q1 & Q2 = 13.5
Bertrand ModelBertrand Model
0
Chapter 12 Slide 40
Price Competition
Why not charge a higher price to raise profits?
How does the Bertrand outcome compare to the Cournot outcome?
The Bertrand model demonstrates the importance of the strategic variable (price versus output).
Bertrand ModelBertrand Model
Chapter 12 Slide 41
Price Competition
CriticismsWhen firms produce a homogenous good,
it is more natural to compete by setting quantities rather than prices.
Even if the firms do set prices and choose the same price, what share of total sales will go to each one?
It may not be equally divided.
Bertrand ModelBertrand Model
Chapter 12 Slide 42
Competition Versus Collusion:The Prisoners’ Dilemma
Why wouldn’t each firm set the collusion price independently and earn the higher profits that occur with explicit collusion?
Chapter 12 Slide 43
Assume:
16$ 6$ :Collusion
12$ 4$ :mEquilibriuNash
212 :demand s2' Firm
212 :demand s1' Firm
0$ and 20$
122
211
P
P
PPQ
PPQ
VCFC
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 44
Possible Pricing Outcomes:
4$204)6)(2(12)6(
20
20$206)4)(2(12)4(
20
4$ 6$
$16 6$ :2 Firm 6$ :1 Firm
111
222
QP
QP
PP
PP
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 45
Payoff Matrix for Pricing Game
Firm 2
Firm 1
Charge $4 Charge $6
Charge $4
Charge $6
$12, $12 $20, $4
$16, $16$4, $20
Chapter 12 Slide 46
These two firms are playing a noncooperative game.Each firm independently does the best it
can taking its competitor into account.
QuestionWhy will both firms both choose $4 when
$6 will yield higher profits?
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 47
An example in game theory, called the Prisoners’ Dilemma, illustrates the problem oligopolistic firms face.
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 48
ScenarioTwo prisoners have been accused of
collaborating in a crime.They are in separate jail cells and cannot
communicate.Each has been asked to confess to the
crime.
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 49
-5, -5 -1, -10
-2, -2-10, -1
Payoff Matrix for Prisoners’ Dilemma
Prisoner A
Confess Don’t confess
Confess
Don’tconfess
Prisoner B
Would you choose to confess?
Chapter 12 Slide 50
Payoff Matrix forthe P & G Prisoners’ Dilemma
Conclusions: Oligipolistic Markets
1) Collusion will lead to greater profits
2) Explicit and implicit collusion is possible
3) Once collusion exists, the profit motive to break and lower
price is significant
Chapter 12 Slide 51
Charge $1.40 Charge $1.50
Charge$1.40
Unilever and Kao
Charge$1.50
P&G
$12, $12 $29, $11
$3, $21 $20, $20
Payoff Matrix for the P&G Pricing Problem
What price should P & G choose?
Chapter 12 Slide 52
Implications of the Prisoners’Dilemma for Oligipolistic Pricing
Observations of Oligopoly Behavior
1) In some oligopoly markets, pricing behavior in time can create a
predictable pricing environment and implied collusion may occur.
Chapter 12 Slide 53
Observations of Oligopoly Behavior
2) In other oligopoly markets, the firms are very aggressive and collusion is not possible.
Firms are reluctant to change price because of the likely response of their competitors.
In this case prices tend to be relatively rigid.
Implications of the Prisoners’Dilemma for Oligipolistic Pricing
Chapter 12 Slide 54
The Kinked Demand Curve
$/Q
Quantity
MR
D
If the producer lowers price thecompetitors will follow and the
demand will be inelastic.
If the producer raises price thecompetitors will not and the
demand will be elastic.
Chapter 12 Slide 55
The Kinked Demand Curve
$/Q
D
P*
Q*
MC
MC’
So long as marginal cost is in the vertical region of the marginal
revenue curve, price and output will remain constant.
MR
Quantity
Chapter 12 Slide 56
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
Price Signaling
Implicit collusion in which a firm announces a price increase in the hope that other firms will follow suit
Price Signaling & Price LeadershipPrice Signaling & Price Leadership
Chapter 12 Slide 57
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
Price Leadership
Pattern of pricing in which one firm regularly announces price changes that other firms then match
Price Signaling & Price LeadershipPrice Signaling & Price Leadership
Chapter 12 Slide 58
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
The Dominant Firm ModelIn some oligopolistic markets, one large
firm has a major share of total sales, and a group of smaller firms supplies the remainder of the market.
The large firm might then act as the dominant firm, setting a price that maximized its own profits.
Chapter 12 Slide 59
Price Setting by a Dominant Firm
Price
Quantity
D
DD
QD
P*
At this price, fringe firmssell QF, so that total
sales are QT.
P1
QF QT
P2
MCD
MRD
SF The dominant firm’s demandcurve is the difference between
market demand (D) and the supplyof the fringe firms (SF).
Chapter 12 Slide 60
Cartels
Characteristics
1) Explicit agreements to set output and price
2) May not include all firms
Chapter 12 Slide 61
Cartels
Examples of successful cartels
OPEC International
Bauxite Association
Mercurio Europeo
Examples of unsuccessful cartels
Copper Tin Coffee Tea Cocoa
Characteristics
3) Most often international
Chapter 12 Slide 62
Cartels
Characteristics
4) Conditions for successCompetitive alternative sufficiently
deters cheatingPotential of monopoly power--inelastic
demand
Chapter 12 Slide 63
Cartels
Comparing OPEC to CIPECMost cartels involve a portion of the market
which then behaves as the dominant firm
Chapter 12 Slide 64
The OPEC Oil Cartel
Price
Quantity
MROPEC
DOPEC
TD SC
MCOPEC
TD is the total world demandcurve for oil, and SC is the
competitive supply. OPEC’s demand is the difference
between the two.
QOPEC
P*
OPEC’s profits maximizingquantity is found at the
intersection of its MR andMC curves. At this quantity
OPEC charges price P*.
Chapter 12 Slide 65
Cartels
About OPECVery low MCTD is inelasticNon-OPEC supply is inelastic
DOPEC is relatively inelastic
Chapter 12 Slide 66
The OPEC Oil Cartel
Price
Quantity
MROPEC
DOPEC
TD SC
MCOPEC
QOPEC
P*
The price without the cartel:• Competitive price (PC) where DOPEC = MCOPEC
QC QT
Pc
Chapter 12 Slide 67
The CIPEC Copper Cartel
Price
Quantity
MRCIPEC
TD
DCIPEC
SC
MCCIPEC
QCIPEC
P*PC
QC QT
• TD and SC are relatively elastic• DCIPEC is elastic• CIPEC has little monopoly power• P* is closer to PC
Chapter 12 Slide 68
Cartels
ObservationsTo be successful:
Total demand must not be very price elastic
Either the cartel must control nearly all of the world’s supply or the supply of noncartel producers must not be price elastic
Chapter 12 Slide 69
Summary
In a monopolistically competitive market, firms compete by selling differentiated products, which are highly substitutable.
In an oligopolistic market, only a few firms account for most or all of production.
Chapter 12 Slide 70
Summary
In the Cournot model of oligopoly, firms make their output decisions at the same time, each taking the other’s output as fixed.
In the Stackelberg model, one firm sets its output first.
Chapter 12 Slide 71
Summary
The Nash equilibrium concept can also be applied to markets in which firms produce substitute goods and compete by setting price.
Firms would earn higher profits by collusively agreeing to raise prices, but the antitrust laws usually prohibit this.
Chapter 12 Slide 72
Summary
The Prisoners’ Dilemma creates price rigidity in oligopolistic markets.
Price leadership is a form of implicit collusion that sometimes gets around the Prisoners Dilemma.
In a cartel, producers explicitly collude in setting prices and output levels.
End of Chapter 12
Monopolistic Competition and
Oligopoly
Monopolistic Competition and
Oligopoly