Monopolistic Competition and...
Transcript of Monopolistic Competition and...
Monopolistic Competition and Oligopoly 16
Monopolistic Competition and Oligopoly
Competition, you know, is a lot like
chastity. It is widely praised, but alas,
too little practiced.
— Carol Tucker
CHAPTER 16
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopolistic Competition and Oligopoly 16
Monopolistic Competition
• A market structure in which there are many firms selling differentiated products with few barriers to entry
McGraw-Hill/Irwin Colander, Economics 2
Monopolistic Competition and Oligopoly 16
Characteristics of Monopolistic Competition
1. Many sellers
• Do not take into account the reaction of competitors
2. Product differentiation
•Goods are NOT identical
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Monopolistic Competition and Oligopoly 16
Characteristics of Monopolistic Competition
3. Multiple dimensions of competition
• Since these products have substitutes, firms use non-price competition such as advertising, brand names and packaging, service, etc.
4. Easy entry and exit of firms in the long run
• There are no significant barriers to entry
McGraw-Hill/Irwin Colander, Economics 4
Monopolistic Competition and Oligopoly 16
“Monopoly” + ”Competition”= Monopolistic Competition
Monopolistic Qualities
• Control over price of own good due to differentiated product
• D greater than MR
• Plenty of advertising
• Not efficient
Perfect Competition Qualities
• Large number of smaller firms
• Relatively easy entry and exit
• Zero economic profit in long-run since firms can enter
McGraw-Hill/Irwin Colander, Economics 5
Monopolistic Competition and Oligopoly 16
Advertising and Monopolistic Competition
• Perfectly competitive firms have no incentive to advertise, but monopolistic competitors do
• The goals of advertising are to increase demand and make demand more inelastic
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Monopolistic Competition and Oligopoly 16
Advertising and Monopolistic Competition
• Advertising increases ATC
• The increase in cost of a monopolistically competitive product is the cost of “differentness”
McGraw-Hill/Irwin Colander, Economics 7
Monopolistic Competition and Oligopoly 16
Monopolistic Competition
• A monopolistic firm can earn profits, losses, or break even in the short run
• At its profit maximizing output, marginal cost will be less than price
McGraw-Hill/Irwin Colander, Economics 8
Monopolistic Competition and Oligopoly 16Drawing the Graph
Monopolistic Competition Earning a Profitin the Short run
• Draw a downward sloping demand curve
• The MR curve starts at the same point on the price axis as does P
• It bisects the demand curve
• Draw your MC curve
McGraw-Hill/Irwin Colander, Economics 9
Monopolistic Competition and Oligopoly 16
Drawing the Graph Monopolistic Competition Earning a Profit
in the Short run• Find the point where MC=MR
• Take this point down to the quantity axis to determine profit maximizing quantity
• Take this point up the demand curve and over to the price axis to determine price
McGraw-Hill/Irwin Colander, Economics 10
Monopolistic Competition and Oligopoly 16
Drawing the Graph Monopolistic Competition Earning a Profit
in the Short run
• Now, add your ATC to show a profit
• ATC should be below price
• Take price off the demand curve down to ATC to find the profit
• Shade the area of profit
McGraw-Hill/Irwin Colander, Economics 11
Monopolistic Competition and Oligopoly 16
Q
P
Q1
MC
D
MR
Draw the Graph Monopolistic Competition Earning a Profit
in the Short run
P1
ATC
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Profit
Monopolistic Competition and Oligopoly 16
Drawing the Graph Monopolistic Competition Earning a Loss
in the Short run
• In this graph, ATC will be above price
• Take the price off the demand curve up to the ATC to determine the area of loss
• Shade the area of loss
McGraw-Hill/Irwin Colander, Economics 13
Monopolistic Competition and Oligopoly 16
Q
P
Q1
MC
D
MR
Draw the Graph Monopolistic Competition Earning a Loss
in the Short run
P1
ATC
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Loss
Monopolistic Competition and Oligopoly 16Drawing the Graph
Monopolistic Competition in the Long Run: Zero Economic Profit
• In this graph the ATC will be tangent to the demand curve at the output the firm produces but NOT at its minimum
• For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)
McGraw-Hill/Irwin Colander, Economics 15
Monopolistic Competition and Oligopoly 16
Q
P
ATC
Q1
MC
D
MR
Draw the Graph Monopolistic Competition in the Long Run:
Zero Economic Profit
P1
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Monopolistic Competition and Oligopoly 16
Are Monopolistically Competitive Firms Efficient?
• Socially optimal/allocatively efficient level (SO/AE): where D=MC (or supply=demand)• Not allocatively efficient because P MC
• Productively efficient level: minimum ATC; using the least combination of inputs to produce maximum output for minimum cost• Not productively efficient because not
producing at minimum ATC
McGraw-Hill/Irwin Colander, Economics 17
Monopolistic Competition and Oligopoly 16
Are Monopolistically Competitive Firms Efficient?
• Firms have excess capacity: firm could be producing at the lowest cost but is producing less (not allocatively efficient)
McGraw-Hill/Irwin Colander, Economics 18
Monopolistic Competition and Oligopoly 16
Q
P
Q1
MC
D
MR
Draw the Graph: Monopolistic Competition Earning a Profit in the Short run with SO and PE
P1
ATC
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PE
SO/AE
QPEQso
PPE
Pso
•Socially optimal/allocatively efficient level: where D=MC
•Productively efficient level: minimum ATC
Monopolistic Competition and Oligopoly 16
Monopolistic Competition Graph Compared with a Perfect Competition Graph
• In monopolistic competition in the long run,
P > min ATC
• In perfect competition in the long run, P = min ATC
• Outcome: monopolistic competition output is lower and price is higher than perfect competition
McGraw-Hill/Irwin Colander, Economics 20
Monopolistic Competition and Oligopoly 16
Monopolistic Competition compared to Perfect Competition
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Q
P
QMC
MC
D
MR
PMC
ATC
QC
PC
DWL
Because a monopolistically competitive firm produces at a higher price and a lower output than a perfectly competitive firm there is DWL
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Comparing Monopolistic Competition with a Monopoly
• It is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entry
• No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entry
• For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)
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Monopolistic Competition and Oligopoly 16
Oligopolies
McGraw-Hill/Irwin Colander, Economics 23
Monopolistic Competition and Oligopoly 16
Characteristics of Oligopolies
• A market in which there are only a few firms in an industry that have a large market share
• Examples: car industry, cell phone industry, cereal industry)
• May produced standardized products or differentiated products
McGraw-Hill/Irwin Colander, Economics 24
Monopolistic Competition and Oligopoly 16
Characteristics of Oligopolies
• In any decision a firm makes, it must take into account the expected reaction of other firms
• Firms are mutually interdependent
• Can be collusive or noncollusive
McGraw-Hill/Irwin Colander, Economics 25
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Characteristics of Oligopolies
• Firms may engage in strategic decision making where each firm takes explicit account of a rival’s expected response to a decision it is making
• High barriers to entry
• Generally, there are high start-up costs and costs of raw materials
McGraw-Hill/Irwin Colander, Economics 26
Monopolistic Competition and Oligopoly 16
Models of Oligopoly Behavior: The Cartel Model
• The cartel model is when a combination of firms acts as if it were a single firm and amonopoly price is set
• Assumes that oligopolies act as if they
were a monopoly and set a price to
maximize profit
• If oligopolies can limit the entry of other
firms, they can increase profits
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Implicit Price Collusion
• Explicit (formal) collusion is illegal in the U.S.
while implicit (informal) collusion is permitted
• Implicit price collusion exists when multiple
firms make the same pricing decisions even
though they have not consulted with one
another
• Sometimes the largest or most dominant firm
takes the lead in setting prices and the others
follow16-28
Monopolistic Competition and Oligopoly 16
Why Are Prices Sticky?
• Sticky prices are prices that don’t change
frequently
• Caused by informal collusion
• Look at the kinked demand curve (not
tested)
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Models of Oligopoly Behavior: The Contestable Market Model
• Where barriers to entry and exit, not market structure, determines a firms’ price and output decisions
• An oligopoly with no barriers to entry sets a competitive price
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Monopolistic Competition and Oligopoly 16
Comparing Contestable Market and Cartel Models
• The cartel model is appropriate for
oligopolists that collude, set a monopoly
price, and prevent market entry
• The contestable market model describes
oligopolies that set a competitive price and
have no barriers to entry
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Monopolistic Competition and Oligopoly 16
Comparing Contestable Market and Cartel Models
• Both models use strategic pricing decisions where firms set their price based on the expected reactions of other firms
McGraw-Hill/Irwin Colander, Economics 32
Monopolistic Competition and Oligopoly 16
New Entry as a Limit on the Cartelization Strategy and Price Wars
• Price wars are the result of strategic pricing decisions gone wild—sometimes the goal is to drive the competitor out of business even if it hurts the firm itself
• A predatory pricing strategy involves temporarily pushing the price down in order to drive a competitor out of business
McGraw-Hill/Irwin Colander, Economics 33
Monopolistic Competition and Oligopoly 16
Comparison of Market Structures
Monopoly OligopolyMonopolistic Competition
Perfect Competition
No. of firms One Few Many Almost infinite
Barriers to entry Significant Significant Few None
Pricing decisions MC = MR Strategic pricing MC = MR MC = MR = P
Output decisionsMost output
restrictionOutput
restricted
Outputrestricted,
product differentiation
No outputrestriction
InterdependenceNo
competitorsInterdependent
decisions Each firm
independentEach firm
independent
LR profit Possible Possible None None
P and MC P > MC P > MC P > MC P = MC
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Classifying Industries and Markets in Practice
• An industry rarely fits neatly into one
category or another
• One way to classify markets is by its cross-
price elasticity
• Goods with a cross-price elasticity of 3 or
more are in the same industry
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Empirical Measures of Industry Structure
• The concentration ratio is the value of sales
by the top firms of an industry stated as a
percentage of total industry sales
• The Herfindahl index is the sum of the
squared value of the individual market shares
of all firms in the industry (on the chapter
test)
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Empirical Measures of Industry Structure
• Because it squares market shares, the Herfindahl index gives more weight to firms with large market shares than does the concentration ratio measure
McGraw-Hill/Irwin Colander, Economics 37
Monopolistic Competition and Oligopoly 16
Chapter Summary
• Monopolistic competition is characterized by:
• Many sellers
• Differentiated products
• Multiple dimensions of competition
• Ease of entry of new firms
• The central characteristic of oligopoly is that there are a small number of interdependent firms
• Monopolistic competitors differ from perfect competitors in that the former face a downward sloping demand curve
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Chapter Summary
• Monopolistic competitors differ from monopolists in that monopolistic competitors make zero long-run profit
• In monopolistic competition firms act independently; in an oligopoly they take account of each other’s actions
• An oligopolist’s price will be somewhere between the competitive price and the monopolistic price
• A contestable market theory of oligopoly judges an industry’s competitiveness more by performance and barriers to entry than by structure
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Chapter Summary
• Cartel models of oligopoly concentrate on market structure
• Industries are classified by economic activity in the North American Industry Classification System (NAICS)
• Industry structures are measured by concentration ratios and Herfindahl indexes
• A concentration ratio is the sum of market shares of the largest firms in an industry
• A Herfindahl index is the sum of the squares of the market shares of all firms in an industry
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