Monopolistic Competition and Oligopoly Superior Cheese CHAPTER TWENTY-FIVE.

Monopolistic Monopolistic CompetitionCompetition

andandOligopolyOligopoly

Monopolistic Monopolistic CompetitionCompetition

andandOligopolyOligopoly

SuperiorCheese

CHAPTER TWENTY-FIVE

Four Market ModelsFour Market Models

Market Structure ContinuumMarket Structure Continuum

PurePureCompetitionCompetition

PurePureMonopolyMonopoly

MonopolisticMonopolisticCompetitionCompetition

Monopolistic CompetitionMonopolistic CompetitionCharacteristics...Characteristics...

• Relatively Large NumbersRelatively Large Numbers


• Relatively Large NumbersRelatively Large NumbersSmall Market ShareSmall Market Share


• Relatively Large NumbersRelatively Large NumbersSmall Market ShareSmall Market ShareNo CollusionNo Collusion


• Relatively Large NumbersRelatively Large NumbersSmall Market ShareSmall Market ShareNo CollusionNo CollusionIndependent ActionsIndependent Actions



• Product DifferentiationProduct Differentiation



• Product DifferentiationProduct DifferentiationProduct AttributesProduct Attributes



• Product DifferentiationProduct DifferentiationProduct AttributesProduct AttributesServicesServices



• Product DifferentiationProduct DifferentiationProduct AttributesProduct AttributesServicesServicesLocationLocation



• Product DifferentiationProduct DifferentiationProduct AttributesProduct AttributesServicesServicesLocationLocationBrand Names and PackagingBrand Names and Packaging



• Product DifferentiationProduct DifferentiationProduct AttributesProduct AttributesServicesServicesLocationLocationBrand Names and PackagingBrand Names and PackagingSome Control Over PriceSome Control Over Price

• Easy Entry and ExitEasy Entry and Exit


• Easy Entry and ExitEasy Entry and Exit• Nonprice CompetitionNonprice Competition


• Easy Entry and ExitEasy Entry and Exit• Nonprice Competition Nonprice Competition • AdvertisingAdvertising


• Easy Entry and ExitEasy Entry and Exit• Nonprice Competition Nonprice Competition • AdvertisingAdvertising• Monopolistically Monopolistically

Competitive Competitive IndustriesIndustries


Short-Run Price and Output DeterminationShort-Run Price and Output Determination

QQ

PPP

rice

an

d C

ost

sP

rice

an

d C

ost

sMonopolistic competitorsMonopolistic competitors

have an elastic demand curve,have an elastic demand curve,but not perfectly elastic... but not perfectly elastic...

Copyright McGraw-Hill, Inc., 1999

QQ

DD

PPP

rice

an

d C

ost

sP

rice

an

d C

ost

s



QQ

DD

MRMR

PPP

rice

an

d C

ost

sP

rice

an

d C

ost

s



QQ

DD

MRMR

MCMCPPP

rice

an

d C

ost

sP

rice

an

d C

ost

s

QQCopyright McGraw-Hill, Inc., 1999


QQ

DD

MRMR

MCMCPP

ATCATCP

rice

an

d C

ost

sP

rice

an

d C

ost

s

QQCopyright McGraw-Hill, Inc., 1999


QQ

DD

MRMR

MCMCPP

ATCATCP

rice

an

d C

ost

sP

rice

an

d C

ost

s

QQ

EconomicProfits

Expect New CompetitorsExpect New CompetitorsShort-Run Price and Output DeterminationShort-Run Price and Output Determination

QQ

DD

MRMR

MCMCPP

ATCATCP

rice

an

d C

ost

sP

rice

an

d C

ost

s

QQ

EconomicProfits

How wouldHow wouldshort-run lossesshort-run losses

be different?be different?

How wouldHow wouldshort-run lossesshort-run losses

be different?be different?


QQ

DD

MRMR

MCMCPP

ATCATC

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

QQ

EconomicLossesExpectExpect

LessLessCompetitorsCompetitors


QQ

DD

MRMR

MCMCPP

ATCATC

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

QQ

EconomicLossesExpectExpect

LessLessCompetitorsCompetitors

How wouldthe long-run

differ?

How wouldthe long-run

differ?


QQ

DD

MRMR

MCMCPP

ATCATCP

rice

an

d C

ost

sP

rice

an

d C

ost

s

QQ

EconomicProfits


QQ

DD

MRMR

MCMCPP

ATCATC

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

QQ

Long-run equilibriumLong-run equilibriumShort-Run Price and Output DeterminationShort-Run Price and Output Determination

Q @ ATC Min ?Q @ ATC Min ?

P = MCP = MC

Monopolistic CompetitionMonopolistic Competitionand Economic Efficiencyand Economic Efficiency


• Not Productively EfficientNot Productively Efficient


• Not Productively EfficientNot Productively Efficient• Not Allocatively EfficientNot Allocatively Efficient


• Not Productively EfficientNot Productively Efficient• Not Allocatively EfficientNot Allocatively Efficient• Excess CapacityExcess Capacity


Nonprice CompetitionNonprice Competition



Nonprice CompetitionNonprice Competition• Product DifferentiationProduct Differentiation



Nonprice CompetitionNonprice Competition• Product DifferentiationProduct Differentiation• Product DevelopmentProduct Development


Features of a Monopolistic Competitive Markets:1. Many sellers 2. Unique Products that have close or identical substitutes:

Big Mac v Whopper3. Small barrier to entry or exit4. Some market power exists5. Price is greater than MR, Separate DARP and MR curves6. Non price competition and advertising exist7. Profits maximized at the Quantity and Price where MC = MR8. Excess or Economic Profits in the Short Run only (P>ATC)9. Profits must be Normal in the Long Run (P=ATC) 10. Firms should shut down when P < AVC11. Excess capacity exists in terms of potential output 12. Demand is relatively elastic by comparison to monopoly13. Example market - Minimarts, Fast food at local franchises14. This market is much closer to perfect competition than

pure monopoly

Four Market ModelsFour Market ModelsOligopolyOligopoly

Market Structure ContinuumMarket Structure Continuum

PurePureCompetitionCompetition

PurePureMonopolyMonopoly

MonopolisticMonopolisticCompetitionCompetition

Oligopoly: CharacteristicsOligopoly: Characteristics

Oligopoly: CharacteristicsOligopoly: Characteristics• Oligopoly DefinedOligopoly Defined

Oligopoly: CharacteristicsOligopoly: Characteristics• Oligopoly DefinedOligopoly Defined• Homogeneous or Homogeneous or

Differentiated ProductsDifferentiated Products


Differentiated ProductsDifferentiated Products• Control over PriceControl over Price


Differentiated ProductsDifferentiated Products• Control over PriceControl over Price• Mutual InterdependenceMutual Interdependence


Differentiated ProductsDifferentiated Products• Control over PriceControl over Price• Mutual InterdependenceMutual Interdependence• Entry BarriersEntry Barriers


Differentiated ProductsDifferentiated Products• Control over PriceControl over Price• Mutual InterdependenceMutual Interdependence• Entry BarriersEntry Barriers• MergersMergers

• Concentration RatiosConcentration RatiosOligopoly: CharacteristicsOligopoly: Characteristics

Ratios that look at what the concentration of firms are in the industry.

• Concentration RatiosConcentration Ratios - Herfindahl Index – The larger- Herfindahl Index – The largerthe index number the higher the the index number the higher the concentration of the industry.concentration of the industry.

Oligopoly: CharacteristicsOligopoly: Characteristics

Oligopoly BehaviorOligopoly BehaviorA Game Theory Overview...A Game Theory Overview...

HighHigh

LowLow

HighHigh LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

RareAir’s Price StrategyRareAir’s Price Strategy

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

HighHigh LowLow

GreatestGreatestCombinedCombined

ProfitProfit



HighHigh

LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

HighHigh LowLow

IndependentIndependentActionsActions

StimulateStimulateResponseResponse



HighHigh

LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

HighHigh LowLow

IndependentIndependentActionsActions

StimulateStimulateResponseResponseGravitatingGravitating

to theto theWorst CaseWorst Case



HighHigh

LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

HighHigh LowLow

CollusionCollusionInvites aInvites aDifferentDifferentSolutionSolution



HighHigh

LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

A

C

B$12 $15

$12 $6

$6 $8

$15 $8

D

HighHigh LowLow

CollusionCollusionInvites aInvites aDifferentDifferentSolutionSolutionBut, theBut, the

incentiveincentiveto cheatto cheat

is very realis very real



HighHigh

LowLow

Up

tow

n’s

Pri

ce S

trat

egy

Up

tow

n’s

Pri

ce S

trat

egy

Company A High Ads $100,000 – 20,000 = $80,000 Low Ads $50,000 – 10,000 = $40,000

Company B Low Ads $50,000 – 10,000 = $40,000 High Ads $100,000 – 20,000 = $80,000

Company A Low Ads $75,000 – 10,000 = $65,000 High Ads $75,000 – 20,000 = $55,000

Company B Low Ads $75,000 – 10,000 = $65,000 High Ads $75,000 – 20,000 = $55,000

Ads Effect Sales (Q) and P x Q = TR so Ads effect Total Revenue!Low Cost Ads: 120 :30 second Ads/week for $10,000High Cost Ads: 240 :30 second Ads/week for $20,000

Pay Off Matrix Oligopoly – Reasons for Collusion

TR - TC = TP TR - TC = TP

If either duopolist begins running High Ads, its competitor willcounter with High Ads!Games Theory and Collusion’s answer is an agreement by “both”to keep advertising low in order to maximize profits!Would their be incentive to Cheat?

No Standard Model due to...No Standard Model due to...

Three Oligopoly ModelsThree Oligopoly Models


DiversityDiversity



DiversityDiversityInterdependenceInterdependence




1 - Kinked Demand Curve1 - Kinked Demand Curve




1 - Kinked Demand Curve1 - Kinked Demand Curve2 - Collusive Pricing2 - Collusive Pricing




1 - Kinked Demand Curve1 - Kinked Demand Curve2 - Collusive Pricing2 - Collusive Pricing3 - Price Leadership3 - Price Leadership


Kinked Demand: Noncollusive OligopolyKinked Demand: Noncollusive OligopolyPP

QQDD11

MRMR11QuantityQuantity

The firm’s demandThe firm’s demandand marginaland marginal

revenue curvesrevenue curveswhen rivals followwhen rivals followpricing patterns.pricing patterns.

PP

QQDD11

MRMR22

DD22


The firms demandThe firms demandand marginaland marginal

revenue curves when revenue curves when rivals don’t followrivals don’t followpricing patterns.pricing patterns.

Kinked Demand: Noncollusive OligopolyKinked Demand: Noncollusive Oligopoly

PP

QQ

MRMR22DD11

DD22


Rivals tend toRivals tend tofollow a price cutfollow a price cut


PP

QQ

MRMR22DD11

DD22


Rivals tend toRivals tend tofollow a price cutfollow a price cut

or ignore aor ignore aprice increaseprice increase


PP

QQ

MRMR22DD11

DD22


Effectively creatingEffectively creatinga kinked demand curvea kinked demand curve


PP

QQ

MRMR22

DD11

DD22


Effectively creatingEffectively creatinga kinked demand curvea kinked demand curve


MCMC22

MCMC11

Cartels and CollusionCartels and Collusion

Oligopoly is conducive to collusionOligopoly is conducive to collusion


If a few firms face identical orIf a few firms face identical orhighly similar demand and costs...highly similar demand and costs...



If a few firms face identical orIf a few firms face identical orhighly similar demand and costs...highly similar demand and costs...


They will seek joint profitThey will seek joint profitmaximization...maximization...


QQ

DD

Colluding Oligopolists WillColluding Oligopolists WillSplit the Monopoly Profits Split the Monopoly Profits

MCMC

ATCATC

MRMR

PP

EconomicEconomicProfitProfit

Pric

eP

rice

QuantitQuantityy

MR = MCMR = MC

Overt CollusionOvert CollusionCartels and CollusionCartels and Collusion

Overt CollusionOvert CollusionOPEC CartelOPEC Cartel


Overt CollusionOvert CollusionOPEC CartelOPEC Cartel

Covert CollusionCovert Collusion


Obstacles to CollusionObstacles to Collusion


Demand & Cost DifferencesDemand & Cost Differences


Demand & Cost DifferencesDemand & Cost DifferencesNumber of FirmsNumber of Firms


Demand & Cost DifferencesDemand & Cost DifferencesNumber of FirmsNumber of FirmsCheatingCheating


Demand & Cost DifferencesDemand & Cost DifferencesNumber of FirmsNumber of FirmsCheatingCheatingRecessionRecession


Demand & Cost DifferencesDemand & Cost DifferencesNumber of FirmsNumber of FirmsCheatingCheatingRecessionRecessionPotential EntryPotential Entry


Demand & Cost DifferencesDemand & Cost DifferencesNumber of FirmsNumber of FirmsCheatingCheatingRecessionRecessionPotential EntryPotential EntryLegal Obstacles: AntitrustLegal Obstacles: Antitrust

Price LeadershipPrice Leadership

Price LeadershipPrice LeadershipLeadership TacticsLeadership Tactics


Infrequent ChangesInfrequent Changes


Infrequent ChangesInfrequent Changes

CommunicationCommunication


Infrequent ChangesInfrequent ChangesCommunicationCommunicationLimit Pricing - Limit Pricing - sometimessometimessmaller companies will wage price smaller companies will wage price wars to knock the leader down.wars to knock the leader down.

Oligopoly & AdvertisingOligopoly & Advertising

Advertising Effects on Output & Average CostsAdvertising Effects on Output & Average Costs

QQ

Un

it C

ost

sU

nit

Co

sts

QQ

ATCATCwithoutwithout

advertisingadvertising


QQ

Un

it C

ost

sU

nit

Co

sts

QQ



ATCATCwithwith




QQ

Un

it C

ost

sU

nit

Co

sts

QQ



ATCATCwithwith


Advertising CostsAdvertising Costs



Oligopoly and Economic EfficiencyOligopoly and Economic Efficiency

Allocative EfficiencyAllocative Efficiency(Price = MC)(Price = MC)

Recall...Recall...



Productive EfficiencyProductive Efficiency(Price = Minimum ATC)(Price = Minimum ATC)

Recall...Recall...



Productive EfficiencyProductive Efficiency(Price = Minimum ATC)(Price = Minimum ATC)

Recall...Recall...

Neither is likely in anNeither is likely in anoligopoly market structureoligopoly market structure

Features of an Oligopolistic Markets:

1. Few sellers (Less than seven), Duopoly - two main sellers + the fringe firms

2. Unique Products but similar products Coke v Pepsi, Chevy v Ford3. Large barrier to entry or exit4. A large measure of market power exists5. Price is greater than MR, Separate DARP and MR curves6. Non price competition and advertising exist

Procter & Gamble: $3,277,000,000 in Ads 19997. Profits maximized at the Quantity and Price where MC = MR8. Excess or Economic Profits possible in the Long Run (P>ATC)9. Interdependence, Collusion, Spies, Pay off Matrix Price and Innovative Leaders exist, Gamesmanship “A Beautiful Mind”10. Firms should shut down when P < AVC11. Excess capacity exists in terms of potential output 12. Demand is relatively inelastic 13. Theory of the Kinked Demand Curve and Price Stickiness results from collusion and gamesmanship14. Example market - Automobiles, Soda, Beer, Steel, Tobacco Products may be differentiated (Toyota v Ford) or homogeneous (Steel)

QQ

Un

it C

ost

sU

nit

Co

sts

QQ



ATCATCwithwith


Advertising CostsAdvertising Costs



QuestionsQuestionsandand

Discussion...Discussion...

monopolistic monopolistic competitioncompetition

product product differentiationdifferentiation

nonprice competitionnonprice competition excess capacityexcess capacity oligopolyoligopoly homogeneous homogeneous

oligopolyoligopoly differentiated differentiated

oligopolyoligopoly mutual mutual

interdependenceinterdependence concentration ratioconcentration ratio

interindustry interindustry competitioncompetition

import competitionimport competition Herfindahl indexHerfindahl index game theory modelgame theory model collusioncollusion kinked demand kinked demand

curvecurve price warprice war cartelcartel tacit understandingstacit understandings price leadershipprice leadership

Next...Next...

Chapter 26Chapter 26

Technology, Technology, R&D, R&D, and and EfficiencyEfficiency

Monopolistic Competition and Oligopoly Superior Cheese CHAPTER TWENTY-FIVE.

Documents

Transcript of Monopolistic Competition and Oligopoly Superior Cheese CHAPTER TWENTY-FIVE.