Monopolistic Competition &

Oligopoly

Characteristics of Monopolistic Competition

• A relatively large number of sellers(Small Market Share, No Collusion, Independent Action)• Differentiated products(Product Attributes, Service, Location, Brands)• Easy entry and exit from the industry(Entry Eliminates Profits, Exits Eliminate Losses)• Advertising & Non Price Competition

Monopolistically Competitive Industries

• Clothing Industry• Restaurants• Jewelry• Consumer Electronics

Price and Output in Monopolistic Competition (SR vs. LR)

Monopolistic Competition and Efficiency

• Productive efficiency is P= min ATC

• Allocative efficiency is P= MC• Not productive or allocative

efficiency • P>MC, meaning that resources

are underallocated; not allocatively efficient

• Firms do not produce where P= min ATC; therefore, not productively efficient

• Marginal revenue curve will never coincide with D=AR=P

Monopolistic Competition&Excess Capacity

• Product differentiation creates excess capacity

• means that fewer firms operating at capacity could supply the industry output

• Excess capacity is the gap between the minimum ATC output and the profit-maximization output

Monopolistic Competition &Product Variety

• Firms are able to have profit from differentiation in the long run because no exact substitute).

• Advertising may increase costs, but also demand, and help maintain long-run profit.

• Satisfies a wide range of consumer tastes and encourages innovation to differentiate.

• Max Profit is Price x Product x Advertising

Characteristics of Oligopoly

1) A few large producers (Oil, Telecom, Soda).2) Homogenous OR differentiated products(Oil and Gasoline versus Automobiles)3) Price maker, but still mutually interdependent(Strategic Behaviour & Interdependance KEY!!)4) Relatively high entry barriers

Mergers

• Merging of two or more competing firms is beneficial in that it may increase their market share significantly, and thus achieve greater economies of scale.

• The larger firm that results from a merger would have greater control over market supply and price.

Measures of Industry Concentration

• Price Leadership• The Four Firm Concentration Ratio(determines whether a industry is monopolistic competition or oligopoly, magic number is 40%)• Herfindahl Index (Herfindahl-Hirschman Index

or HHI)(the sum of the squares of the market shares of each individual firm)

Oligopoly Behavior: A Game Theory Overview

• Game Theory: study of how people/firms behave in strategic situations.

• Game Theory Model: can be used to analyse the behaviour of oligopolists.

• The “Payoff Matrix” and Collusive Behaviour.• Often the “Payoff Matrix” is represented by

the Prisoner’s Dilemma, which is used to explain ologopoly behaviour.

Prisoner’s Dilemma

Mutual Interdependence Revisited

• Oligopolistic firms can influence rival's profits by changing pricing strategies

• Each firm's profit depends on their pricing strategy in relation to their rival's

• Firms make decisions based on how they think other firms will react. They anticipate the next move

• Collusion is best, but firms cheat : (

Oligopoly and Advertising

• Positive Effects of Ads:> Low-cost means to obtain info on product> Diminishes monopoly power by providing info on competing goods• Negative Effects of Ads:> Manipulate or persuade consumers> May create a barrier to entry with costs of advertising

Oligopoly and Efficiency

• Remember the triple equality for economic efficiency: (P = MC = minimum ATC), Oligopolists do not achieve this.

• Produce where P > minimum ATC so they are not productively efficient.

• Produce where P > MC so they are not alocatively efficient.

• Oligopolies can be less desirable than monopolies because no regulation.