Transcript Monopolistic Competition

Monopolistic Competition
and Basic Oligopoly Models
Monopolistic Competition
(Chamberlin Model)
Free entry, many firms sell (physically
or perceivably) differentiated products.
Firms ignore competitors. Each redefines
market to a segment (consumers preferences)
& estimates its own downward demand d.
Other brands make firm’s demand d more
elastic (for segment only) than market share
curve M (for entire market). Firm’s market
power limited, but still allows P > MC.
In short run firm may move along d, but
eventually similar conditions lead to similar
P: each firm operates at d & M intersection.
Equilibrium when firm’s re-estimated
d intersects M where SMC = MR.
Monopolistic Competition in the Log-Run
The Good
(for Consumers):
Product Variety
$
Long Run Equilibrium
(P = AC, so zero profits)
AC
The Bad
(for Society):
P*
P > MC =>
P1 = AC1
Inefficiencies
AC*
& Misallocations
The Ugly
(for Managers):
Free Entry drives
Long Run Profit
to Normal = 0
MC
Entry
MR
Q1 Q*
Transitory
Total Profit
MR1
D
D1
Quantity of Brand
X
Strategies to Avoid (or Delay)
the Zero Profit Outcome
• Change; don’t let the long-run set in.
• Be the first to introduce new brands or to
improve existing products and services.
• Seek out sustainable niches.
• Create barriers to entry.
• Increase the time it takes others to clone your
brand with “trade secrets” and “strategic plans”.
Oligopoly
• Few sellers (< 10, 2 in duopoly) of homogeneous or differentiated
product actively competing for market share.
• Barriers to entry:
• Entry limiting pricing P < P* and Market saturation: discourage entry
• Fed Trade Commission antitrust against General Mills, General Foods
& Kellogg for proliferation of brands (fill shelves & prevent entry)
• Excess capacity (econ of scale) & reputed P retaliation: P cutting
• In 1971 Proctor & Gamble (west cost) promoted (advertisement & P)
its Folger in Pitt & Cleveland (General Foods’ Maxwell House turf).
• GF lowered P & started promoting in midwest (shared turf).
GF’s  30% in 1970, –30% in 1974. After PG retreated P &  recovered.
• Capital requirements
• Product differentiation, hard for entrant to attract customers
• Strategic Interaction
• What you do affects the profits of your rivals
• What your rival does affects your profits
Strategic Interdependence
Firm is not in
complete control
of its own destiny.
Change in firm’s
quantity demanded
depends on whether
rivals match firm’s
change in price!
P
D2 (Rivals match your
price change)
PH
D (Rivals match your
price Reductions but
not price Increases)
P0
PL
Q0
D1 (Rivals hold
their price
constant)
Q
Sweezy (Kinked
Demand) Model
Few firms in the market
(entry barriers) produce
differentiated products.
Each firm believes rivals
match price reductions,
but not price increases.
Key feature: Price-Rigidity
( cost firms operate at kink)
With econ wide increase
in production costs, firm
might profitable increase
price, regardless of others.
When others follow adjust
d upward to new kink Q3,P2
P
M = DMarket
MCH
MC
MCL
PK
MRM
d = DFirm
MRd
QK
MR
D
Q
Sweezy Model: An Example
• P = 10, TC = 1500 + 3Q + 0.0025Q2
• Consultant QM = 1500 - 50P
and Qd = 3000 - 200P
• At kink: Pk = 10 and
Qk = 1000
QM = 1500 - 50P = 3000 - 200P = Qd
• Vertical gap in MR (at Qk= 1000):
MRM = 30 - 0.04*1000 = -10
MRd = 15 - 0.005*1000 = 5 < MC
MC = 3 + 0.005*1000 = 8
•  max: MRF -MC = 0 =>
QF = 800, PF = 11
•  Qk = 3000
<
Q* = 3300
Cournot Duopoly
• Two firms produce homogenous product in
an industry with barriers to entry
• Firms maximize profit by setting output, as
opposed to price
• Each firm wrongly believes their rival will
hold output constant if it changes its own
output
• Firm’s reaction (or best-response) function:
profit maximizing amount of output for
each quantity of output produced by rival
Cournot’s Costless Duopoly
50
Cournot Equilibrium
• Each firm produces the profit maximizing output, given the output
of rival firms
• No firm gains by unilateral changes in its output
• Assume:
P = 950 - (Q1 + Q2) and MC = 50
P = a - b(Q1 + Q2) and MCi = Ci
 max: MRi = 950 - 2Qi - Qj = 50 = MC
MRi = a - 2bQi - bQj = Ci
Qi = r(Qj) = 450 - 0.5Qj
Qi = r(Qj)= (a-Ci)/2b - Qj/2
Simultaneously
solved:
Q1 = Q2 = 300
• Perfect competition: P = MRT = 950 - QT = 50 = MC => QT = 900
Duopoly:
Q1 = Q2 = 300 & 300 unserved
• Qn = Qpc[n/(1+n)], where n = # of firm in oligopoly
Cournot Equilibrium
• Q1* maximizes firm 1’s profits, given that firm 2 produces Q2*
• Q2* maximizes firm 2’s profits, given that firm 1 produces Q1*
• No firm has an incentive to change output, given rival’s output
• Beliefs are consistent:
• In equilibrium, each
firm “thinks” rival
will stick to current
output - and they do!
Q2
r1 (Firm 1’s Reaction Function)
Cournot Equilibrium
Q2M
Q2*
r2
Q1*
Q1M
Q1
Stackelberg Model
• Few firms produce differentiated or homogeneous
products in industry with barriers to entry
• Firm leader commits to an output before followers
• Remaining firms, followers, profit maximizing
outputs, given the leader’s output.
• Commitment and first-mover advantage can
enhance profits in strategic environments
• Leader produces more than in Cournot equilibrium
(Larger market share, higher profits)
• Follower produces less than in Cournot equilibrium
(Smaller market share, lower profits)
Stackelberg Equilibrium
• Assume: P = a - b(Q1 + Q2)and
MCi = Ci
• Q1
chosen to maximize profit
Q2 = r(Q1) = (a-C2)/2b - Q1/2 Cournot reaction to Q1
• 1 = PQ1 - TC1 = [a - b(Q1 + Q2)]Q1 - TC1
= {a - b[Q1 + (a-C2)/2b - Q1/2]}Q1 - TC1
• max 1: d1/dQ1 = a - 2bQ1 - (a-C2)/2 + bQ1 - C1 = 0
Q1 = (a + C2 - 2C1) / 2b
Q2 = (a-C2)/2b - Q1/2
• Q1Stackelberg > [QiCournot = (a-Ci)/2b - Qj/2] > Q2Stackelberg
Bertrand and Edgeworth Duopoly
• Two firms produce identical products at constant MC,
in an industry with barriers to entry
• Each firm independently sets its profit maximizing price
• Consumers have perfect knowledge & no transaction costs
• Suppose MC < P1 < P2
• Firm 1 earns (P1 - MC) per unit and firm 2 earns nothing
• Firm 2 undercuts firm 1’s price to capture the entire market
• Firm 1 then undercuts firm 2’s price
• Undercutting continues until equilibrium: P1 = P2 = MC
• Perfect competition profit maximizing solution P = MC
possible with few firms and severe price competition
• If duopolists have limited capacity relative to the Bertrand
equilibrium, Edgeworth argued that price will not be stable
Chamberlin Duopoly
• Chamberlin applied results from his analysis of monopolistic
competition on oligopoly
• Cournot, Bertrand and Edgeworth models assume that
competitors are extremely naïve
• Chamberlin argued that oligopolists would recognize their
mutual or strategic interdependence and engage in tacit or
informal collusion: independently choose monopoly price and
split profits
• Managers signal to competitors their desire not to engage
in destructive price war by setting price
• Agreements are not necessary because firms realize any other
strategy is less profitable
• Formal Collusive agreements are illegal, although U. S. firms
have been permitted to agree on export pricing
Perfect Collusion: The Cartel
• Monopoly against world. Max profit: Pcartel>MRcartel=MCmembers
• Production allocated inside with MC rule: MRcartel=MCA=…=MCn
(Ideal that lowest unit cost member has the highest Q & profit is
sometimes modified in short run to maintain unity)
• Assume Q=1660–200P. Set MR=8.3-.001Q=.305+.000508Q=MC
(MCA=.15+.00015QA, MCB=.60+.0002QB & MCC=.25+.000125QC)
and solve for QT=5300, P=5.65 and MR=3.
Set MR=3=MCi and solve for allocations: QA=1900, QB=1200 & QA=2200
Contestable Markets
• Few sellers but free entry: Oligopoly will price at a
perfect competition level & have only normal  = 0
• Key Assumptions
• Producers have access to same technology
• Consumers respond quickly to price changes
• Existing firms cannot respond quickly to entry by
lowering price
• Absence of sunk costs
• Key Implications
• Threat of entry disciplines firms already in the market
• Incumbents have no market power, even if there is only
a single incumbent (a monopolist)
Summary
• Different oligopoly scenarios lead to different
optimal strategies and different outcomes
• Your optimal price and output depends on …
• Beliefs about the reactions of rivals
• Your choice variable (P or Q) and the nature of the
product market (differentiated or homogeneous
products)
• Your ability to commit