Transcript leather goods brand

Chapter 9: Monopolistic
Competition and Oligopoly
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
Characteristics of
Monopolistic Competition
 Large number of sellers:
 Small market shares
 No collusion
 Independent action
 Differentiated products:
 Firms have some control over prices.
 Products may differ in




attributes
services
location
brand name and packaging
Examples:
• furniture,
• jewelry,
• leather goods,
• grocery stores,
• gas stations,
• restaurants,
• clothing stores,
• medical care.
 Easy entry and exit
LO: 9-1
9-2
Pricing and Output in
Monopolistic Competition
 Monopolistically competitive firms engage in
non-price competition (such as advertising) in order
to differentiate their products.
 Because products are differentiated, the demand
curve of a monopolistically competitive firm is
not perfectly elastic (although it is more elastic than
pure monopolist’s demand).
 The price elasticity of firm’s demand is higher
 The larger the number of rival firms
 The weaker the product differentiation
LO: 9-2
9-3
Profits and Losses in
Monopolistic Competition
Short run
Long run
 The monopolistically competitive
firm uses the MC=MR Rule to
maximize profit or minimize loss
in the short run.
 It produces a quantity Q at which
MR = MC and charges a price P
based on its demand curve.
 When P > ATC, the firm earns
an economic profit.
 When P < ATC, the firm
incurs a loss.
 Because entry and exit are
easy,
 Economic profits attract
new firms, which lowers
profits of existing firms,
until P=ATC.
 Economic losses make
firms exit until P=ATC.
 As a result, monopolistic
competitors will earn only a
normal profit in the long run.
LO: 9-2
9-4
Short-Run Profits in
Monopolistic Competition
Price and Costs
MC
ATC
P
ATC
Economic
Profit
D in SR
MR = MC
MR
0
Q
Quantity
LO: 9-2
9-5
Long-Run Profits in
Monopolistic Competition
Price and Costs
MC
ATC
P
ATC
P=
ATC
Economic
Profit
MR = MC
D in SR
D in LR
MR
0
Q
Quantity
LO: 9-2
9-6
Monopolistic Competition vs.
Pure Competition
Price and Costs
MC
ATC
PMC
PPC
Price is Higher
D3
MR = MC
Excess Capacity at
Minimum ATC
0
MR
QMC
QPC
Quantity
LO: 9-2
Monopolistic competition is not efficient
9-7
Characteristics of
Oligopoly
 A few large producers:
 Firms are price makers
 Firms engage in strategic behavior
 Firms’ profits depend on action of
other firms
 Homogeneous or differentiated
products:
 If products are differentiated, firms
engage in advertising
Examples:
• tires,
• beer,
• cigarettes,
• copper,
• greeting cards,
• automobiles,
• breakfast cereals,
• airlines.
 Blocked entry
LO: 9-3
9-8
Oligopoly and Game Theory
 Behavior of firms in the oligopoly can be analyzed
using game theory.
 Consider an example of two firms (a duopoly) which
decide whether to set their price high or low.
 A payoff matrix can be constructed to show payoffs
(profit) to each firm that result from each combination
of strategies.
Game theory is the study of how people or firms behave in
strategic situations.
LO: 9-4
9-9
Oligopoly and Game
Theory: Example
RareAir’s Price Strategy
• 2 competitors
• 2 price strategies
• Each strategy has a
payoff matrix
• Greatest combined
profit
• Independent actions
stimulate a response
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
LO: 9-4
9-10
Oligopoly and Game
Theory: Example
RareAir’s Price Strategy
• Independently lowered
prices in expectation of
greater profit leads to the
worst combined outcome
• Eventually low outcomes
make firms return to
higher prices
• There is a gain from
collusion
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
LO: 9-4
9-11
Kinked-Demand Model of
Oligopoly
 In the kinked-demand model, oligopolists face a
demand curve based on the assumption that rivals
will ignore a price increase and follow a price
decrease.
 An oligopolist’s rivals will ignore a price increase above the
going price but follow a price decrease below the going
price.
 The demand curve is kinked at this price and the marginalrevenue curve has a vertical gap.
 Price and output are optimized at the kink.
 This model helps explain why prices are generally stable
in noncollusive oligopolistic industries.
LO: 9-5
9-12
Kinked-Demand Model of
Oligopoly
Competitor and rivals strategize versus each other
Consumers effectively have 2 partial demand curves
and each part has its own marginal revenue part
e
P0
f
D2
Rivals Match g
Price Decrease
0
Q0
MR1
Quantity
MR2
Price and Costs
Price
Rivals Ignore
Price Increase
MC1
D2
P0
e
MR2
f
MC2
g
D1
D1
0
Q0
MR1
Quantity
LO: 9-5
9-13
Collusion
 Collusion, through price control, may allow oligopolists to
reduce uncertainty, increase profits, and possibly block
potential entry.
 If oligopolistic firms produce an identical product and have
identical cost, demand, and marginal-revenue curves, then
each firm can maximize profit using the MR=MC Rule.
 Firms will choose the price and quantity according to MR=MC
Rule because it is the most profitable price-output
combination.
 One form of collusion is the cartel.
Cartel is a formal agreement among producers to set the price and the
individual firm’s output levels of a product. One example is OPEC.
LO: 9-6
9-14
Profit Maximization by a
Cartel
Price and Costs
MC
Effectively Sharing
The Monopoly Profit
P0
ATC
A0
MR=MC
Economic
Profit
D
MR
Q0
Quantity
LO: 9-6
Cartel-type oligopoly is inefficient
9-15
Obstacles to Collusion




Anti-trust law prevents cartels from forming
Demand and costs may be different across firms
There may be too many firms to coordinate
There are strong incentives to cheat
 If rivals charge prices lower than Po, then the demand curve of
the firm charging Po will shift to the left as customers turn to its
rivals, and profits will fall.
 The firm can retaliate and cut its price, too. However, all firms’
profits would eventually fall.
 Recessions increase excess capacity and
strengthen incentives to cheat
 High profits attract potential entry
LO: 9-6
9-16
Oligopoly and Advertising
Oligopolists have sufficient financial resources to engage in
product differentiation through product development and
advertising.
Positive effects of advertising
Negative effects of advertising
 Enhances competition
 Reduces consumers’ search
time, direct costs, and indirect
costs
 Facilitates the introduction of
new products
 Alters consumers’ preferences
in favor of the advertiser’s
product
 Brand-loyalty promotes
monopoly power
LO: 9-7
9-17