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Managerial Economics Eighth Edition Truett + Truett Chapter 9: Monopolistic Competition, Oligopoly, and Related Topics John Wiley & Sons, Inc. 7/16/2015 Slides by Jim Witsmeer 1 Introduction 7/16/2015 Should a monopoly advertise? Should a supplier in perfect competition advertise? Does either firm have to compete for market share? What is product differentiation is it real or perceived? 2 Definitions Oligopoly is a market with a few sellers of the same product actively competing for market share. Monopolistic competition is a market with many firms selling similar products with some differentiation. The difference relates to how much rivalry there is among firms. 7/16/2015 3 Topics of Discussion 7/16/2015 Monopolistic Competition Oligopoly Duopoly Barriers to Entry Price Rigidity Without Collusion Price Leadership Efficient firm Dominant firm Perfect Collusion: Cartels 4 Market Share Curve Market share curve (Ma) is firm’s demand curve when all firms change price. Firms operate at intersection of its demand and market share curves. In short run it may be possible for firm to move along Di, but eventually, similar conditions will result in similar prices for all firms. 140 100 80 60 Di 40 20 Ma 0 -20 -40 7/16/2015 Equilibrium Point 120 0 5 10 15 20 25 30 MRi 5 Monopolistic Competition in the Short Run Firm’s Short-Run 160 Equilibrium 140 Firm must adjust estimate 120 of d so it intersects M 100 where SMC=MR. 80 If where d intersects M, firm’s SMC is not equal to 60 MR, firm will have to make 40 further adjustments (re20 estimate d or, perhaps, 0 make some changes in product differentiation to -20 move M). -40 7/16/2015 SMC d M 0 5 10 15 20 25 30 MR 6 Monopolistic Competition in the Long Run Long-Run Equilibrium of the Firm Free entry assures the firm’s economic profit will only be normal over the long run. 7/16/2015 7 Duopoly: An Oligopoly with only two competitors 7/16/2015 Several economic theories have attempted to define the optimum strategy in a duopolistic competition (price war). Most scenarios in the long-run result in both competitors losing and one or both going out of business. In this situation a strategy of collusion or cooperative pricing for mutual benefit is optimal. 8 Barriers to Market Entry 7/16/2015 Entry-limit pricing Excess capacity and economies of scale Capital requirements Product differentiation or brand recognition Criminal intimidation Government controls Sales and distribution networks 9 Price Rigidity Without Collusion The kinked demand curve occurs when the competing firms follow a price decrease but not an increase. The kink is the equilibrium point. Firms with differing costs (profits) will operate at the same quantity/price. 7/16/2015 10 Rising Prices with a kinked demand curve If costs rise to the extent shown here (MC2), then the firm must raise price to P2 To maximize profits and wait for the rest of the firms to follow which will move the kink to F and rotate the demand and MR curves adjusting the maximum profit and increasing sales to F. 7/16/2015 11 Sample Problem Initial Equilibrium TR =QP=101000= $10,000 25 TC 1500 3Q .0025Q 20 2 T = $10,000-$7,000 = $3,000 Maximum Profit PM 30 .02Q 15 Pd 15 .005Q dTRd MRd 15 .01Q dQ TC=1500+3800+.0025800 2 dSTC 3 .005Q dQ 10 5 TR = QP = 11800 = $8,800 SMC 0 -5 0 500 1000 1500 2000 2500 3000 -10 -15 MRM dTRM 30 .04Q dQ -20 T = $8,800-$5,500 = $3,300 7/16/2015 12 Tacit Collusion 7/16/2015 An informal type of coordination among firms. Formal Collusive agreements are illegal, although U. S. firms have been permitted to agree on export pricing. Firms may get away with informal collusion, but they could be prosecuted under antitrust laws. 13 Price Leadership Efficient Firm When the lead firm changes price others will follow shortly. Firm b has maximum profit at Pb but must adjust to Pa to sustain market share. 7/16/2015 14 Price Leadership Dominant Firm The dominant share of the market is so large that competitors must accept the set market price as in perfect competition. Dominant Firm Entire Market The demand curve Ss = MCs for the dominant firm is obtained by subtracting the quantity supplied by small firms from the total market quantity demanded. The dominant firm selects Pe, which is the MR curve for small firms, who supply QS’. 7/16/2015 QL Qs QM 15 Sample Problem Dominant Firm Entire Market If small firm 600 supply is: SS 500 QS=0.9P+150 and market demand is: 400 QM=1403-2.6P than MCL 300 demand for the QM 200 DM dominant firm is DL MRL 100 QS Q QL QL = QM-QS or L 0 QL=1253-3.5P 1200 1000 800 600 400 200 00 200 400 600 800 1000 1200 We can find TR = Q*P and MR = dTR/dQ. The MC is estimated to be constant at $260 so that the maximum profit for the dominant firm at MC=MR is at the point indicated and divides the market into 171.5 units for the dominant firm and 428 units for the small firms collectively. 7/16/2015 16 The Cartel: Perfect Collusion To maximize profit, cartel managers must allocate production based on the rule of marginal cost, which dictates that MR = MCA = MCB = …= MCn for all participants. This is the ideal and is sometimes modified in the short run to maintain unity. 7/16/2015 17 Sample Problem A three member cartel estimates the market demand function for its product to be Qc = 1660 – 200Pc. The three members have marginal cost functions as follows: MCi = .25 +.000125Qi , MCs = .60 + .0002Qs and MCu = .15 + .00015Qu. The sum of these equals the marginal cost function: MCc = 0.305 + .000508Qc. The cartel marginal revenue is: MRc = dTR/dQ = 8.3 - .001Q. Setting MR=MC and solving for Qc gives us a quantity of 5300 units and MR = 3.0. Substituting this value into the cartel demand equation yields a price of $5.65. This divides among the cartel by setting all of their marginal costs equal to 3.0 and solving for their respective quantity allocations. MC i .25 MC s 0.6 MC u .15 Qi 2200 Qs 1200 Qu 1900 .00125 0.2 .015 7/16/2015 18 Cartel Problem (graphically) 10 9 8 7 6 5 4 3 2 1 0 SMCs SACu Pc Pc 0 1000 Qu2000 Pc PROFIT PROFIT SMCu SACi SACs MRs MRu 3000 UWAQ 0 4000 Qs2000 3000 SHERAN 1000 4000 0 PROFIT SMCi 10 9 8 7 6 5 4 3 i2 1 0 MR Qi3000 IRUN 1000 Pc 2000 4000 0 Dc MRc MCc Qc 6000 CARTEL 2000 4000 8000 Allocations are made to the members in accordance with the rule of marginal cost. The lower cost producers receive the largest allocation and the largest profit. 7/16/2015 Qc Qi Qs Qu 19 End of Chapter 9 7/16/2015 Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the United States copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. 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