Transcript Chapter 12
Monopolistic Competition Characteristics 1) Many firms 2) Free entry and exit 3) Differentiated product (but high degree of substitutability) The amount of monopoly power depends on the degree of differentiation. Examples of this common market structure include: Toothpaste; Soap; Cold remedies; Soft Drinks; Coffee Chapter 12 Slide 1 A Monopolistically Competitive Firm in the Short and Long Run $/Q Short Run $/Q MC Long Run MC AC AC PSR PLR DSR DLR MRSR QSR Quantity MRLR QLR Quantity Monopolistic Competition in the SR Observations (short-run) Downward sloping demand - differentiated product Demand is relatively elastic - good substitutes MR < P Profits are maximized when MR = MC This firm is making economic profits Chapter 12 Slide 3 Monopolistic Competition in the LR Observations (long-run) Profits will attract new firms to the industry (no barriers to entry) The old firm’s demand will decrease to DLR Firm’s output and price will fall Industry output will rise No economic profit (P = AC) P > MC -- some monopoly power Chapter 12 Slide 4 Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium Monopolistic Competition Perfect Competition $/Q $/Q MC Deadweight loss AC MC AC P PC D = MR DLR MRLR QC Quantity QMC Quantity Monopolistic Competition Reduction in Economic Efficiency The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, total surplus would increase by the yellow triangle. Although there are no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists. Chapter 12 Slide 6 Oligopoly Characteristics Small number of firms Product differentiation may or may not exist Barriers to entry Examples: Automobiles, Steel, Aluminum, Petrochemicals, Electrical equipment, Computers Chapter 12 Slide 7 Oligopoly Barriers to entry include: Scale economies; Patents; Technology; Name recognition Strategic action: Flooding the market; Controlling an essential input Management Challenges Strategic actions Rival behavior Chapter 12 Slide 8 Oligopoly Equilibrium in an Oligopolistic Market In perfect competition, monopoly, and monopolistic competition the producers did not have to consider a rival’s response when choosing output and price. In oligopoly the producers must consider the response of competitors when choosing output and price. Chapter 12 Slide 9 Oligopoly Equilibrium in an Oligopolistic Market Defining Equilibrium Firms do the best they can and have no incentive to change their output or price All firms assume competitors are taking rival decisions into account. Nash Equilibrium Chapter 12 Each firm is doing the best it can given what its competitors are doing. Slide 10 Quantity Competition: Cournot The Cournot Model Chapter 12 Duopoly Two firms competing with each other Homogeneous good The output of the other firm is assumed to be fixed Slide 11 Firm 1’s Output Decision If Firm 1 thinks Firm 2 will produce nothing, its demand curve, D1(0), is the market demand curve. P1 D1(0) If Firm 1 thinks Firm 2 will produce 50 units, its demand curve is shifted to the left by this amount. MR1(0) D1(75) If Firm 1 thinks Firm 2 will produce 75 units, its demand curve is shifted to the left by this amount. MR1(75) MC1 MR1(50) 12.5 25 Chapter 12 D1(50) 50 Q1 Slide 12 Reaction Curves and Cournot Equilibrium Q1 100 Firm 1’s reaction curve shows how much it will produce as a function of how much it thinks Firm 2 will produce. The x’s correspond to the previous example. Firm 2’s reaction curve shows how much it will produce as a function of how much it thinks Firm 1 will produce. 75 Firm 2’s Reaction Curve Q2*(Q1) 50 x 25 Cournot Equilibrium Firm 1’s Reaction Curve Q*1(Q2) 25 Chapter 12 In Cournot equilibrium, each firm correctly assumes how much its competitors will produce and thereby maximizes its own profits. x 50 x 75 x 100 Q2 Slide 13 Price Competition: Bertrand Competition in an oligopolistic industry may occur with price instead of output. The Bertrand Model is used to illustrate price competition in an oligopolistic industry with homogenous goods. How will consumers respond to a price differential? (Hint: Consider homogeneity) Chapter 12 Slide 14 Price Competition Bertrand Model Why not charge a higher price to raise profits? How does the Bertrand outcome compare to the Cournot outcome? The Bertrand model demonstrates the importance of the strategic variable (price versus output). Chapter 12 Slide 15 Price Competition Price Competition with Differentiated Products Chapter 12 Market shares are now determined not just by prices, but by differences in the design, performance, and durability of each firm’s product. Slide 16 Nash Equilibrium in Prices P1 Firm 2’s Reaction Curve $4 Firm 1’s Reaction Curve Nash Equilibrium $4 Chapter 12 P2 Slide 17 Competition Versus Collusion: Payoff Matrix for Pricing Game Firm 2 Charge $4 Charge $4 Charge $6 $12, $12 $20, $4 $4, $20 $16, $16 Firm 1 Charge $6 Chapter 12 Slide 18 Competition Versus Collusion: The Prisoners’ Dilemma These two firms are playing a noncooperative game. Question Each firm independently does the best it can taking its competitor into account. Why will both firms both choose $4 when $6 will yield higher profits? An example in game theory, called the Prisoners’ Dilemma, illustrates the problem oligopolistic firms face. Chapter 12 Slide 19 Competition Versus Collusion: The Prisoners’ Dilemma Scenario Two prisoners have been accused of collaborating in a crime. They are in separate jail cells and cannot communicate. Each has been asked to confess to the crime. Chapter 12 Slide 20 Payoff Matrix for Prisoners’ Dilemma Prisoner B Confess Confess Prisoner A Don’t confess Chapter 12 -5, -5 Don’t confess -1, -10 Would you choose to confess? -10, -1 -2, -2 Slide 21 Payoff Matrix for the Prisoners’ Dilemma Conclusions: Oligopolistic Markets 1) Collusion will lead to greater profits 2) Explicit and implicit collusion is possible 3) Once collusion exists, the profit motive to break and lower price is significant Chapter 12 Slide 22 Payoff Matrix for the P&G Pricing Problem Unilever and Kao Charge $1.40 Charge $1.40 P&G $12, $12 Charge $1.50 $29, $11 What price should P & G choose? Charge $1.50 Chapter 12 $3, $21 $20, $20 Slide 23 Implications of the Prisoners’ Dilemma for Oligopolistic Pricing Price Signaling & Price Leadership Price Signaling: Implicit collusion in which a firm announces a price increase in the hope that other firms will follow suit. Price Leadership: Pattern of pricing in which one firm regularly announces price changes that other firms then match. Chapter 12 Slide 24