Transcript Chapter 23
Chapter 11 Monopolistic Competition and Oligopoly McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Objectives • Characteristics of monopolistic competition • Normal profit in the long run • Characteristics of oligopoly • Game theory • The oligopolist’s kinked demand curve • Collusion among oligopolists • The effects of advertising 11-2 Monopolistic Competition • Large number of sellers – Small market shares – No collusion, limited control of price – Independent action • Differentiated Products – Product attributes (pizza) – Service (Men’s Warehouse) – Location (hotels) – Brand names and packaging (Air Jordan) – Some control over price (preference) 11-3 Monopolistic Competition • Easy entry and exit • Need for advertising –Nonprice Competition • Which industries? –Degree of concentration –Four-firm concentration ratio • Less that 40% –Herfindahl index • Closer to 0 than 10,000 11-4 Table 11.1 Monopolistic Competition • Firm’s demand curve –Highly elastic • Short run profit or loss –Produce where MR=MC • Long run normal profit –Entry and exit • Inefficient • Product variety 11-6 Monopolistic Competition Short-Run Profits Price and Costs MC ATC P1 A1 Economic Profit D1 MR = MC MR 0 Q1 Quantity 11-7 Monopolistic Competition Short-Run Losses Price and Costs MC ATC A2 P2 Loss D2 MR = MC MR 0 Q2 Quantity 11-8 Monopolistic Competition Long-Run Equilibrium MC Price and Costs ATC P3= A3 D3 MR = MC MR 0 Q3 Quantity 11-9 Monopolistic Competition P=MC=Min ATC for pure competition (recall) Price and Costs MC ATC P3= A3 P4 Price is Lower D3 MR = MC Excess Capacity at Minimum ATC 0 MR Q3 Q4 Quantity Monopolistic competition is not efficient 11-10 Oligopoly • A few large producers • Homogeneous (steel) or differentiated products (cars) • Control over price –Mutual interdependence –Strategic behavior • Entry barriers (EOS, capital, control of resources) • Mergers (tv, newspapers, banks) 11-11 Examples • Tennis Balls: Wilson, Penn, Dunlop and Spalding. • Cars: GM, Ford, DaimlerChrysler • Cereal: Quaker, Ralston Food, Kellogg, Post and General Mills. • Aircraft: Boeing (McDonnell Douglas) and Lockheed Martin • Grocery stores: (Giant Eagle, Shopn’Save, Wal-Mart) Most Famous Oligopoly - OPEC Oligopoly • Four-firm concentration ratio –Needs to be more than 40% –Half of U.S. manufacturing • Localized markets • Interindustry competition • World trade –Import Competition • Herfindahl index 11-14 Game Theory RareAir’s Price Strategy High Uptown’s Price Strategy • 2 competitors • 2 price strategies • Each strategy has a payoff matrix • Greatest combined profit • Independent actions stimulate a response A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 11-15 Game Theory RareAir’s Price Strategy High Uptown’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 A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 11-16 Game Theory • Mutual interdependence –Pricing policy • Collusion –Enhances profit • Incentive to cheat • Prisoner’s dilemma 11-17 Three Oligopoly Models • • • • Kinked-demand curve Collusive pricing Price leadership Why three models? –Diversity of oligopolies –Complications of interdependence • D, MR often unknown • Stable economy = sticky prices • Price shifts often occur collusively 11-18 Kinked-Demand Curve • Noncollusive oligopoly (differentiated product) • Strategies –Match price changes –Ignore price changes • Combined strategy • Price inflexibility • The kinked-demand curve 11-19 Kinked-Demand Curve 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 Resulting in a kinked-demand curve to the consumer – price and output are optimized at the kink 11-20 Kinked-Demand Curve • Criticisms of the model –How does price get to P0 –Explains inflexibility, not price –Prices are not that rigid (unstable economy) –Price wars (often due to recession) 11-21 Cartels and Other Collusion • Price and output – Joint profit maximization – Easiest with standardized product Price and Costs MC Effectively Sharing The Monopoly Profit P0 ATC A0 MR=MC Economic Profit D MR Q0 Quantity 11-22 The OPEC Cartel Daily oil production (barrels) , November 2008 Saudi Arabia Iran Kuwait Venezuela Iraq Nigeria UAE Angola Libya Algeria Qatar Indonesia Ecuador 8,904,000 3,843,000 2,538,000 2,368,000 2,297,000 2,183,000 2,117,000 1,804,000 1,737,000 1,417,000 848,000 843,000 530,000 Source: A. T. Kearney, Foreign Policy 11-23 Cartels and Other Collusion • Covert collusion –Tacit understandings • Obstacles to collusion –Demand and cost differences –Number of firms –Cheating –Recession (increases in ATC) –Potential entry –Legal obstacles: antitrust law 11-24 Price Leadership Model Leadership tactics • Usually largest/most efficient firm • Infrequent price changes • Communications • Limit pricing to keep barriers to entry • Breakdowns in price leadership: –Price wars 11-25 Advertising • Prevalent in monopolistic competition and oligopoly • Capture market share • Better than a price cut • Information for consumers (HD TVs) – more competition? • Manipulation (Air Jordan) – less competition? • Efficiency – more or less? 11-26 Oligopoly and Advertising The Largest U.S. Advertisers, 2006 Company Advertising Spending Millions of $ Proctor and Gamble AT&T General Motors Time Warner Verizon Ford Motor GlaxoSmithKline Walt Disney Johnson & Johnson Unilever $4898 3345 3296 3089 2822 2577 2444 2320 2291 2098 Source: Advertising Age 11-27 Oligopoly and Advertising World’s Top 10 Brand Names, 2007 Coca-Cola Microsoft IBM General Electric Nokia Toyota Intel McDonald’s Disney Mercedes-Benz Source: Interbrand 11-28 Oligopoly and Efficiency • • • • P = MC = min ATC Not productively efficient Not allocatively efficient Tendency to share the monopoly profit • Qualifications – Increased foreign competition (cars) – Limit pricing to keep barriers to entry – Technological advance (R&D) 11-29 Oligopoly in the Beer Industry • From hundreds to a few firms • Demand side changes – Taste shifts to lighter beers – Shift from tap to cans or bottles • Supply side changes – Technological change increased minimum efficient scale – National brands enjoy cost advantages • Consolidation into oligopoly 11-30 Key Terms • monopolistic competition • product differentiation • nonprice competition • four-firm concentration ratio • Herfindahl index • excess capacity • oligopoly • homogeneous oligopoly • differentiated oligopoly • strategic behavior • mutual interdependence • interindustry competition • import competition • game theory • collusion • kinked-demand curve • price war • cartel • price leadership 11-31 Next Chapter Preview… Technology, R&D, And Efficiency 11-32