Transcript ECONOMICS

Chapter 10
Monopolistic Competition
and Oligopoly
© 2009 South-Western/ Cengage Learning
Monopolistic Competition
• Characteristics
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–
–
–
Real world situation—example: fast food industry
Many producers
Low barriers to entry
Slightly different products
• A firm that raises prices: lose some customers to rivals
– Some control over price ‘Price makers’
• Downward sloping demand curve
– Act independently
•2
Monopolistic Competition
• Product differentiation
– Physical differences
• Appearance; quality
– Location
• Where products can be found
– Services
• Customer support
– Product image
• Promotion; advertising
•3
Short-Run Profit Max. or Loss Min.
– Demand curve AR
– Marginal revenue MR
– Average total cost ATC
– Average variable cost AVC
– Marginal cost MC
• Maximize profit
– Produce the quantity: MR=MC
– Price: on demand curve
•4
Max. Profit or Min. Loss in Short-Run
• If P>ATC: demand curve above ATC
– Economic profit
• If ATC>P>AVC: demand curve between ATC
and AVC
– Economic loss
– Produce in short run
• If P<AVC: AVC curve above demand curve
– Economic loss
– Shut down in short run
•5
Exhibit 1
Monopolistic competition in the short run
(a) Maximizing short-run profit
(b) Minimizing short-run loss
b
p
c
Profit
MC
ATC
c
D
e
Dollars per unit
Dollars per unit
MC
c
p
Loss
q
Quantity
per period
(a) Economic profit = (p-c)×q
AVC
b
D
e
MR
0
ATC
c
MR
0
q
Quantity
per period
(b) Economic loss = (c-p)×q
The firm produces the output at which MR=MC (point e) and charges the price
indicated by point b on the downward sloping D curve.
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Zero Economic Profit in the Long-Run
• Short run economic profit
– New firms enter the market
– Draw customers away from other firms
– Reduce demand facing other firms—individual
demand curves shift to left
– Profit disappears in long run
• Zero economic profit
• Price = ATC
•7
Zero Economic Profit in the Long-Run
• Short run economic loss
– Some firms exit the market
– Their customers switch to other firms
– Increase demand facing the remaining firms—
individual demand curves shift to the right
– Loss is erased in the long run
• Zero economic profit
• Price = ATC
•8
Exhibit 2
Dollars
per unit
Long-run equilibrium in monopolistic competition
b
p
a
0
q
Economic profit in short run:
MC
- new firms enter the industry in the
long run
ATC - reduces the D facing each firm
- Each firm’s D shifts leftward until:
-MR=MC (point a) and
-D is tangent to ATC curve: point b
D
- Economic profit = 0 at output q
No more firms enter; the industry is in
long-run equilibrium.
MR
Quantity per period
The same long-run outcome occurs if firms suffer a short-run loss. Firms
leave until remaining firms earn just a normal profit.
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Monopolistic vs. Perfect Competition
• Both
– Zero economic profit in long run
– MR=MC for quantity
• where demand curve is tangent to ATC
• Perfect competition
– Firm’s demand: horizontal line
– Produces at minimum average cost
– Productive and allocative efficiency
•10
Monopolistic vs. Perfect Competition
• Monopolistic competition
– Downward sloping demand curve
– Don’t produce at minimum average cost
• Excess capacity
• Could increase output
– Lower average cost
– Increase social welfare
– Produces less, charges more
•11
Exhibit 3
Perfect competition versus monopolistic competition
in long-run equilibrium
(a) Perfect competition
(b) Monopolistic competition
MC
MC
p
Dollars per unit
d=MR=AR
0
q
Quantity
per period
p’
ATC
Dollars per unit
ATC
0
D
MR
q’
Quantity
per period
Cost curves are assumed the same. The monopolistically competitive firm produces
less output and charges a higher price than does a perfectly competitive firm,
excess capacity in the industry. Neither earns economic profit in the long run. 12
Oligopoly
• Few sellers
• Identical or similar products
• Barriers to entry
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–
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Economies of scale
Legal restrictions
Brand names
Control over an essential resource
High cost of entry
• Start-up costs; advertising
• Crowding out the competition—multiple products
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Exhibit 4
Economies of scale as a barrier to entry
ca
Dollars per unit
a
A new entrant able to sell only S automobiles would incur a much
higher average cost of ca at point a.
If automobile prices are below ca, a new entrant would suffer a loss.
At point b, an existing firm can produce M or more
automobiles at an average cost of cb.
b
cb
0
S
M
Long-run average cost
Autos per year
In this case, economies of scale serve as a barrier to entry, insulating firms
that have achieved minimum efficient scale from new competitors.
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Models of Oligopoly
– Interdependence, choice between-• Cooperation, or:
• Fierce competition
• Collusion/cartels
• Price leadership
• Game theory
•15
Collusion and Cartels
• Collusion
– Agreement among firms to
• Divide the market
• Fix the price
• Cartel
– Group of firms that agree to collude
• Act as monopoly
• Increase economic profit
• Illegal in U.S.
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Exhibit 5
Cartel as a monopolist
Dollars per unit
MC
p
c
D
A cartel acts as a monopolist.
Here, D is the market demand
curve, MR the associated
marginal revenue curve, and
MC the horizontal sum of the
marginal cost curves of cartel
members (assuming all firms in
the market join the cartel).
Cartel profits are maximized
when the industry produces
quantity Q and charges price p.
MR
0
Q
Quantity per period
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Collusion and Cartels
• Maximize profit
– Allocate output among cartel members
– Same MC of the final unit produced
• Difficulties to maintain a cartel:
– Differentiated product
– Differences in average cost
– Many firms in the cartel
– Low barriers to entry
– Cheating
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Price Leadership
• Informal, tacit collusion—all players behave as
if there was an explicit collusive agreement.
• Price leader
– Sets the price for the industry
– Initiate price changes
– Followed by the other firms
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Price Leadership
• Obstacles
– U.S. antitrust laws—difficult to prove with tacit
collusive behavior
– Product differentiation
– No guarantee others will follow
– Barriers to entry
– Cheating
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Game Theory
• Behavior of decision makers
– Series of strategic moves and countermoves—
action/reaction functions
– Among rival firms
• Choices affect one another
• General approach
– Focus: each player’s incentives to cooperate or
compete
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Game Theory
• Prisoner’s dilemma
– Two thieves; cannot coordinate
• Strategy
– The player’s game plan
• Payoff matrix
– Table listing the rewards
• Dominant-strategy equilibrium
– Each player’s action does not depend on what he
thinks the other player will do
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Exhibit 6
The prisoner’s dilemma payoff matrix (years in jail)
Jerry
“Rats”
“Rats”
Clam up
5
10
5
0
Ben
0
Clam up
10
1
1
Best outcome would be for both thieves to “clam up” (1 year each).
However, each player has the incentive to “rat” on the other,
regardless of the behavior of the other person. As a result, both
players “rat” on each other resulting in the worst possible outcome (5
years each)
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Exhibit 7
Price-setting payoff matrix (profit per day)
Exxon
Low price
Low
price
High price
$500
$500
$200
$1,000
Texaco
High
price
$1,000
$200
$700
$700
Nash Equilibrium: each
player maximizes profit,
given the price chosen by
the other.
Neither can increase profit
by changing the price,
given the price chosen by
the other.
Best outcome would be to cooperate and each charge the high price.
However, the incentive is for both to charge the low price which results in
the worst outcome.
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Game Theory
• One-shot versus repeated games
– One-shot game
• Game is played just once
– Repeated game
• Learn how the other players play the game
• Establish reputation for cooperation
• Tit-for-tat strategy
– Highest payoff
• Do the players engage in cooperative behavior
or opportunistic behavior
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Oligopoly vs. Perfect Competition
• Oligopoly
– If firms collude or operate with excess capacity
• Higher price
• Lower output
– If price wars
• Lower price
– Higher profits in the long run if the firms engage in
“tacit” collusion and cooperate
•26