Transcript lec19 - people.vcu.edu

Today
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Monopolistic competition
Cartels
Monopolistic Competition and
Oligopoly
Chapter 23
Four Basic Models
Monopolistic Competition
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Firms are able to charge different prices
than their competitors because they sell
heterogeneous products.
We call these differentiated products.
Differentiated Product: a product for
which there exist a lot of varieties,
quality levels, or images. Brand name
may matter to consumers.
Examples of Differentiated
Products
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Cars
Cigarettes
Clothing
Breakfast cereal
Bread
Sunscreen
Demand for Differentiated
Products
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If each firm’s offering is somewhat
different from its competitors, then it has
more discretion over the price it
charges.
The firm has a “monopoly” on the
particular variety it produces.
The firm faces a downward-sloping
demand curve for its variety.
Demand for Differentiated
Products, Cont’d.
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The demand for a particular variety will
be more price elastic than the market
demand for the good.
The demand for an existing variety will
decrease when new, desirable varieties
become available.
Profit-Maximization in
Monopolistic Competition
P
Choose Q where MR
= MC. Charge the
price on the demand
curve.
MC
p*
D
LRATC
Price must cover
AVC in the SR.
Q*
MR
Q
Price must cover
ATC in the LR.
LR equilibrium in Monopolistic
Competition
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Just as in perfect competition, we
assume no barriers to entry or exit in
monopolistic competition.
Profits will attract entry, in the form of a
firm offering a new variety.
With more varieties available, demand
for each variety is smaller.
Effect of New Variety
P
Demand for a given
variety decreases.
MC
Quantity, price,
profits fall.
D
LRATC
p’
D’
Q’
MR’
MR
Q
Long-Run Equilibrium
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Firms continue to offer additional
varieties as long as there is a profit
opportunity.
The monopolistically competitive market
is in long-run equilibrium when firms
earn zero profits, zero losses.
Long-Run Equilibrium
P
MC
LRATC
P”
Q”
MR’
Q
D’
The demand for and
costs of each variety
may be different, the
price and quantity
may be different, but
there are zero profits
earned on all
varieties.
Notes on Efficiency
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In equilibrium, the firms are producing
on the downward-sloping portion of their
LRAC curves. Wasteful excess
capacity?
P > MC. Producing too little?
But, the broadest possible range of
products is available, which benefits
consumers.
Advertising and Product
Differentiation
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Advertising can be used to “create”
demand for a product.
– Calvin Klein products.
– Toilet bowl cleaners.
– 4-wheel drive vehicles (in cities)
– Moisturizers
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Is this sort of advertising wasteful?
Location as Product
Differentiation
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Is the 7-Eleven across the street
offering the same “product” as the 7-one
at Gaskins Rd & Patterson Ave?
Is oceanfront the same as oceanview?
Quality as Product
Differentiation
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Do we all demand the same quality clothing?
Housing? Food?
Note: Advertising can make you believe
brand name is an indication of quality
(RealLemon, branded gas, Clorox).
Note: Advertising can also create a range
quality levels in the minds of consumers,
even if they don’t exist (ex: mattresses).
Oligopoly
Four Basic Models
How can two firms in a market
maximize profit?
Assume at first that they can
cooperate with each other.
Two Cooperating Firms
P
For simplicity, assume MC is
constant.
What would the monopolist
do?
What should two firms do?
MC
MR
D
Q
Cartel
P
The monopolist chooses the
point on D that maximizes
profits. Two firm cooperating
do best by emulating the
monopolist.
PM
Suppose they split the
monopolist’s output.
This is a cartel.
MC
25
50 MR
D
Q
A Cartel
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A cartel is a cooperative arrangement
among firms designed to maximize joint
profits.
It is illegal to form a cartel under U.S.
antitrust law (because it hurts
consumers).
Not prohibited internationally.
The Problem for Potential Cartels
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Each firm knows that if it produces more
than its “quota” it can earn more profits.
Firms tend to “cheat”, produce more,
which spoils the price.
Incentive to Cheat
If firm 1 produces 25 units,
then firm 2 sees the
remainder of the demand
curve as the demand for its
output.
P
PM
The MR from firm 2’s 26th
unit (Q = 51) is greater than
its MC.
MC
25
50
D
MR
Q
Difficulties of Cartels
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Incentive to cheat
Monitoring
– If price falls, is it because of a drop in
demand or cheating? How can members
monitor each other’s output?
Difficulties of Cartels, Cont’d.
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Entry
– Other potential firms see profits and wish
to enter the market without joining the
cartel.
– They cause price to fall, and members see
they no longer benefit from the cartel.
Organization of Petroleum
Exporting Countries (OPEC)
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The most successful cartel in history.
Cheating: For many years limited. But
more in the last 10 years.
Entry: limited by geology. North Sea &
Alaskan wells were started due to high
prices in the 1970s and 1980s.
Monitoring: A futures market in oil
makes it harder to tell who intends to
cheat.
Coming Up:
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Oligopoly
Group Work: Monopolistic Competition
Monopolistic Competition versus
Perfect Competition & Monopoly
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Fill in the blanks in the table with the
appropriate descriptor for a
monopolistically competitive firm. In
some cases, the feature listed for either
perfect competition or monopoly will be
correct. In other cases, you will need to
modify your answer.
Table 1a
Perfect Comp
Monopolistic
Competition
Monopoly
Firms are price
takers
Firms are price
makers
Choose q where
P=MC
Choose q where
MR=MC
In SR, P AVC in
order to produce.
In SR, P AVC in
order to produce.
In LR, P ATC in
order to produce.
In LR, P ATC in
order to produce.
Firms face perfectly
elastic demand for
their product.
Firms face
downward-sloping
market demand.
Table 1b
Perfect Comp
Monopolistic
Competition
Monopoly
No profits or losses
in LR
May have profits in
LR
No barriers to entry
or exit
Barriers to Entry
Firms produce at
lowest possible
LRAC
May or may not
produce at lowest
possible LRAC
In LR equilibrium, P
= MC
In LR equilibrium, P
> MC
Table 1c
Perfect Comp
Monopolistic
Competition
Monopoly
No need for
advertising, goods
are homogeneous
Advertising may
increase demand for
product
Brand name is
unimportant to
consumers
Only one brand to
choose from
Differentiated Educational
Institutions
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Institutions of higher education may not
be profit-maximizing entities, but they
are highly differentiated.
List the dimensions in which institutions
differentiate themselves to try to attract
students. List as many dimensions as
you can think of (at least 5)