Transcript P 0

Monopolistic
Competition and
Oligopoly
Chapter 11
Monopolistic Competition
• Large number of sellers
–Small market shares
–No collusion
–Independent action
• Differentiated Products
–Product attributes
–Service
–Location
–Brand names and packaging
–Some control over price
11-2
Monopolistic Competition
• Easy entry and exit
• Need for advertising
–Nonprice Competition
• Which industries?
–Degree of concentration
–Four-firm concentration ratio
–Herfindahl index
11-3
Monopolistic Competition
• Firm’s demand curve
–Highly elastic, differentiating it from
monopoly and pure competition
• Short run profit or loss
–Produce where MR=MC
11-4
Monopolistic Competition
Short-Run Profits
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
11-5
Monopolistic Competition
Short-Run Losses
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
11-6
Monopolistic Competition
• Long run normal profit
–Entry and exit
–As firms enter, the demand faced
by individual firm falls until it is
tangential to ATC
11-7
Monopolistic Competition
Long-Run Equilibrium
MC
Price and Costs
ATC
P3= A3
D3
MR = MC
MR
0
Q3
Quantity
11-8
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
11-9
Monopolistic Competition
• Inefficient
–Neither allocative nor productive
efficiency achieved
• Product variety
–Can maintain profits by
maintaining product differentiation
11-10
Oligopoly
• A few large producers
• Homogeneous or
differentiated products
• Control over price
–Mutual interdependence
–Strategic behavior
• Entry barriers
• Mergers
11-11
Oligopoly
• Four-firm concentration ratio
–Needs to be more than 40%
Shortcomings:
1. Localized markets
2. Inter-industry competition
–substitutes
11-12
Oligopoly
3. World trade
–Import Competition
4. Dominant firms
–A firm may have close to 100%
share and operate as a
monopoly while others operate
as oligopoly
• Solution: Herfindahl index
11-13
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
11-14
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
11-15
Game Theory
• Mutual interdependence
–Pricing policy
• Collusion
–Enhances profit by agreeing to a
high price policy
• Incentive to cheat
• Prisoner’s dilemma
–Fearful that other will cheat, both
firms will probably cheat
11-16
Three Oligopoly Models
1. Kinked-demand curve
2. Collusive pricing
3. Price leadership
• Why three models?
–Diversity of oligopolies
–Complications of interdependence
11-17
Kinked-Demand Curve
• Noncollusive oligopoly
• What does D look like?
–Will depend on how rivals
react to a price change
1.Match price changes
–Steep D and MR because if P
cut, sales will increase
modestly as other firms also
cut P
11-18
Kinked-Demand Curve
2. Ignore price changes
–Flatter D and MR
–P cut will ensure significant
gain in sales
–As P rises, all sales will not be
lost due to product
differentiation
11-19
Kinked-Demand Curve
Price
Competitor and rivals strategize versus each other
D2
g
MR2
D1
0
MR1
Quantity
Combined strategy
• Which assumption should the firm
make about its rivals?
–Depends on direction of price
change
• Match price decline below P0
• as they act to prevent price
cutter from taking their customers
• Ignore price increases above P0
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
11-22
Price inflexibility
• On the D side, any change in P will be for
the worse
• If it raises P, many customers will desert it
• If it lowers P, sales will only improve
modestly as rivals also lower P
• On the cost side, all positions of MC
between MC1 and MC2 will result in same
decision
Kinked-Demand Curve
• Criticisms of the model:
1. Explains inflexibility not how
does price get to P0
2. Prices are not that rigid
when macroeconomy is
unstable resulting in price
wars
11-24
Cartels and Other Collusion
• Price and output
–Joint profit maximization
Price and Costs
MC
Effectively Sharing
The Monopoly Profit
P0
ATC
A0
MR=MC
Economic
Profit
D
MR
Q0
Quantity
11-25
Cartels and Other Collusion
• Covert collusion
–Tacit understandings
• Obstacles to collusion
–Demand and cost differences
–Number of firms
–Cheating
–Recession
–Potential entry
–Legal obstacles: antitrust law
11-26
Price Leadership Model
• One dominant firm sets price
• Infrequent price changes
–Risk that rivals might not follow
• Communications
• Limit pricing
–May lower prices to discourage
entry
• Breakdowns in price leadership:
–Price wars
11-27
Oligopoly and Efficiency
• Not productively efficient
• Not allocatively efficient
• Tendency to share the monopoly
profit
• Qualifications
–Increased foreign competition
–Limit pricing
–Technological advance
11-28