Transcript Microeconomics Chapter 11 Final PPT

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
• The oligopolist’s kinked demand
curve
• Collusion among oligopolists
• The effects of advertising
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Monopolistic Competition
• Monopolistic competition is
characterized by a relatively
large number of sellers who
offer similar but not identical
products
– Each firm has a small
percentage of the total market
– Collusion (working together to
establish a price every firm
agrees upon) is nearly
impossible with so many firms
– Firms act independently, the
actions of one firm are ignored
by the other firms in the industry
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Monopolistic Competition
• Product differentiation and other
types of nonprice competition give
the individual firm some degree of
monopoly power
– Product differentiation may be physical
– There may be special services and
conditions that go along with the
product
– Brand names and packaging may be
different
– Product differentiation allow producers
to have some control over the prices of
their products
Monopolistic Competition
• The monopolistic firm’s demand
curve is highly elastic, but not
perfectly so
– This relatively high elasticity means
that increases in price result in a
significant loss of customers
– The seller has many rivals producing
close substitutes
– It is less elastic than in pure
competition because the seller’s
product is differentiated from its rivals,
so that the firm has some control over
price
Monopolistic Competition
• In the short-run situation, the firm
will maximize profits or minimizes
losses by producing where MC =
MR, as in both pure competition
and monopoly
Monopolistic Competition
Short-Run Profits
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
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Monopolistic Competition
Short-Run Losses
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
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Long-run Situation
• In the long-run situation, the firm will tend to earn
a normal profit only, that it, it will break even
– Firms can enter the industry easily and will when an
economic profit can be made
– As firms enter the industry, this decreases the
demand curve facing an individual firm as buyers
shift some demand to new firms
– The demand curve will shift until the firm just breaks
even
– If the demand shifts below the break-even point,
some firms will leave the industry in the long run
– When firms leave the industry, the demand curve
facing each firm will be raised (fewer substitutes for
buyers) and the break-even point (normal profits) will
be reached
Monopolistic Competition
Long-Run Equilibrium
MC
Price and Costs
ATC
P3= A3
D3
MR = MC
MR
0
Q3
Quantity
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Exceptions to long-run
normal profit scenario
• The products of some firms may become
so differentiated that they are not easily
duplicated by rivals
– These firms may enjoy economic profits in
the long-run
• Some restrictions to entry in the industry
such as financial barriers may exist,
especially for small firms
Economics Efficiency
• Monopolistic firms do not have allocative
or productive efficiency
– Allocative efficiency occurs when price =
marginal cost; i.e., the right amount of
resources are allocated to the product
– Productive efficiency occurs when price =
minimum average total cost; where
production occurs using the least-cost
combination of resources
– The gap between price and marginal cost for
each firm creates a loss in efficiency
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
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Oligopoly
• Oligopoly exists where a few
large firms that produce either
a homogeneous (almost
identical) or differentiated
product dominate the market
• There are few enough firms in
the industry that firms are
mutually interdependent
• Because there are so few firms
in the industry, oligopolists
have considerabe control over
their prices
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–Some oligopolistic industries
produce standardized products
such as steel and cement, while
others produce differentiated
products such as automobiles
–They must consider the reactions
of their business rivals when ever
they change prices, output, or
advertise.
Oligopoly
• There are barriers to entry by new firms
– Economies of scale may exist due to technology
and market share
– Capital investment requirements may be very
large
– Other barriers may exist such as patents, control
of raw materials, retaliatory pricing, large
advertising budgets, and brand loyality
• While some firms have become oligopolists
through growth of the business, others have
acquired the status through mergers and
acquistions
Three Oligopoly Models
• Because of the diversity in
oligopolistic firms, there are three
models used to explain the priceoutput behavior
–Kinked-demand curve
–Collusive pricing
–Price leadership
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The kinked-demand Model
• Assumes firms do not act together in a collusive
manner
• Each firm believes the other firm will match any
price cuts
– Because of that, they do not want to lower prices
since total revenue will fall when demand is inelastic
• However, they do not believe any other firm would
raise prices if they did
– With a price raise, the demand would be elastic;
revenue would decrease
• This analysis is one explanation of the fact that
prices tend to be inflexible in oligopolistic
industries
The kinked-demand Model
• Movement of the demand curve will depend
upon whether there is a price cut or a price
increase involved, and the response of the
other rival firms
• If firm A cuts their price, its sales increase
only a little because business rivals will also
cut their price to prevent firm A from gaining
an advantage over them
– The small increase in sales that firm A receives
is from other firms in the industry
– Firm A probably wouldn’t raise their prices, and
lose market share
The kinked-demand Model
• Other firms might choose to ignore the
price changes by firm A
– If firm A lowers price and its rivals do not, firm
A will gain significantly at the expense of its
rivals
– If the firm raises its price, and its rivals do not,
firm A will lose customers to its rivals
because it will be undersold
– However, even if firm A raises its price, it will
not be totally priced out of the market
because of product loyalty.
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
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Collusions
• Collusion between firms reduces
uncertainty, increases profits, and may
prohibit the entry of new rivals
• A cartel is a group of producers that sign
formal agreements as to how each may
produce and charge (such as OPEC)
– Assuming each member had identical cost,
demand, and marginal-revenue data, the
resulting cartel would behave economically
as if they were made up of a single monopoly
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
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Cartels and Other Collusion
• Covert collusion – not formalized
– Tacit understandings
• Obstacles to collusion
– Demand and cost differences among
firms
– Too many firms in the industry
– An incentive to cheat
– Recession with decreasing demand
and increasing average total costs
– Potential entry when profits become
too high
– Legal obstacles: antitrust law that
prohibit collusion
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Price Leadership Model
• Price leadership is a type of
gentleman’s agreement to
coordinate their prices legally
–No formal agreements
–One firm, usually the largest,
changes the price first and then the
other firms follow
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Price Leadership Model
Several price leadership tactics are practiced by the
leading firm
• Prices are changed only when cost and demand
conditions have been significantly altered
industry-wide
• Publicizing the “need to raise prices” through
publications and speeches puts other firms on
alert
• The new price may be below the short-run profitmaximizing level (an economic loss) to
discourage new firms from entering the industry
• Price leadership in oligopoly occasionally breaks
down and a price war may result
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
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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
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Oligopoly and Efficiency
• Not productively efficient
• Not allocatively efficient
• Tendency to share the monopoly
profit
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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
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Next Chapter Preview…
Technology, R&D,
And Efficiency
11-31