Transcript Chapter 14
14 Monopolistic Competition and Oligopoly McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Four Market Models Characteristics of the Four Basic Market Models Characteristic Pure Competition Monopolistic Competition Oligopoly Monopoly Number of firms A very large number Many Few One Type of product Standardized Differentiated Standardized or differentiated Unique; no close subs. Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Considerable Conditions of entry Very easy, no obstacles Relatively easy Significant obstacles Blocked Nonprice competition None Considerable emphasis on advertising, brand names, trademarks Typically a great deal, particularly with product differentiation Mostly public relation advertising Examples Agriculture Retail trade, dresses, shoes Steel, auto, farm implements Local utilities LO1 Monopolistic Competition • Relatively large number of sellers • Differentiated products • Easy entry and exit • Advertising LO1 Monopolistically Competitive • Industry concentration • Measured by: • Four-firm concentration ratios • Percentage of 4 largest firms 4-Firm CR = Output of four largest firms Total output in the industry • Herfindahl index • Sum of squared market shares HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2 LO1 Price and Output in Monopolistic Comp • Demand is highly elastic • Short run profit or loss • Produce where MR=MC • Long run normal profit • Entry and exit • Inefficient • Product variety LO2 The Short Run: Profit or Loss Price and Costs MC ATC P1 A1 Economic Profit D1 MR = MC MR 0 Q1 Quantity LO2 The Short Run: Profit or Loss Price and Costs MC ATC A2 P2 Loss D2 MR = MC MR 0 Q2 Quantity LO2 The Long Run: Only a Normal Profit MC Price and Costs ATC P3= A3 D3 MR = MC MR 0 Q3 Quantity LO2 Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO2 Monopolistic Competition: Efficiency 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 Q3 MR Q4 Quantity Monopolistic competition is not efficient LO2 Product Variety • The firm constantly manages price, • LO2 product, and advertising • Better product differentiation • Better advertising The consumer benefits by greater array of choices and better products • Types and styles • Brands and quality Oligopoly • A few large producers • Homogeneous or differentiated • • • LO3 products Limited control over price • Mutual interdependence • Strategic behavior Entry barriers Mergers Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be oligopoly • Shortcomings • Localized markets • Inter-industry competition • World price • Dominant firms LO3 Game Theory Overview • Oligopolies display strategic pricing behavior • Mutual interdependence • Collusion • Incentive to cheat • Prisoner’s dilemma LO4 Game Theory Overview RareAir’s Price Strategy LO4 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 Game Theory Overview RareAir’s Price Strategy LO4 High Uptown’s Price Strategy • Independently lowered prices in expectation of greater profit leads to 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 Three Oligopoly Models • Kinked-demand curve • Collusive pricing • Price leadership • Reasons for 3 models • Diversity of oligopolies • Complications of interdependence LO5 Kinked-Demand Curve Rivals Ignore Price Increase MC1 e P0 f D2 Q0 Quantity LO5 P0 e MR2 f MC2 MR2 Rivals Match g Price Decrease 0 Price Price D2 g D1 MR1 D1 0 Q0 Quantity MR1 Kinked-Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6 Cartels and Other Collusion Price and Costs MC P0 ATC A0 MR=MC Economic Profit Q0 LO6 D MR Quantity Overt Collusion • Cartels - a group of firms or nations • • LO6 that collude • Formally agreeing to the price • Sets output levels for members Collusion is illegal in the United States OPEC Obstacles to Collusion • Demand and cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles LO6 Price Leadership Model • Price Leadership • Dominant firm initiates price • • LO6 changes • Other firms follow the leader Use limit pricing to block entry of new firms Possible price war Oligopoly and Advertising • Prevalent to compete with product development and advertising • Less easily duplicated than a price change • Financially able to advertise LO7 Advertising Positive Effects Negative Effects Low-cost way of providing information to consumers Can be manipulative Enhances competition Contains misleading claims that confuse consumers Speeds up technological progress Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product Can help firms obtain economies of scale LO7 Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > minATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7