Transcript Monopolistic Competition and Oligopoly

Monopolistic
Competition
and
Oligopoly
CHAPTER TWENTY-FIVE
Four Market Models
Monopolistic
Competition
Pure
Monopoly
Pure
Competition
Market Structure Continuum
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Product Attributes
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Product Attributes
Services
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Product Attributes
Services
Location
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Product Attributes
Services
Location
Brand Names and Packaging
Monopolistic Competition
Characteristics...
• Relatively Large Numbers
Small Market Share
No Collusion
Independent Actions
• Product Differentiation
Product Attributes
Services
Location
Brand Names and Packaging
Some Control Over Price
Monopolistic Competition
Characteristics...
• Easy Entry and Exit
Monopolistic Competition
Characteristics...
• Easy Entry and Exit
• Nonprice Competition
Monopolistic Competition
Characteristics...
• Easy Entry and Exit
• Nonprice Competition
• Advertising
Monopolistic Competition
Characteristics...
• Easy Entry and Exit
• Nonprice Competition
• Advertising
• Monopolistically
Competitive
Industries
Short-Run Price and Output Determination
Price and Costs
P
Monopolistic competitors
have an elastic demand curve,
but not perfectly elastic...
Q
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Short-Run Price and Output Determination
Price and Costs
P
D
Q
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Short-Run Price and Output Determination
Price and Costs
P
D
MR
Q
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Short-Run Price and Output Determination
MC
Price and Costs
P
D
MR
Q
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Q
Short-Run Price and Output Determination
MC
P
Price and Costs
ATC
D
MR
Q
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Q
Short-Run Price and Output Determination
P
Expect New Competitors
MC
Price and Costs
ATC
Economic
Profits
D
MR
Q
Q
Short-Run Price and Output Determination
P
Expect New Competitors
MC
Price and Costs
ATC
How would
short-run losses
Economic
Profitsdifferent?
be
D
MR
Q
Q
Short-Run Price and Output Determination
MC
Price and Costs
P
ATC
Economic
Losses
Expect
Less
Competitors
D
MR
Q
Q
Short-Run Price and Output Determination
MC
Price and Costs
P
How would
Economic
the
long-run
Losses
Expect
differ?
Less
Competitors
ATC
D
MR
Q
Q
Short-Run Price and Output Determination
P
Expect New Competitors
MC
Price and Costs
ATC
Economic
Profits
D
MR
Q
Q
Short-Run Price and Output Determination
P
Long-run equilibrium
MC
Price and Costs
ATC
P = MC
D
MR
Q
Q
Q @ ATC Min ?
Monopolistic Competition
and Economic Efficiency
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
• Not Allocatively Efficient
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
• Not Allocatively Efficient
• Excess Capacity
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
• Not Allocatively Efficient
• Excess Capacity
Nonprice Competition
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
• Not Allocatively Efficient
• Excess Capacity
Nonprice Competition
• Product Differentiation
Monopolistic Competition
and Economic Efficiency
• Not Productively Efficient
• Not Allocatively Efficient
• Excess Capacity
Nonprice Competition
• Product Differentiation
• Product Development
Features of a Monopolistic Competitive Markets:
1. Many sellers
2. Unique Products that have close or identical substitutes:
Big Mac v Whopper
3. Small barrier to entry or exit
4. Some market power exists
5. Price is greater than MR, Separate DARP and MR curves
6. Non price competition and advertising exist
7. Profits maximized at the Quantity and Price where MC = MR
8. Excess or Economic Profits in the Short Run only (P>ATC)
9. Profits must be Normal in the Long Run (P=ATC)
10. Firms should shut down when P < AVC
11. Excess capacity exists in terms of potential output
12. Demand is relatively elastic by comparison to monopoly
13. Example market - Minimarts, Fast food at local franchises
14. This market is much closer to perfect competition than
pure monopoly
Four Market Models
Oligopoly
Pure
Competition
Monopolistic
Competition
Market Structure Continuum
Pure
Monopoly
Oligopoly: Characteristics
Oligopoly: Characteristics
• Oligopoly Defined
Oligopoly: Characteristics
• Oligopoly Defined
• Homogeneous or
Differentiated Products
Oligopoly: Characteristics
• Oligopoly Defined
• Homogeneous or
Differentiated Products
• Control over Price
Oligopoly: Characteristics
• Oligopoly Defined
• Homogeneous or
Differentiated Products
• Control over Price
• Mutual Interdependence
Oligopoly: Characteristics
• Oligopoly Defined
• Homogeneous or
Differentiated Products
• Control over Price
• Mutual Interdependence
• Entry Barriers
Oligopoly: Characteristics
• Oligopoly Defined
• Homogeneous or
Differentiated Products
• Control over Price
• Mutual Interdependence
• Entry Barriers
• Mergers
Oligopoly: Characteristics
• Concentration Ratios
Ratios that look at what the concentration of firms are in the industry.
Oligopoly: Characteristics
• Concentration Ratios
- Herfindahl Index – The larger
the index number the higher the
concentration of the industry.
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Greatest
Combined
Profit
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Independent
Actions
Stimulate
Response
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Independent
Actions
Stimulate
Response
Gravitating
to the
Worst Case
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Collusion
Invites a
Different
Solution
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Collusion
Invites a
Different
Solution
Oligopoly Behavior
A Game Theory Overview...
RareAir’s Price Strategy
Uptown’s Price Strategy
High
A
$12
Low
B
$15
High
$12
C
$6
$6
D
Low
$15
$8
$8
Collusion
Invites a
Different
Solution
But, the
incentive
to cheat
is very real
Pay Off Matrix Oligopoly – Reasons for Collusion
Ads Effect Sales (Q) and P x Q = TR so Ads effect Total Revenue!
Low Cost Ads: 120 :30 second Ads/week for $10,000
High Cost Ads: 240 :30 second Ads/week for $20,000
TR - TC = TP
TR - TC = TP
Company A
High Ads $100,000 – 20,000 = $80,000
Low Ads $50,000 – 10,000 = $40,000
Company B
Low Ads $50,000 – 10,000 = $40,000
High Ads $100,000 – 20,000 = $80,000
Company A
Low Ads $75,000 – 10,000 = $65,000
High Ads $75,000 – 20,000 = $55,000
Company B
Low Ads $75,000 – 10,000 = $65,000
High Ads $75,000 – 20,000 = $55,000
If either duopolist begins running High Ads, its competitor will
counter with High Ads!
Games Theory and Collusion’s answer is an agreement by
“both”to keep advertising low in order to maximize profits!
Would their be incentive to Cheat?
Three Oligopoly Models
No Standard Model due to...
Three Oligopoly Models
No Standard Model due to...
Diversity
Three Oligopoly Models
No Standard Model due to...
Diversity
Interdependence
Three Oligopoly Models
No Standard Model due to...
Diversity
Interdependence
1 - Kinked Demand Curve
Three Oligopoly Models
No Standard Model due to...
Diversity
Interdependence
1 - Kinked Demand Curve
2 - Collusive Pricing
Three Oligopoly Models
No Standard Model due to...
Diversity
Interdependence
1 - Kinked Demand Curve
2 - Collusive Pricing
3 - Price Leadership
Kinked Demand: Noncollusive Oligopoly
P
The firm’s demand
and marginal
revenue curves
when rivals follow
pricing patterns.
D1
Quantity
MR1
Q
Kinked Demand: Noncollusive Oligopoly
P
The firms demand
and marginal
revenue curves when
rivals don’t follow
pricing patterns.
D2
D1
Quantity
MR1
MR2
Q
Kinked Demand: Noncollusive Oligopoly
P
Rivals tend to
follow a price cut
D2
D1
Quantity
MR1
MR2
Q
Kinked Demand: Noncollusive Oligopoly
P
Rivals tend to
follow a price cut
or ignore a
price increase
D2
D1
Quantity
MR1
MR2
Q
Kinked Demand: Noncollusive Oligopoly
P
Effectively creating
a kinked demand curve
D2
D1
Quantity
MR1
MR2
Q
Kinked Demand: Noncollusive Oligopoly
P
Effectively creating
a kinked demand curve
D2
MC1
MR2
MC2
D1
Quantity
MR1
Q
Cartels and Collusion
Cartels and Collusion
Oligopoly is conducive to collusion
Cartels and Collusion
Oligopoly is conducive to collusion
If a few firms face identical or
highly similar demand and costs...
Cartels and Collusion
Oligopoly is conducive to collusion
If a few firms face identical or
highly similar demand and costs...
They will seek joint profit
maximization...
Colluding Oligopolists Will
Split the Monopoly Profits
Price
MC
P
ATC
D
MR = MC
Economic
Profit
MR
Q
Quantity
Cartels and Collusion
Overt Collusion
Cartels and Collusion
Overt Collusion
OPEC Cartel
Cartels and Collusion
Overt Collusion
OPEC Cartel
Covert Collusion
Obstacles to Collusion
Obstacles to Collusion
Demand & Cost Differences
Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Potential Entry
Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Potential Entry
Legal Obstacles: Antitrust
Price Leadership
Price Leadership
Leadership Tactics
Price Leadership
Leadership Tactics
Infrequent Changes
Price Leadership
Leadership Tactics
Infrequent Changes
Communication
Price Leadership
Leadership Tactics
Infrequent Changes
Communication
Limit Pricing - sometimes
smaller companies will wage price
wars to knock the leader down.
Oligopoly & Advertising
Unit Costs
Advertising Effects on Output & Average Costs
ATC
without
advertising
Q
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Q
Advertising Effects on Output & Average Costs
ATC
Unit Costs
with
advertising
ATC
without
advertising
Q
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Q
Advertising Effects on Output & Average Costs
Advertising Costs
ATC
Unit Costs
with
advertising
ATC
without
advertising
Q
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Q
Oligopoly and Economic Efficiency
Recall...
Allocative Efficiency
(Price = MC)
Oligopoly and Economic Efficiency
Recall...
Allocative Efficiency
(Price = MC)
Productive Efficiency
(Price = Minimum ATC)
Oligopoly and Economic Efficiency
Recall...
Allocative Efficiency
(Price = MC)
Productive Efficiency
(Price = Minimum ATC)
Neither is likely in an
oligopoly market structure
Features of an Oligopolistic Markets:
1. Few sellers (Less than seven),
Duopoly - two main sellers + the fringe firms
2. Unique Products but similar products Coke v Pepsi, Chevy v Ford
3. Large barrier to entry or exit
4. A large measure of market power exists
5. Price is greater than MR, Separate DARP and MR curves
6. Non price competition and advertising exist
Procter & Gamble: $3,277,000,000 in Ads 1999
7. Profits maximized at the Quantity and Price where MC = MR
8. Excess or Economic Profits possible in the Long Run (P>ATC)
9. Interdependence, Collusion, Spies, Pay off Matrix
Price and Innovative Leaders exist, Gamesmanship
“A Beautiful Mind”
10. Firms should shut down when P < AVC
11. Excess capacity exists in terms of potential output
12. Demand is relatively inelastic
13. Theory of the Kinked Demand Curve and Price Stickiness
results from collusion and gamesmanship
14. Example market - Automobiles, Soda, Beer, Steel, Tobacco
Products may be differentiated (Toyota v Ford) or homogeneous (Steel)
Advertising Effects on Output & Average Costs
Advertising Costs
Unit Costs
ATC
Questions
and
ATC
Discussion... advertising
with
advertising
without
Q
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Q
u
u
u
u
u
u
u
u
u
monopolistic competition
product differentiation
nonprice competition
excess capacity
oligopoly
homogeneous oligopoly
differentiated oligopoly
mutual interdependence
concentration ratio
u
u
u
u
u
u
u
u
u
u
interindustry competition
import competition
Herfindahl index
game theory model
collusion
kinked demand curve
price war
cartel
tacit understandings
price leadership
Next...
Technology,
R&D,
and
Efficiency
Chapter 26