Monopolistic Competition and Oligopoly

1. 9 Monopolistic Competition and Oligopoly

2. Monopolistic Competition • Relatively large number of sellers • Differentiated products • Easy entry and exit • Advertising LO1

3. Price and Output in Monopolistic Competition • Demand is highly elastic • Short-run profit or loss • Produce where MR = MC • Long-run normal profit • Entry and exit • Inefficient • Product variety LO2

4. The Short Run: Profit or Loss ATC MC P1 A1 Price and Costs Economic Profit D1 MR = MC MR 0 Q1 Quantity LO2

5. The Short Run: Profit or Loss ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR 0 Q2 Quantity LO2

6. The Long Run: Only a Normal Profit MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity LO2

7. Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO2

8. Monopolistic Competition: Efficiency MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity P = MC = min ATC for pure competition (recall) P4 Price is lower Excess capacity at minimum ATC Q4 Monopolistic competition is not efficient LO2

9. Product Variety • The firm constantly manages price, 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 LO2

10. Oligopoly • A few large producers • Homogeneous or differentiated products • Limited control over price • Mutual interdependence • Strategic behavior • Entry barriers • Mergers LO3

11. Game Theory Overview • Oligopolies display strategic pricing behavior • Mutual interdependence • Collusion • Incentive to cheat • Prisoner’s dilemma LO4

12. Game Theory Overview RareAir’s Price Strategy • 2 competitors • 2 price strategies • Each strategy has a payoff matrix • Greatest combined • profit • Independent actions stimulate a response High Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8 LO4

13. Game Theory Overview RareAir’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 High Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8 LO4

14. Kinked-Demand Theory • Noncollusive oligopoly • Uncertainty about rivals’ reactions • Rivals match any price change • Rivals ignore any price change • Assume combined strategy • Match price reductions • Ignore price increases LO5

15. Kinked-Demand Curve MC1 D2 e MR2 MC2 P0 f g D1 Q0 MR1 LO5

16. Kinked-Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6

17. Price Leadership Model • Price leadership • Dominant firm initiates price changes • Other firms follow the leader • Use limit pricing to block entry of new firms • Possible price war LO6

18. Collusion • Cartel • Overt collusion • Covert collusion • Joint-profit maximization LO6

19. Collusion Price and Costs Quantity MC P0 ATC A0 MR=MC Economic profit D MR Q0 LO6

20. Overt Collusion • Cartels: a group of firms or nations that collude • Formally agree to the price • Set output levels for members • Collusion is illegal in the United States • OPEC LO6

21. Obstacles to Collusion • Demand and cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles LO6

22. Oligopoly and Advertising • Prevalent to compete with product development and advertising • Less easily duplicated than a price change • Financially able to advertise LO7

23. Positive Effects of Advertising • Low-cost way of providing information to consumers • Enhances competition • Speeds up technological progress • Can help firms obtain economies of scale LO7

24. Oligopoly and Advertising Source: Advertising Age, www.adage.com LO7

25. Negative Effects of Advertising • Can be manipulative • Contains misleading claims that confuse consumers • Consumers pay high prices for a good while forgoing a better, lower-priced, unadvertised version of the product LO7

26. Global Snapshot LO7

27. Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > min ATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7

28. Oligopoly in the Beer Industry • The beer industry is now an oligopoly • Changes in demand • Change in tastes • Consumed at home and mass produced • Changes in supply • Technological advance • Economies of scale LO2