Chapter 12: Oligopoly and Monopolistic Competition

1. Chapter 12: Oligopoly and Monopolistic Competition

2. Characteristics of a monopolistically competitive market • Many buyers and sellers • Differentiated products • Easy entry and exit

3. examples • running shoes • fast food franchises • clothing • cleaning supplies • beauty products

4. product differentiation • physical differences • color, size, taste ... • location • convenience, drug stores • services • delivery • image • high quality vs. value

5. Relationship to perfect competition • Monopolistic competition is similar to perfect competition in that: • There are many buyers and sellers • There are no barriers to entry or exit • But it is difference because: • Product is NOT identical • Downward sloping demand curve

6. Relationship to monopoly • Monopolistic competition is similar to monopoly in that: • Each firm is the sole producer of a particular product (although close substitutes) • The firm faces a downward sloping demand curve for its product • But it is different from monopoly in that • No barriers to entry • Many firms

7. P, cost D MR Q Demand curve facing a monopolistically competitive firm

8. The firm’s demand curve and entry and exit • Monopolistically competitive demand curve • More elastic than monopoly • Less elastic than perfect competition

9. The firm’s demand curve and entry and exit • As firms enter a monopolistically competitive market, the demand facing a typical firm • Declines • becomes more elastic.

10. P D D after entry Q Before entry

11. P, cost MC P* D MR Q Q* Short-run equilibrium in a monopolistically competitive industry • choose price & output like a monopolist

12. economic profit P, cost MC P* ATC D MR Q Q* Short-run equilibrium in a monopolistically competitive industry • Economic profits lead to entry and a reduction in the demand facing a typical firm. ATC*

13. Long Run • zero economic profit • why? • economic profit leads to entry • Falling FIRM demand • economic loss leads to exit • Rising FIRM demand • no entry/exit with zero economic profit

14. P, cost MC P* ATC D MR Q Q* Long-run equilibrium in a monopolistically competitive industry • Entry continues until economic profit equals zero • “tangency equilibrium.” ATC*

15. P, cost MC P* ATC D MR Q Q* Short-run equilibrium with economic losses ATC*

16. Long-run equilibrium

17. Excess capacity • firms output is not at minimum of ATC • Cost is not minimized • output too small • loss of economic welfare • This is the tradeoff for product variety

18. Monopolistic competition vs. perfect competition

19. Monopolistic competition and efficiency • As the number of firms rises, a monopolistically competitive firm’s demand curve becomes more elastic. • As the number of firms in a market expands, the market approaches a perfectly competitive market. • Thus, economic inefficiency may be smaller when there is a large number of firms in a monopolistically competitive market.

20. Product differentiation and advertising • Monopolistically competitive firms may receive short-run economic profit from successful product differentiation and advertising. • These profits are, however, expected to disappear in the long run as other firms copy successful innovations.

21. Location decisions • Why do gas stations locate across the street? • To eliminate customer choice based solely on location • Monopolistically competitive firms often locate near each other to appeal to the “median” customer in a geographical region. • Example: auto row (Genesee St.)

22. Next time, 11/8 • Dr. Spizman • Oligopoly (chapter 12)

23. Oligopoly • a small number of firms produce most output • a standardized or differentiated product • recognized mutual interdependence, and • difficult entry.

24. Strategic behavior • Strategic behavior occurs when the best outcome for one party depends upon the actions and reactions of other parties.

25. Kinked demand curve model • Other firms are assumed to match price decreases, but not price increases. • There is little evidence suggesting that this model describes the behavior of oligopoly firms. • Game theory models are more commonly used.

26. Game theory • Examines the payoffs associated with alternative choices of each participant in the “game.”

27. Game theory examples • Prisoners’ dilemma • Duopoly pricing game

28. Dominant strategy • A dominant strategy is one that provides the highest payoff for an individual for each and every possible action by rivals. • Confession is the dominant strategy in the prisoners’ dilemma game. A low price is the dominant strategy in the duopoly pricing game • It is more difficult to predict the outcome when no dominant strategy exists or when the game is repeated with the same players.

29. Shared monopoly • Joint profits are higher when firms behave as a shared monopoly • Such a cartel arrangement is illegal in the U.S. • Price leadership • Facilitating practices (e.g., cost-plus pricing, recommended retail prices, etc.)

30. Cartels • Cartels are legal in some countries • A cartel arrangement can maximize industry profits • Each firm can increase its profits by violating the agreement • Cartel agreements have generally been unstable.

31. Imperfect information • Brand name identification – serves as a signal of product quality. Customers are willing to pay a higher price for products produced by firms that they recognize. • Product guarantees also serve as a signal of product quality