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Roger LeRoy Miller Economics Today

Roger LeRoy Miller Economics Today. Chapter 25 Monopolistic Competition, Oligopoly, and Strategic Behavior.

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Roger LeRoy Miller Economics Today

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  1. Roger LeRoy Miller Economics Today Chapter 25 Monopolistic Competition, Oligopoly, and Strategic Behavior

  2. Shoppers at the Web site of the apparel manufacturer Eddie Bauer can use a “virtual dressing room” to click and drag clothes together for a closer look. By making its Web site interesting and useful Eddie Bauer seeks to differentiate its brand name and attract customers. To understand the actions of firms that sell similar but differentiated goods, you must learn about monopolistic competition. Introduction

  3. Learning Objectives • Discuss the key characteristics of a monopolistically competitive industry • Contrast the output and pricing decisions of monopolistically competitive firms with those of perfectly competitive firms

  4. Learning Objectives • Outline the fundamental characteristics of oligopoly • Understand how to apply game theory to evaluate the pricing strategies of oligopolistic firms

  5. Learning Objectives • Explain the kinked demand curve theory of oligopolistic price rigidity • Describe theories of how firms may deter market entry by potential rivals

  6. Chapter Outline • Monopolistic Competition • Price and Output for the Monopolistic Competitor • Comparing Perfect Competition with Monopolistic Competition • Oligopoly

  7. Chapter Outline • Strategic Behavior and Game Theory • Price Rigidity and the Kinked Demand Curve • Strategic Behavior with Implicit Collusion: A Model of Price Leadership • Deterring Entry into an Industry • Comparing Market Structures

  8. Did You Know That... • 80 percent of initial customer contacts for General Motors Saturn division now originate on the Internet? • GM and other businesses leave no stone unturned to inform people about what they sell, where people can buy it, and at what price?

  9. Monopolistic Competition • Monopolistic Competition • A market situation in which a large number of firms produce similar but not identical products • Entry into the industry is relatively easy

  10. Monopolistic Competition • Characteristics of monopolistic competition • Significant number of sellers in a highly competitive market • Differentiated products • Sales promotion and advertising • Easy entry of new firms in the long run

  11. Monopolistic Competition • Implications of the large number of firms • Small market share • Lack of collusion • Independence

  12. Monopolistic Competition • Product Differentiation • The distinguishing of products by brand name, color, and other minor attributes

  13. Monopolistic Competition • Product differentiation and price • Differentiate perfectly • Producer is a monopoly • Significant influence on price • Differentiation is not perfect • Producer is a monopolistic competitor • The more successful it is at differentiation the more control over price

  14. Monopolistic Competition • Ease of entry • Threat of a more efficient competitor is always present

  15. Monopolistic Competition • Sales promotion and advertising • Can increase demand for a firm • Can differentiate a firm’s product • Should be continued to the point at which the additional revenue from one more dollar of advertising just equals that one dollar of marginal cost

  16. Monopolistic Competition • Advertising as signaling behavior • Advertising over a long period of time is a signal that a firm wants repeat business

  17. Monopolistic Competition • What do you think? • Would a perfect competitor have any incentive to advertise? • Why would a monopolistically competitive firm advertise? • Can advertising lead to efficiency?

  18. Short-Run and Long-RunEquilibrium with Monopolistic Competition • Price (P1) > ATC • Economic profit Figure 25-1, Panel (a)

  19. Short-Run and Long-RunEquilibrium with Monopolistic Competition -Price (P1) < ATC -Economic loss Figure 25-1, Panel (b)

  20. Short-Run and Long-RunEquilibrium with Monopolistic Competition -Price (P1) = ATC -Normal rate of return Figure 25-1, Panel (c)

  21. Comparing Perfect Competitionwith Monopolistic Competition • Perfect competitors and monopolistic competitors earn zero economic profit. • How are they different?

  22. Comparison of the Perfect Competitorwith the Monopolistic Competitor Figure 25-2, Panels (a) and (b)

  23. Comparing Perfect Competitionwith Monopolistic Competition • What do you think? • Would you want to live in a perfectly competitive world with homogenous products?

  24. Oligopoly • Oligopoly • A market situation in which there are very few sellers • Each seller knows that the other sellers will react to its changes in prices and quantities

  25. Oligopoly • Characteristics of oligopoly • Small number of firms • Interdependence • Strategic dependence

  26. Oligopoly • Strategic Dependence • A situation in which one firm’s actions with respect to price, quality, advertising, and related changes may be strategically countered by the reactions of one or more other firms in the industry

  27. Oligopoly • Why oligopoly occurs • Economies of scale • Barriers to entry • Mergers • Vertical mergers • Horizontal mergers

  28. Oligopoly • Vertical Merger • The joining of a firm with another to which it sells an output or from which it buys an input • Horizontal Merger • The joining of firms that are producing or selling a similar product

  29. Oligopoly • Measuring industry concentration • Concentration Ratio • The percentage of all sales contributed by the leading four or leading eight firms in an industry

  30. 400 88.9% = 450 Four-firm concentration ratio = Computing the Four-Firm Concentration Ratio Annual Sales Firm ($ Millions) 1 150 2 100 3 80 4 70 5 through 25 50 Total number of firms in Industry = 25 Total 450

  31. Computing the Four-Firm Concentration Ratio Percentage of Value of Total Domestic Shipments Accounted Industry For By the Top Four Firms % Domestic motor vehicles 84 Breakfast cereals 85 Soft drinks 69 Tobacco products 93 Primary aluminum 59 Household vacuum cleaners 59 Electronic computers 45 Printing and publishing 23 Source: U.S. Bureau of the Census

  32. Oligopoly • What do you think? • Are oligopolies inefficient?

  33. Strategic Behaviorand Game Theory • Explaining the pricing and output behavior of oligopoly markets • Reaction Function • The manner in which one oligopolist reacts to a change in price, output, or quality made by another oligopolist in the industry

  34. Strategic Behaviorand Game Theory • Game Theory • A way of describing the various possible outcomes in any situation involving two or more interacting individuals when those individuals are aware of the interactive nature of their situation and plan accordingly

  35. Strategic Behaviorand Game Theory • Cooperative Game • A game in which the players explicitly cooperate to make themselves better off

  36. Strategic Behaviorand Game Theory • Noncooperative Game • A game in which the players neither negotiate nor cooperate in any way

  37. Strategic Behaviorand Game Theory • Zero-Sum Game • A game in which any gains within the group are exactly offset by equal losses by the end of the game

  38. Strategic Behaviorand Game Theory • Negative-Sum Game • A game in which players as a group lose at the end of the game

  39. Strategic Behaviorand Game Theory • Positive-Sum Game • A game in which players as a group are better off at the end of the game

  40. Strategic Behaviorand Game Theory • Strategies in noncooperative games • Strategy • Any rule that is used to make a choice • Any potential choice that can be made by players in a game • Dominant Strategies • Strategies that always yield the highest benefit

  41. Prisoner’s Dilemma • You and your partner rob a bank and get caught.

  42. Prisoner’s Dilemma • You are separated and given these options: • Both confess and get 5 years in jail • Neither confess and get 2 years • One confess and the other does not • Confessor goes free • One who does not confess get 10 years

  43. Prisoner’s Dilemma • What would you do? • Remember • No cooperation

  44. The Prisoners’ Dilemma Payoff Matrix Figure 25-3

  45. Strategic Behaviorand Game Theory • Applying game theory to pricing strategies • Would you choose a high price or a low price? • Remember • No collusion

  46. Strategic Behaviorand Game Theory Figure 25-4

  47. Strategic Behaviorand Game Theory • Opportunistic Behavior • Actions that ignore the possible long-run benefits of cooperation and focus solely on short-run gains

  48. Strategic Behaviorand Game Theory • Opportunistic behavior • Implies a noncooperative game • Not realistic • We make repeat transactions

  49. Strategic Behaviorand Game Theory • Tit-for-Tat Strategic Behavior • In game theory, cooperation that continues so long as the other players continue to cooperate

  50. International Example:Strategically Relating Subsidies to Nuclear Weapons • Pakistan agreed to certain conditions for an IMF loan • In 1999, the IMF discovered that Pakistan had spent much of this loan on the development of nuclear weapons • Soon, Pakistan had to default on its debt • Why would Pakistan engage in this behavior with the IMF?

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