Chapter 12

1. Chapter 12 Between Competition and Monopoly . . . neither fish nor fowl. JOHN HEYWOOD

2. Monopolistic Competition • Monopolistic competition • Many buyers and sellers • Freedom of exit and entry • Perfect information • Heterogeneous products • Product differentiation • Imperfect substitutes

3. Monopolistic Competition • Monopolistic competition • Different from perfect competition • Product differentiation • Demand curve – negative slope • Flatter than monopoly • Price increase • Lose some customers

4. Monopolistic Competition • Short-run equilibrium • Marginal revenue curve • Below demand curve • Maximize profit • Output: MR = MC • Price: demand curve

5. Figure 1 Short-run equilibrium of the firm under monopolistic competition MC AC $3.40 P E C $3.00 $2.80 Price per Gallon $2.50 D MR 0 12,000 Gallons of Gasoline per Week

6. Monopolistic Competition • Long-run equilibrium • Short-run economic profit • New firms enter industry • Each firm’s • Demand curve – decrease • MR curve – decrease • Zero economic profit: P = AC • Demand curve - tangent to AC curve

7. Figure 2 Long-run equilibrium of the firm under monopolistic competition MC AC P M E $2.85 $2.70 Price per Gallon D MR 0 10,000 15,000 Gallons of Gasoline per Week

8. Monopolistic Competition • Excess capacity theorem • Long run • Output – lower • Not minimize per unit costs • Excess capacity • Unused / wasted capacity • Increase output • Decrease per unit costs

9. Oligopoly • Oligopolistic behavior models • Ignoring interdependence • Firms – ignore interdependence • Strategic interaction • Operate in same market • Interdependence

10. Oligopoly • Oligopolistic behavior models • Cartel • Group of sellers – collude • Control: production, sales, price • Advantages of monopoly • Difficult • Organize • Enforce • Illegal in United Sates

11. Oligopoly • Price war • Each firm – lower price than rivals • Oligopolistic behavior models • Price leadership & Tacit collusion • One firm sets price • Others follow • Easy to break down

12. Oligopoly • Sales – maximization • Maximize total revenues • Keep producing until MR = 0 • Produce more & Lower price • Than with profit maximization

13. Figure 3 Sales-maximization equilibrium MC E F B A $1.00 .80 .69 .75 AC Price per Box D MR 0 2.5 3.75 Millions of Boxes per Year

14. Oligopoly • Kinked demand curve model • One demand • Competitors match price moves • Second demand • Competitors stick to initial price levels • Kinked demand curve • Changes slope abruptly • “Sticky” price • Doesn’t respond • To minor cost changes

15. Figure 4 d The kinked demand curve D D A $8 7 D Price d d (Competitors’ Prices are fixed) (Competitors respond to price changes) 0 1,000 1,400 1,100 Quantity per Year

16. d Figure 5 The kinked demand curve and sticky prices MC D A B C D E $8 Price d MR 0 1,000 Quantity Supplied per Year mr

17. Oligopoly • Game theory • Strategic game • Players – firms • Payoff matrix • Expected earnings • Based on strategies • Duopoly • Oligopoly with two firms

18. Table 1 Firm A’s payoff matrix; game with a dominant strategy

19. Oligopoly • Game theory • Dominant strategy • Yields higher payoff • Indifferent to strategy of competitors • Duopoly • Market – better off • Than monopoly • No collusion

20. Table 2 Two-firm payoff matrix in a game with dominant strategies

21. Oligopoly • Games without dominant strategy • Maximin criterion • Player – select strategy • Maximum payoff • Assume – opponent: maximum damage

22. Table 3 Firm A’s payoff matrix in a game without a dominant strategy

23. Oligopoly • Nash equilibrium • Each player – strategy • Highest possible payoff • Rival – sticks to strategy chosen • Zero-sum game • One player’s gain • The other player’s loss

24. Table 4 Zero-sum payoff matrix

25. Oligopoly • Repeated games • Game played a number of times • Reputation • Tit for tat (tacit collusion) • Credible threat • Doesn’t harm firm making threat • If carried out

26. Figure 6 Entry and entry-blocking strategy Enter Big Factory Don’t Enter Enter Small Factory Don’t Enter

27. Public Welfare • Monopolistic competition • Excess capacity • Not socially optimal • Oligopoly • Cartels • Misleading advertising • Not socially optimal

28. Public Welfare • Perfectly contestable market • Costless & unimpeded entry & exit • Profitable contestable market • Attracts potential entrants • Constant threat of entry

29. Public Welfare • Socially desirable characteristics • Freedom of entry • Eliminates excess economic profits • Inefficient enterprises • Cannot survive • Firms • Operate as efficiently as possible • Charge prices – low • Long-run financial survival

30. Comparing the Four Market Forms • Perfect competition & pure monopoly • Analyticalpurposes • Zero economic profits • Long-run equilibrium • Perfect competition • Monopolistic competition • AC = AR • Easy entry & exit

31. Comparing the Four Market Forms • MC = MR: all market forms • Except oligopoly • Perfectly competitive firm & industry • Efficient allocation of resources • Maximizes benefits to consumers • Monopoly • Misallocate resources • Restrict output • Raise prices & profits

32. Comparing the Four Market Forms • Monopolistic competition • Excess capacity • Inefficiency • Oligopoly • Anything can happen

33. Table 5 Attributes of the four market forms