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CHAPTER 9 MONOPOLISTIC COMPETITION AND OLIGOPOLY

Part Two: Microeconomics of Product Markets. CHAPTER 9 MONOPOLISTIC COMPETITION AND OLIGOPOLY. In this chapter you will learn:. 9.1 The characteristics of monopolistic competition 9.2 Why monopolistic competitors earn only a normal profit in the long run

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CHAPTER 9 MONOPOLISTIC COMPETITION AND OLIGOPOLY

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  1. Part Two: Microeconomics of Product Markets CHAPTER 9 MONOPOLISTIC COMPETITION AND OLIGOPOLY

  2. In this chapter you will learn: 9.1 The characteristics of monopolistic competition 9.2 Why monopolistic competitors earn only a normal profit in the long run 9.3 The characteristics of oligopoly 9.4 How game theory relates to oligopoly 9.5 The incentives and obstacles to collusion among oligopolies 9.6 The positive and potential negative effects of advertising Chapter 9

  3. Characteristics of Monopolistic Competition • Relatively Large Number of Sellers • Small Market Shares • No Collusion • Independent Action Chapter 9.1

  4. Characteristics of Monopolistic Competition • Differentiated Products • Product Attributes • Service • Location • Brand Names and Packaging • Some Control Over Price Chapter 9.1

  5. Characteristics of Monopolistic Competition • Relatively Large Number of Sellers • Differentiated Products • Easy Entry and Exit • Advertising Chapter 9.1

  6. Chapter 9.1

  7. MC Figure 9-2A Monopolistically Competitive Firm ATC P p Elastic Demand Curve Economic profit Expect new competitors Price and Costs D MR Q Q Chapter 9.2

  8. A Monopolistically Competitive Firm Economic profits decrease MC Demand curve shifts left P In the long run, profits are zero ATC p Price and Costs D MR Q Q Chapter 9.2

  9. A Monopolistically Competitive Firm Loss ATC MC P p Price and Costs Expect fewer competitors D MR Q Q Chapter 9.2

  10. A Monopolistically Competitive Firm MC ATC P p Some firms exit - D shifts right - Losses get smaller Price and Costs In the long run, profits are zero D MR Q Q Chapter 9.2

  11. Price and Output in Monopolistic Competition Complications: • Persistent positive profits may persist if: • there is continuing and significant product differentiation • entry is somewhat limited by the financial investment required to establish product differentiation • Cverall, we still expect the general results Chapter 9.2

  12. Monopolistic Competition and Efficiency 1. Allocative Efficiency • P > MC • Too little is produced 2. Productive Efficiency • Costs high • Excess capacity Chapter 9.2

  13. Figure 9-3The Inefficiency of Monopolistic Competition MC P ATC p Price and Costs Excess Capacity D MR Q Q Chapter 9.2

  14. Product Variety • Benefits • Better match to consumer tastes • Better products • Tradeoff between variety and efficiency • Further Complexity • Price, product, and advertising must be juggled to achieve maximum profit Chapter 9.2

  15. The Characteristics of Oligopoly • A Few Large Producers • Homogeneous or Differentiated Products • Control Over Price, but Mutual Interdependence • Entry Barriers • Economies of scale • High capital costs • Ownership of raw materials • Mergers Chapter 9.3

  16. Measures of Industry Concentration Concentration Ratio • The % of total output produced and sold by an industry’s largest firms • Industry considered oligopolistic if four-firm concentration ratio > 40% Chapter 9.3

  17. Measures of Industry Concentration Concentration Ratio • Three shortcomings: • Localized Markets • Interindustry Competition • World Trade • Herfindahl Index • (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2 Chapter 9.3

  18. 4775 4365 3481 Herfindahl Index 2453 2273 2069 1965 1038 Chapter 9.3

  19. Game Theory Overview • Oligopolists must make plans in light of the actions and expected reactions of their rivals • Basic concepts: • Players • Rules • Strategies • Payoffs • Equilibrium Chapter 9.4

  20. Prisoner’s Dilemma • Two prisoners cannot communicate • Difficult to cooperate, even when mutually beneficial Chapter 9.4

  21. Figure 9-5Prisoner’s Dilemma Payoff Matrix Al’s strategies Not confess Confess 4 B 12 A Bruno’s strategies Confess 2 4 C 2 D 2 Not confess 12 2 Chapter 9.4

  22. Figure 9-6Profit Payoff for a Two-Firm Oligopoly RareAir’s price strategy If both firms choose a high-price strategy, each earns $12 million in profit Collusive tendencies Low High Uptown’s price strategy $12 B $15 A High $6 $12 C $6 D $8 Low $15 $8 Chapter 9.4

  23. Strategies in a Two-firm Oligopoly RareAir’s price strategy If RareAir uses a low-price strategy against Uptown’s high prices, profits will increase to $15 million Low High Uptown’s price strategy $12 B $15 A Uptown’s profits fall to $6 million High $6 $12 C $6 D $8 Low $15 $8 Chapter 9.4

  24. Strategies in a Two-firm Oligopoly RareAir’s price strategy Uptown could also profit by switching to lower prices, as long as RareAir charges high prices Low High Uptown’s price strategy $12 B $15 A High $6 $12 C $6 D $8 Low $15 $8 Chapter 9.4

  25. Strategies in a Two-firm Oligopoly RareAir’s price strategy Low High Uptown’s price strategy If both firms shift to a low-price strategy, profits are $8 million $12 B $15 A High $6 $12 C $6 D $8 Low $15 $8 Chapter 9.4

  26. Strategies in a Two-firm Oligopoly RareAir’s price strategy Low High Uptown’s price strategy $12 B $15 A Incentive to cheat High $6 $12 C $6 D $8 Low $15 $8 Chapter 9.4

  27. Two Oligopoly Strategies: The Incentives and Obstacles to Collusion • Two distinct pricing strategies: • Collusive pricing • Price leadership • There is no one simple model to predict outcomes due to: • Diversity of oligopolies • Complications of interdependence Chapter 9.5

  28. Cartels and Other Collusion: Cooperative Strategies • Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition • Each firm acts as if it were a pure monopolist Illustrated… Chapter 9.5

  29. Figure 9-7 Collusion and Joint-Profit Maximization MC P Price and Costs ATC P0 Economic profit A0 D MR=MC MR Q Q0 Chapter 9.5

  30. Cartels and Other Collusion: Cooperative Strategies • Three identical firms • Each firm finds it most profitable to charge P0, but only if its rivals do • The answer: collude and agree on price P0 Chapter 9.5

  31. GLOBAL PERSPECTIVE 9.1 Overt Collusion – The OPEC Cartel Chapter 9.5

  32. Cartels and Other Collusion • Covert Collusion: Relatively Recent Examples • Cement firms in Quebec • Tacit understandings Chapter 9.5

  33. Obstacles to Collusion • Demand and Cost Differences • Number of Firms • Cheating • Recession • Potential Entry • Legal Obstacles: Anticombines Laws Chapter 9.5

  34. Price Leadership Model • Dominant firm leads the way • Leadership strategy: • Infrequent Price Changes • Communications • Limit Pricing • Breakdowns in price leadership: price wars Chapter 9.5

  35. Oligopoly and Advertising • Oligopolists prefer not to compete on price • Product development and advertising preferred: • Less easily duplicated • Oligopolists have sufficient financial resources Chapter 9.6

  36. Table 9-1 Chapter 9.6

  37. Positive Effects of Advertising • Low cost source of information • Can diminish monopoly power • Can speed up technological progress Chapter 9.6

  38. Potential Negative Effects of Advertising • Only persuasion • Misleading claims • Barrier to entry • Self-cancelling advertising Chapter 9.6

  39. GLOBAL PERSPECTIVE 9.2 Chapter 9.6

  40. Oligopoly and Efficiency • Impossible to say anything definitive • Outcomes could be identical to pure monopoly • Unlikely because of: • Increased foreign competition • Limit pricing • Technological advance Chapter 9.6

  41. Chapter Summary • 9.1 Characteristics of Monopolistic Competition • 9.2 Price and Output in Monopolistic Competition • 9.3 The Characteristics of Oligopoly • 9.4 Oligopoly Pricing Behaviour • A Game Theory Overview • 9.5 Two Oligopoly Strategies • Collusive oligopolists • Price leadership • 9.6 Oligopoly and Advertising Chapter 9

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