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Monopolistic Competition

Product Differentiation. Product differentiation

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Monopolistic Competition

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    1. Monopolistic Competition Monopolistic competition – many sellers of similar products. Since a monopolistic competitor sells a product that is different than its competitors, it will have some degree of market power.

    2. Product Differentiation Product differentiation – the process of distinguishing a firm’s product from similar products. 1. to increase the firm’s market power. See Example 1 on page 23-2. 2. to increase the demand for the firm’s product. See Example 2 on page 23-2.

    3. Demand and Marginal Revenue A monopolistic competitor faces a downward sloping demand curve, with the degree of slope depending largely on product differentiation. See Example 3 on page 23-2. The marginal revenue curve will be twice as steeply downward sloping as the demand curve.

    4. Profit-Maximization A monopolistic competitor will maximize profits by producing the quantity of output where MR = MC.

    5. Profit-Maximization

    6. Monopolistic Competition versus Perfect Competition Compared to perfect competition, monopolistic competition results in less output at a higher price.

    7. Perfect Competition

    8. Monopolistic Competition

    9. Economic Inefficiency Monopolistic competition is economically inefficient. Monopolistic competition results in a quantity of output where price exceeds marginal cost, and thus where MSB exceeds MSC.

    10. Economic Inefficiency

    11. Monopolistic Competition in the Long Run In the long run, economic profits (or losses) are eliminated by firms entering (or exiting) the industry. See Example 5 on page 23-4.

    12. Oligopoly Oligopoly – an industry dominated by a few mutually interdependent firms. See Example 6 on page 23-5. Oligopoly usually results from barriers to entry, especially economies of scale.

    13. Theories of Oligopoly 1. Kinked demand curve theory. 2. Unkinked demand curve theory. 3. Cartel theory.

    14. Kinked Demand Curve Theory Assumes that other firms will match a price reduction, but will not match a price increase. The different response to an increase in price versus a decrease in price will cause the demand curve to be kinked at its current price and quantity.

    15. Kinked Demand Curve

    16. Marginal Revenue Curve The kink in the demand curve will result in a gap in the marginal revenue curve.

    17. Marginal Revenue Curve

    18. Profit-Maximization Profit-maximization will occur where the marginal cost curve passes through the gap in the marginal revenue curve.

    19. Profit-Maximization

    20. Kinked Demand Curve Theory The gap in the marginal revenue curve means that a change in marginal cost may result in no change in price or quantity. The kinked demand curve theory predicts “sticky” prices for an oligopoly.

    21. Change in Marginal Cost

    22. Unkinked Demand Curve Theory According to economist George Stigler, there is no kink in the demand curve for an oligopoly. Thus, oligopoly is similar to monopolistic competition.

    23. Cartel Theory A cartel is an organization through which members jointly make decisions about prices and production. See Example 8 on page 23-8. A cartel sets output for the industry, as would a monopoly, and allocates production to the member firms.

    24. Maintaining a Cartel Cartels are difficult to maintain due to: 1. Noncartel competition. See Example 9 on page 23-8. 2. The tendency of cartel members to “cheat” on the agreement. See Example 10 on page 23-8.

    25. Economic Inefficiency Oligopoly is economically inefficient. Oligopoly results in a quantity of output where price exceeds marginal cost, and thus where MSB exceeds MSC.

    26. Game Theory Game theory – a method for analyzing strategic behavior. See the “prisoners’ dilemma” game in Example 12 on pages 23-9, 23-10 and 23-11.

    27. Payoff Matrix

    28. Dominant Strategy Dominant strategy – a strategy that always yields the best result regardless of the strategies of the other players. The dominant strategy for both Bo and Luke is to confess.

    29. Nash Equilibrium Nash equilibrium – the outcome when each game player has chosen their best strategy, assuming that all other players have chosen their best strategies. The Nash equilibrium in a cartel is for all members of the cartel to “cheat”. See Example 13 on page 23-11.

    30. The NCAA Cartel The NCAA is a buying cartel. Its members have agreed to a maximum price for college athletes. The big-revenue college sports can generate millions of dollars in revenue. See Example 15 on page 23-12.

    31. The NCAA Cartel As a result of the NCAA cartel, income is redistributed from the athletes in the big-revenue sports to the athletic departments. See Example 16 on page 23-12.

    32. The NCAA Cartel As a cartel, the NCAA faces noncartel competition from the NFL and the NBA. And there is a strong tendency for NCAA members to “cheat” on the cartel agreement. See Example 17 on page 23-12.

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