Chapter 10 Monopolistic Competition and Oligopoly

1. Chapter 10Monopolistic Competition and Oligopoly • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing

2. In this chapter, you will learn to solve these economic puzzles: How does the NCAA Final Four basketball tournament use imperfect competition Are Cheerios, Rice Krispies, and other brands sold by firms in the breakfast cereal industry produced under monopolistic competition or oligopoly? Why will Ivan’s Oyster Bar make zero economic profit in the long-run? Why do OPEC and other cartels tend to break down?

3. What isImperfect Competition? A market structure between the extremes of perfect competition and monopoly

4. What is Monopolistic Competition? • many small sellers • differentiated product • easy entry and exit

5. What isProduct Differentiation? The process of creating real or apparent differences between goods and services

6. What does Many Small Sellers mean? Each firm is so small relative to the total market that each firm’s pricing decisions have a negligible effect on the market price

7. What isNonprice Competition? A firm competes using advertising, packaging, product development, better service, rather than lower prices

8. How easy is entry and exit in Monopolistic Competition? Not as easy as in Perfect Competition because of product differentiation

9. Why is a Monopolistic Competitive firm a price maker? Product differentiation gives the firm some control over its price

10. What does the demand curve for Monopolistic Competition look like? It is less elastic (steeper) than for a perfectly competitive firm and more elastic (flatter) than for a monopolist

11. What are examples of Monopolistic Competition? • grocery stores • hair salons • gas stations • video rental stores • restaurants

12. How effective is Advertising? Somewhat effective in the short-run but less effective in the long-run

13. What effect does Advertising have on Average Costs? It raises the long-run average cost curve

14. P The effect of Advertising $4.00 With advertising $3.50 $3.00 LRAC2 Cost per unit $2.50 $2.00 $1.50 LRAC1 $1.00 Without advertising $.50 Q 2 4 6 8 10 12 14 16 18

15. How does a firm decide what price to charge and how many units to produce? MR = MC

16. P $50 MR=MC $40 MC $30 $25 ATC $20 Profit $15 AVC $10 D $5 MR Q 1 2 3 4 5 6 7 8 9

17. Why is a Normal Profit made in the Long-run? The combination of the leftward shift in the firm’s demand curve and the upward shift in the LRAC curve

18. P Normal Profit $40 $35 MC $30 $25 $20 LRAC $15 AVC $10 D $5 MR Q 1 2 3 4 5 6 7 8 9

19. How efficient is Monopolistic Competition? Less resources are used and a higher price is charged than would be the case under Perfect Competition

20. P Monopolistic Competition $40 Minimum LRAC $35 MC $30 $25 $20 ATC $15 AVC $10 D $5 MR Q 1 2 3 4 5 6 7 8 9

21. P Perfect Competition $40 Minimum LRAC MC LRAC $35 $30 MR $25 Price & Cost per unit $20 $15 $10 $5 Q 1 2 3 4 5 6 7 8 9

22. What is Oligopoly? • few sellers • either homogeneous or a differential product • difficult market entry

23. How few are a few Sellers? When the firms are so large relative to the total market that they can affect the market price

24. What is a significant Barrier to Entry? Economies of scale

25. What isNonprice Competition? Competition in ways other than pricing policies

26. What is the distinguishing feature of Oligopoly? Mutual interdependence

27. What is Mutual Interdependence? A condition in which an action by one firm may cause a reaction on the part of other firms

28. What does Mutual Interdependence do to the Demand Curve? A kinked demand curve is a possible result of this characteristic

29. What does a Kinked Demand Curve show? It shows that rivals will match a firm’s price decrease, but ignore a price increase

30. P Oligopolist’s Kinked Demand Curve $400 $350 Rivals ignore price changes $300 $250 $200 $150 $100 Rivals match price changes $50 Q 5 10 15 20 25 30 35 40 45

31. How do Oligopolists determine price? They play the game “follow the leader” that economists call price leadership

32. What isPrice Leadership? A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow

33. What is a Cartel? A group of firms formally agreeing to control the price and output of a product

34. What are examples of Cartels? • Organization of Petroleum Exporting Countries (OPEC) • International Telephone Cartel (CCITT) • International Airline Cartel (IATA)

35. What is the major weakness of a Cartel? Member firms cheating

36. P Why a Cartel Member Has an Incentive to Cheat $40 MC LRAC $35 $30 MR2 $25 Price & Cost per unit $20 MR1 $15 $10 $5 Q 1 2 3 4 5 6 7 8 9

37. Key Concepts

38. Key Concepts • What is Imperfect Competition? • What is Monopolistic Competition? • What is Product Differentiation? • What is Nonprice Competition? • Why is a Monopolistic Competitive firm a price maker? • How does a firm decide what price to charge and how many units to produce? • Why is a Normal Profit made in the Long-run?

39. Key Concepts cont. • How efficient is Monopolistic Competition? • What is Oligopoly? • What is Nonprice Competition? • What is the distinguishing feature of Oligopoly? • What does a Kinked Demand Curve show? • How do Oligopolists determine price? • What is a Cartel?

40. Summary

41. Imperfect competition is the market structure between the extremes of perfect competition and monopoly Monopolistic competition and oligopoly belong to the imperfect competition category.

42. Monopolistic competition is a market structure characterized by (1) many small sellers, (2) a differentiated product, and (3) easy market entry and exit. Given these characteristics, firms in monopolistic competition have a negligible effect on the market price.

43. Product differentiation is a key characteristic of monopolistic competition. It is the process of creating real or apparent differences between products.

44. Nonprice competition includes advertising, packaging, product development, better quality, and better service. Under imperfect competition, firms may compete using nonprice competition, rather than price competition.

45. Short-run equilibrium for a monopolistic competitor can yield economic losses, zero economic profits, or economic profits. In the long run, monopolistic competitors make zero economic profits.

46. P $50 MR=MC $40 MC $30 $25 ATC $20 Profit $15 AVC $10 D $5 MR Q 1 2 3 4 5 6 7 8 9

47. Comparing monopolistic competition with perfect competition, we find that the monopolistic competitive firm does not achieve allocative efficiency,charges a higher price, restricts output, and does not produce where average costs are at a minimum.

48. P Monopolistic Competition $40 Minimum LRAC $35 MC $30 $25 $20 ATC $15 AVC $10 D $5 MR Q 1 2 3 4 5 6 7 8 9

49. P Perfect Competition $40 Minimum LRAC MC LRAC $35 $30 MR $25 Price & Cost per unit $20 $15 $10 $5 Q 1 2 3 4 5 6 7 8 9

50. Oligopoly is a market structure characterized by (1) few sellers, (2) a homogeneous or differentiated product, and (3) difficult market entry. Oligopolies are mutually interdependent because an action by one firm may cause a reaction on the part of other firms.