CHAPTER 9 Monopolistic Competition and Oligopoly

1. Part Two: Microeconomics of Product Markets • CHAPTER 9 • Monopolistic Competition and Oligopoly Slides prepared by Bruno Fullone, George Brown College. Edited by Laura Lamb 1

2. 9.1 Characteristics of Monopolistic Competition • Relatively Large Number of Sellers • Small Market Shares • No Collusion • Independent Action Slides prepared by Bruno Fullone, George Brown College 2

3. Characteristics of Monopolistic Competition Differentiated Products Product Attributes Service Location Brand Names and Packaging Some Control Over Price Slides prepared by Bruno Fullone, George Brown College 3

4. Figure 9-2 Monopolistic Competition Short-Run Profits ATC MC P1 A1 Price and Costs Economic Profit D1 MR = MC MR 0 Q1 Quantity Slides prepared by Bruno Fullone, George Brown College 4

5. Monopolistic Competition Short-Run Losses ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR 0 Q2 Quantity Slides prepared by Bruno Fullone, George Brown College 5

6. Monopolistic Competition Long-Run Equilibrium MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity Slides prepared by Bruno Fullone, George Brown College 6

7. Complicating factors • Some firms may earn economic profits greater than zero in the long run. • Why? Slides prepared by Bruno Fullone, George Brown College

8. Monopolistic Competition and Efficiency 1. Allocative Efficiency P > MC Too little is produced 2. Productive Efficiency Costs high Excess capacity Slides prepared by Bruno Fullone, George Brown College 8

9. 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 Slides prepared by Bruno Fullone, George Brown College 9

10. 9.3 Oligopoly: Characteristics 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 Slides prepared by Bruno Fullone, George Brown College 10

11. Two ways to measure industry concentration 1. Concentration ratio • The four-firm concentration ratio gives the percentage of total industry sales accounted for by the four largest firms. Slides prepared by Bruno Fullone, George Brown College

12. 4775 4365 Herfindahl Index 3481 2453 2273 2069 1965 1038 Slides prepared by Bruno Fullone, George Brown College

13. 9.4 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 Slides prepared by Bruno Fullone, George Brown College 13

14. Prisoner’s Dilemma Two prisoners cannot communicate Difficult to cooperate, even when mutually beneficial Slides prepared by Bruno Fullone, George Brown College 14

15. Prisoner’s Dilemma Payoff Matrix Al’s strategies Figure 9-5 Not confess Confess 4 B 12 A Bruno’s strategies Confess 1 4 C 1 D 2 Not confess 12 2 Slides prepared by Bruno Fullone, George Brown College

16. Profit 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 Slides prepared by Bruno Fullone, George Brown College

17. 9.5 The Incentives and Obstacles to Collusion: Two Oligopoly Strategies • 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 Slides prepared by Bruno Fullone, George Brown College

18. 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… Slides prepared by Bruno Fullone, George Brown College

19. Collusion and Joint-Profit Maximization MC P Figure 9-7 Price and Costs ATC P0 Economic profit A0 D MR=MC MR Q Q0 Slides prepared by Bruno Fullone, George Brown College

20. 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 Slides prepared by Bruno Fullone, George Brown College

21. Overt Collusion – The OPEC Cartel Slides prepared by Bruno Fullone, George Brown College 21

22. Obstacles to Collusion Demand and Cost Differences Number of Firms Cheating Recession Potential Entry Legal Obstacles: Competition Policy Slides prepared by Bruno Fullone, George Brown College 22

23. Price Leadership Model Dominant firm leads the way Leadership strategy: Infrequent Price Changes Communications Limit Pricing Breakdowns in price leadership: price wars Slides prepared by Bruno Fullone, George Brown College 23

24. 9.6 Oligopoly and Advertising Oligopolists prefer not to compete on price Product development and advertising preferred: Less easily duplicated Oligopolists have sufficient financial resources Slides prepared by Bruno Fullone, George Brown College 24

25. Positive Effects of Advertising Low cost source of information Can diminish monopoly power Can speed up technological progress Slides prepared by Bruno Fullone, George Brown College 25

26. Potential Negative Effects of Advertising Only persuasion Misleading claims Barrier to entry Self-cancelling advertising Slides prepared by Bruno Fullone, George Brown College 26

27. Global Perspective 9.2 Slides prepared by Bruno Fullone, George Brown College 27

28. Oligopoly and Efficiency Impossible to say anything definitive Outcomes could be identical to monopoly Unlikely because of: Increased foreign competition Limit pricing Technological advance Slides prepared by Bruno Fullone, George Brown College 28

29. The Last Word: Oligopoly in the Beer Industry Since WW II degree of concentration has been increasing, mostly due to mergers Today 80% of production controlled by 2 major companies However, imports and microbreweries are starting to eat away at market share of majors Slides prepared by Bruno Fullone, George Brown College 29