Monopolistic Competition and Oligopoly14McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Four Market ModelsLO1

Characteristics of the Four Basic Market ModelsCharacteristicPure CompetitionMonopolistic CompetitionOligopolyMonopolyNumber of firmsA very large numberManyFewOneType of productStandardizedDifferentiatedStandardized or differentiatedUnique; no close subs.Control over priceNoneSome, but within rather narrow limitsLimited by mutual inter-dependence; considerable with collusionConsiderableConditions of entryVery easy, no obstaclesRelatively easySignificant obstaclesBlockedNonprice competitionNoneConsiderable emphasis on advertising, brand names, trademarksTypically a great deal, particularly with product differentiationMostly public relation advertisingExamplesAgricultureRetail trade, dresses, shoesSteel, auto, farm implementsLocal utilities

Monopolistic CompetitionRelatively large number of sellersDifferentiated productsEasy entry and exitAdvertisingLO1

Monopolistically Competitive Industry concentrationMeasured by:Four-firm concentration ratiosPercentage of 4 largest firms

Herfindahl index Sum of squared market shares

LO14-Firm CR =Output of four largest firmsTotal output in the industryHI = (%S1)2 + (%S2)2 + (%S3)2 + . + (%Sn)2

Price and Output in Monopolistic Comp

Demand is highly elasticShort run profit or lossProduce where MR=MCLong run normal profitEntry and exitInefficientProduct varietyLO2

The Short Run: Profit or LossLO2QuantityPrice and CostsMR = MCMCMRD1ATCEconomicProfitQ1A1P10

The Short Run: Profit or LossLO2QuantityPrice and CostsMCMRD2ATCLossQ2A2P20MR = MC

The Long Run: Only a Normal ProfitLO2QuantityPrice and CostsMCMRD3ATCQ3P3= A30MR = MC

Monopolistic Competition: EfficiencyInefficientProductive inefficiencyP > ATCAllocative inefficiencyP > MCLO2

Monopolistic Competition: EfficiencyLO2P=MC=Min ATC for pure competition (recall)P4Q4Price is LowerExcess Capacity atMinimum ATCMonopolistic competition is not efficient

Product VarietyThe firm constantly manages price, product, and advertisingBetter product differentiationBetter advertisingThe consumer benefits by greater array of choices and better productsTypes and stylesBrands and qualityLO2

OligopolyA few large producersHomogeneous or differentiated productsLimited control over priceMutual interdependenceStrategic behaviorEntry barriersMergersLO3

Oligopolistic IndustriesFour-firm concentration ratio40% or more to be oligopolyShortcomingsLocalized marketsInter-industry competitionWorld priceDominant firms

LO3

Game Theory OverviewOligopolies display strategic pricing behaviorMutual interdependenceCollusionIncentive to cheatPrisoners dilemmaLO4

Game Theory OverviewLO4RareAirs Price StrategyUptowns Price StrategyABCD$12$12$15$6$8$8$6$15HighHighLowLow2 competitors2 price strategiesEach strategy has a payoff matrixGreatest combinedprofitIndependent actionsstimulate a response

Game Theory OverviewLO4RareAirs Price StrategyUptowns Price StrategyABCD$12$12$15$6$8$8$6$15HighHighLowLowIndependently lowered prices in expectation of greater profit leads to worst combined outcomeEventually low outcomes make firms return to higher prices.

Three Oligopoly ModelsKinked-demand curveCollusive pricingPrice leadershipReasons for 3 modelsDiversity of oligopoliesComplications of interdependenceLO5

Kinked-Demand CurveLO5P0MR2D2D1MR1efgRivals IgnorePrice IncreaseRivals MatchPrice DecreaseQ0MR2D2D1MR1Q0MC1MC2P0efgPricePriceQuantityQuantity00

Kinked-Demand CurveCriticismsExplains inflexibility, not pricePrices are not that rigidPrice wars

LO6

Cartels and Other CollusionLO6DMR=MCATCMCMRP0A0Q0EconomicProfit

Overt CollusionCartels - a group of firms or nations that colludeFormally agreeing to the price Sets output levels for membersCollusion is illegal in the United StatesOPECLO6

Obstacles to CollusionDemand and cost differencesNumber of firms CheatingRecessionNew entrantsLegal obstaclesLO6

Price Leadership ModelPrice LeadershipDominant firm initiates price changesOther firms follow the leaderUse limit pricing to block entry of new firmsPossible price war

LO6

Oligopoly and AdvertisingPrevalent to compete with product development and advertisingLess easily duplicated than a price changeFinancially able to advertise LO7

AdvertisingLO7

Positive Effects Negative Effects Low-cost way of providing information to consumersCan be manipulative

Enhances competitionContains misleading claims that confuse consumers

Speeds up technological progressConsumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the productCan help firms obtain economies of scale

Oligopoly and EfficiencyOligopolies are inefficientProductively inefficient P > minATCAllocatively inefficient P > MCQualificationsIncreased foreign competitionLimit pricingTechnological advanceLO7

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