slides prepared by dr. amy peng, ryerson university chapter 9 monopolistic competition and oligopoly...

Slides prepared by Dr. Amy Peng, Ryerson University

CHAPTER 9 CHAPTER 9 MONOPOLISTIC MONOPOLISTIC

COMPETITION AND COMPETITION AND OLIGOPOLYOLIGOPOLY

Part Two: Microeconomics Part Two: Microeconomics of Product Marketsof Product Markets

©2007 McGraw-Hill Ryerson Ltd.

Chapter 9 2

In this chapter you will learn: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 oligopoly9.4 How game theory relates to

oligopoly9.5 The incentives and obstacles to

collusion among oligopolies9.6 The positive and potential negative

effects of advertising


Chapter 9.1 3

Characteristics of Monopolistic Characteristics of Monopolistic CompetitionCompetition

• Relatively Large Number of Sellers– Small Market Shares– No Collusion– Independent Action


Chapter 9.1 4


• Differentiated Products– Product Attributes– Service– Location– Brand Names and Packaging– Some Control Over Price


Chapter 9.1 5


• Relatively Large Number of Sellers

• Differentiated Products• Easy Entry and Exit• Advertising


Chapter 9.1 6

Figure 9-1

% of Output Produced by Four Largest Firms in Selected Low-Concentration

Sectors

0 5 10 15 20 25 30

machine shop industry

sign & display industrywomen's clothing contractors

metal dies & mouldssawmills & planing mills products

construction & mining machinery

children's clothing industryfish products

feed industryplastic bag industry

occupational clothing industry

% of industry total


Chapter 9.2 7

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rice

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Figure 9-2Figure 9-2A Monopolistically Competitive FirmA Monopolistically Competitive Firm

Elastic Demand Curve

ATCATC

Economic Economic profitprofit

Expect new Expect new competitorscompetitorsExpect new Expect new competitorscompetitors


Chapter 9.2 8

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EconomicEconomicprofitsprofits

decreasedecrease

EconomicEconomicprofitsprofits

decreasedecrease

Demand curve Demand curve shifts leftshifts left

Demand curve Demand curve shifts leftshifts leftIn the long run, In the long run,

profits are zeroprofits are zeroIn the long run, In the long run, profits are zeroprofits are zero

A Monopolistically Competitive A Monopolistically Competitive FirmFirm


Chapter 9.2 9

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ppLossLoss

Expect fewer Expect fewer competitorscompetitors

Expect fewer Expect fewer competitorscompetitors



Chapter 9.2 10

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Some firms exitSome firms exit- D shifts right- D shifts right

- Losses get smaller- Losses get smaller

Some firms exitSome firms exit- D shifts right- D shifts right

- Losses get smaller- Losses get smaller


In the long run, In the long run, profits are zeroprofits are zeroIn the long run, In the long run, profits are zeroprofits are zero


Chapter 9.2 11

Price and Output in Monopolistic Price and Output in Monopolistic CompetitionCompetition

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

1. Allocative Efficiency• P > MC• Too little is produced2. Productive Efficiency• Costs high• Excess capacity

Monopolistic Competition and Monopolistic Competition and EfficiencyEfficiency


Chapter 9.2 13

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ExcessExcessCapacityCapacityExcessExcess

CapacityCapacity

Figure 9-3Figure 9-3The Inefficiency of Monopolistic The Inefficiency of Monopolistic

CompetitionCompetition


Chapter 9.2 14

Product VarietyProduct 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 9.3 15

The Characteristics of OligopolyThe 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

Concentration Ratio• The % of total output produced

and sold by an industry’s largest firms

• Industry considered oligopolistic if four-firm concentration ratio > 40%

Measures of Industry Measures of Industry ConcentrationConcentration


Chapter 9.3 17

Concentration Ratio• Three shortcomings:

1. Localized Markets2. Interindustry Competition3. World Trade

• Herfindahl Index= (%S1)2 + (%S2)2 + (%S3)2 + … +

(%Sn)2

Measures of Industry Measures of Industry ConcentrationConcentration


Chapter 9.3 18

Figure 9-4% of Output Produced by the Four Largest Firms in

Selected High-Concentration Industries

0 20 40 60 80 100

steel pipe & tube

frozen fruit & vegetables

biscuit industry

tea & coffee

motor vehicles

potato chip, pretzel & popcorn

brewery products

tobacco products

% of industry output

4775

4365

3481

2453

2273

2069

1965

1038

Herfindahl Index


Chapter 9.4 19

Game Theory OverviewGame 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 DilemmaPrisoner’s Dilemma

• Two prisoners cannot communicate

• Difficult to cooperate, even when mutually beneficial


Chapter 9.4 21

Figure 9-5Figure 9-5Prisoner’s Dilemma Payoff MatrixPrisoner’s Dilemma Payoff Matrix

ConfessConfess Not confessNot confess

ConfessConfess

NotNot confessconfess

Al’s strategiesAl’s strategiesB

run

o’s

B

run

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st

rate

gie

sst

rate

gie

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44 1212

22 22

44 22

1212 22


Chapter 9.4 22

Figure 9-6Figure 9-6Profit Payoff for a Two-Firm OligopolyProfit Payoff for a Two-Firm Oligopoly

HighHigh LowLow

HighHigh

LowLow

RareAir’s price strategyRareAir’s price strategy

Up

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Up

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$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

If both If both firmsfirms

choose a choose a high-price high-price strategy, strategy,

each each earns $12 earns $12 million in million in

profitprofit

If both If both firmsfirms

choose a choose a high-price high-price strategy, strategy,

each each earns $12 earns $12 million in million in

profitprofit

Collusive

Collusive

tendencies

tendencies

Collusive

Collusive

tendencies

tendencies


Chapter 9.4 23

Strategies in a Two-firm Strategies in a Two-firm OligopolyOligopoly

HighHigh LowLow

HighHigh

LowLow


Up

tow

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Up

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$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

If RareAir If RareAir uses a low-uses a low-

price strategy price strategy against against

Uptown’s Uptown’s high prices, high prices, profits will profits will increase to increase to $15 million$15 million

If RareAir If RareAir uses a low-uses a low-

price strategy price strategy against against

Uptown’s Uptown’s high prices, high prices, profits will profits will increase to increase to $15 million$15 million

Uptown’s Uptown’s profits fall to profits fall to

$6 million$6 million

Uptown’s Uptown’s profits fall to profits fall to

$6 million$6 million


Chapter 9.4 24


HighHigh LowLow

HighHigh

LowLow


Up

tow

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Up

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$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

Uptown Uptown could also could also profit by profit by

switching to switching to lower prices, lower prices, as long as as long as

RareAir RareAir charges high charges high

pricesprices

Uptown Uptown could also could also profit by profit by

switching to switching to lower prices, lower prices, as long as as long as

RareAir RareAir charges high charges high

pricesprices


Chapter 9.4 25


HighHigh LowLow

HighHigh

LowLow


Up

tow

n’s

pri

ce

Up

tow

n’s

pri

ce

stra

teg

yst

rate

gy

AA BB

CC DD

$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

If both firms If both firms shift to a shift to a low-price low-price strategy, strategy,

profits are profits are $8 million$8 million

If both firms If both firms shift to a shift to a low-price low-price strategy, strategy,

profits are profits are $8 million$8 million


Chapter 9.4 26


HighHigh LowLow

HighHigh

LowLow


Up

tow

n’s

pri

ce

Up

tow

n’s

pri

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stra

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yst

rate

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AA BB

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$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

Incentive to Incentive to cheatcheat

Incentive to Incentive to cheatcheat


Chapter 9.5 27

Two Oligopoly Strategies: Two Oligopoly Strategies: The Incentives and Obstacles to The Incentives and Obstacles to

CollusionCollusion• Two distinct pricing strategies:

1. Collusive pricing2. 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: Cartels and Other Collusion: Cooperative StrategiesCooperative 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

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PP00Economic profitEconomic profit

Figure 9-7 Figure 9-7 Collusion and Joint-Profit Collusion and Joint-Profit

MaximizationMaximization


Chapter 9.5 30

Cartels and Other Collusion: Cartels and Other Collusion: Cooperative StrategiesCooperative 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

Daily Oil Production (July 1, 2005), barrels

Saudi Arabia 9,099,000

Iran 4,110,000

Venezuela 3,223,000

United Arab Emirates 2,444,000

Nigeria 2,306,000

Kuwait 2,247,000

Libya 1,500,000

Indonesia 1,451,000

Algeria 894,000

Qatar 725,000

Iraq not available

GLOBAL PERSPECTIVEGLOBAL PERSPECTIVE 9.1 9.1

Overt Collusion – The OPEC Overt Collusion – The OPEC CartelCartel


Chapter 9.5 32

Cartels and Other CollusionCartels and Other Collusion

• Covert Collusion: Relatively Recent Examples– Cement firms in Quebec– Tacit understandings


Chapter 9.5 33

Obstacles to CollusionObstacles to Collusion

• Demand and Cost Differences• Number of Firms• Cheating• Recession• Potential Entry• Legal Obstacles: Anticombines

Laws


Chapter 9.5 34

Price Leadership ModelPrice Leadership Model

• Dominant firm leads the way• Leadership strategy:

– Infrequent Price Changes– Communications– Limit Pricing

• Breakdowns in price leadership: price wars


Chapter 9.6 35

Oligopoly and AdvertisingOligopoly 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

The Largest Canadian Advertisers

CompanyAdvertising Spending

($ millions)

Procter & Gamble 174.5

Rogers Communications

102.0

General Motors 99.1

Bell Canada Enterprises

72.9

Hudson’s Bay Company

70.2

Ford Motor Co. 60.0

Table 9-1Table 9-1


Chapter 9.6 37

Positive Effects of AdvertisingPositive Effects of Advertising

1. Low cost source of information2. Can diminish monopoly power3. Can speed up technological

progress


Chapter 9.6 38

Potential Negative Effects of AdvertisingPotential Negative Effects of Advertising

1. Only persuasion2. Misleading claims3. Barrier to entry4. Self-cancelling advertising


Chapter 9.6 39

GLOBAL PERSPECTIVEGLOBAL PERSPECTIVE 9.2 9.2

The World’s Top 10 Brand Names

Coca-Cola

Microsoft

IBM

General Electric

Intel

Nokia

Disney

McDonald’s

Toyota

Marlboro


Chapter 9.6 40

Oligopoly and EfficiencyOligopoly and Efficiency

• Impossible to say anything definitive

• Outcomes could be identical to pure monopoly

• Unlikely because of:1. Increased foreign competition2. Limit pricing3. Technological advance


Chapter 9 41

Chapter SummaryChapter 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

slides prepared by dr. amy peng, ryerson university chapter 9 monopolistic competition and oligopoly...

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