Ch09 Pricing & Output MonopComp & Oligop

8/6/2019 Ch09 Pricing & Output MonopComp & Oligop

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Chapter Nine Copyright 2009 Pearson Education, Inc.Publishing as Prentice Hall.

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Chapter 9

Pricing and OutputDecisions:

Monopolistic Competitionand Oligopoly

Modified by Chris Ball (2009)for EC 600


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Overview

Monopolistic competition

Oligopoly

Pricing under oligopoly

Competing in imperfectlycompetitive markets

Strategy: the challenge for firmsin imperfect competition


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Learning objectives

contrast monopolistic competition andoligopoly

describe the role that mutualinterdependence plays in setting prices inoligopolistic markets


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Learning objectives

explain how non-price factors help firms todifferentiate their products and services

understand the five forces in Portersmodel of competition


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Introduction

Imperfect competition

some market power but not absolutemarket power

firms have the ability to set priceswithin the limits of certain constraints

mutual interdependence: interactionamong competitors when makingdecisions


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IntroductionPerfect Monopoly Monopolistic OligopolyCompetition Competition

Market power? No Yes* Yes Yes

Mutual interdependence No No No Yesamong competingfirms?

Non-price competition? No Optional Yes Yes

Easy market entry Yes No Yes No

or exit ?

* subject to government regulation


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Monopolistic competition:characteristics

many firms relatively easy entry

product differentiation: can set price ata level higher than the price established

by perfect competition use MR = MC rule to maximize profit


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If earning above-normal profits,newcomers will enter the market

market supply curve shifts out and tothe right

firms demand curve shifts down andto the left

ultimately, in the long run, firms earnonly normal profit


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Oligopoly

Oligopoly is a market dominated by arelatively small number of large firms

Herfindahl-Hirschman index (HH)measures market concentration (max HH= 10,000; unconcentrated markets haveHH < 1,000)

n = number of firms in the industry

Si = firms market share

!

!n

i

iSHH

1

2


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Pricingin an oligopolistic market

Mutual interdependence: relatively fewsellers create a situation where each iscarefully watching the others as it sets its

price


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Pricingin an oligopolistic market

Price leader: one firm in the industrytakes the lead in changing prices, andassumes that other firms:

will follow a price increase but will not go even lower in order not

to trigger a price war

Non-price leader: firm that leads thedifferentiation of products on other, non-price attributes


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Competingin imperfectly

competitive markets

Non-price competition: any effort madeby firms in order to change the demandfor their product (other than the price)

Non-price determinants of demand:

tastes and preferences

income

prices of substitutes and complements number of buyers

future expectations of buyers

financing terms


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Chapter Nine Copyright 2009 Pearson Education, Inc.

Publishing as Prentice Hall.

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competitive markets

Examples: of efforts by managers toinfluence non-price demand influences: advertising and promotion

location and distribution channels market segmentation loyalty programs product extensions and new products

special customer services product lock-in or tie-in pre-emptive new product

announcements


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competitive markets

Equalizing at the margin: economicconcept which managers can use to helpmake an optimal decision

eg MR = MC is an example ofequalizing at the margin

can be used to decide the optimalexpenditure level on a non-price factor

may occur over a long period of time firm must adjust MR, MC for the time

value of money


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competitive markets

Examples: the reality of imperfectcompetition

auto industry

small retailers

global credit card issuers


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Strategy for firms in imperfect

competition

How does industry concentration affectthe behavior of firms competing in the

industry?

Strategy: the means by which anorganization uses its scarce resources

to relate to the competitiveenvironment in a manner that isexpected to achieve superior businessperformance over the long run


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competition

Strategy is important when firms areprice makers and are faced with price

and non-price competition as well asthreats from new entrants into themarket

More important for firms inimperfectly competitive markets thanthose in perfectly competitive

markets or monopoly markets


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competition

Managerial economics: the use ofeconomic analysis to make businessdecisions involving the best use of an

organizations scarce resources

Industrial organization: studies theway that firms and markets are

organized and how this organizationaffects the economy


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competition

Structure-Conduct-Performance (S-C-P)paradigm: says structure affects conductwhich affects performance

structure: number of firms inindustry, conditions of entry,product differentiation

conduct: pricing strategies,advertising, product development,legal tactics, collusion

performance: maximization ofsocietys welfare


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Criticism: weak empirical evidence ofrelationship between observedconcentration and profit levels

Weak theoretical foundations.Ignores the likely option thatcausality runs in reverse, for example



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competition

New Theory of IndustrialOrganization: says there is no

necessary connection betweenobserved industry structure andperformance that uniquely leads tomaximum social welfare

theory of contestable markets:performance by firms is ultimatelyinfluenced not by actualcompetition, but by the threat ofpotential competition


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competition

Porters Five Forces model:illustrates the various factors thataffect the ability of any firm in theindustry to earn a profit


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competition

Porters generic strategies for earningabove-average return on investment

Differentiation approach: for amonopoly or monopolisticallycompetitive market following MR= MC rule, firm sets a price on thedemand line that is above AC


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competition

Porters generic strategies for earningabove-average return on investment

Cost leadership approach: forperfect competition

maintain cost structure low

enough so when P = MC, there isa positive difference between Pand AC

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Ch09 Pricing & Output MonopComp & Oligop