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Chapter 11. Monopolistic Competition and Oligopoly. Chapter Objectives. Characteristics of monopolistic competition Normal profit in the long run Characteristics of oligopoly Game theory The oligopolist’s kinked demand curve Collusion among oligopolists The effects of advertising. - PowerPoint PPT Presentation
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Monopolistic Competition and Oligopoly
Chapter 11
Chapter Objectives Characteristics of monopolistic
competition Normal profit in the long run Characteristics of oligopoly Game theory The oligopolist’s kinked demand
curve Collusion among oligopolists The effects of advertising
Monopolistic Competition
Large number of sellersSmall market sharesNo collusionIndependent action
Differentiated ProductsProduct attributesServiceLocationBrand names and packagingSome control over price
Easy entry and exit Need for advertising
Nonprice Competition Which industries?
Degree of concentrationFour-firm concentration ratioHerfindahl index
Monopolistic CompetitionMonopolistic Competition
Short-Run Profits
Quantity
Pric
e an
d C
osts
MR = MC
MC
MR
D1
ATC
EconomicProfit
Q1
A1
P1
0
Monopolistic Competition
Short-Run Losses
Quantity
Pric
e an
d C
osts
MR = MC
MC
MR
D2
ATC
Loss
Q2
A2
P2
0
Monopolistic Competition
Long-Run Equilibrium
Quantity
Pric
e an
d C
osts
MR = MC
MC
MR
D3
ATC
Q3
P3= A3
0
Monopolistic Competition
Firm’s demand curveHighly elastic
Short run profit or lossProduce where MR=MC
Long run normal profitEntry and exit
Inefficient Product variety
Monopolistic Competition
Quantity
Pric
e an
d C
osts
MR = MC
MC
MR
D3
ATC
Q30
P3= A3
P=MC=Min ATC for pure competition
P4
Q4
Price is Lower
Excess Capacity atMinimum ATC
P3>lowest ATC A3; therefore, P ≠ MC & minimum ATC. Productive efficiency is not achieved. P3>MC, meaning underallocation of resources. Allocative efficiency is not achieved
Oligopoly A few large producers Homogeneous or
differentiated products Control over price
Mutual interdependenceStrategic behavior
Entry barriers Mergers
Four-firm concentration ratioNeeds to be more than 40%Half of U.S. manufacturing
Localized markets Interindustry competition World trade
Import Competition Herfindahl index
Oligopoly Behavior: Game Theory
Mutual interdependence-Pricing policy-Oligopolistic firms can increase their profit,
and influence their rivals’ profits by changing their pricing strategies. Each firm’s profit depends on its own pricing strategy and that of its rivals, which is why this relationship between oligopolies is called mutual interdependence.
Collusion-Oligopolists often can benefit from collusion or cooperation with rivals.
Incentive to cheat -After a collusive pricing agreement every oligopolist might be tempted to cheat, because either firm can increase its profit by lowering its price.
Oligopoly Behavior: Game Theory Model
RareAir’s Price Strategy
Upt
own’
s P
rice
Stra
tegy
A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low•2 competitors•2 price strategies•Each strategy has a payoff matrix
•Greatest combinedprofit
• Independent actionsstimulate a response
Game Theory ModelRareAir’s Price Strategy
Upt
own’
s P
rice
Stra
tegy
A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low• Independently lowered prices in expectation of greater profit leads to the worst combined outcome
•Eventually low outcome make firms return to higher prices
Three Oligopoly Models
Kinked-demand curve Collusive pricing Price leadership
Kinked-Demand Curve
Noncollusive oligopoly Strategies
Match price changes- when one firm lowers their prices to have a better profit, the other companies match their price so the demand and marginal revenue curve will be steeper.
Ignore price changes-when a firm changes their prices and their rivals ignore this change, the demand curve for this first firm will be more elastic.
Combined strategyOligopolistic industries suggest that a firm’s rivals will match
price declines below P0, and they will ignore price changes over P0.
Kinked Demand Curve
Price InflexibilityThe kinked demand curve gives each
oligopolist reason to believe that any change in price will be for the worse. If it raises its price, many of its customers will desert it. If it lowers its price, its sales at best will increase very modestly, since rivals will match the lower prices.
Pric
e
Pric
e an
d C
osts
Quantity Quantity
0 0
P0
MR2
D2
D1
MR1
e
f
g
Rivals IgnorePrice Increase
Rivals MatchPrice Decrease
Q0
Competitor and rivals strategize versus each otherConsumers effectively have 2 partial demand curves and
each part has its own marginal revenue part
MR2
D2
D1
MR1Q0
MC1
MC2
P0e
f
g
Kinked-Demand Curve
Pric
e an
d C
osts
Quantity
Cartels and Other Collusion Price and output
Joint profit maximization
D
MR=MC
ATC
MC
MR
P0
A0
Q0
EconomicProfit
Effectively SharingThe Monopoly Profit
Cartels and Other Collusion Overt collusion Covert collusion
Tacit understandings Obstacles to collusion
Demand and cost differencesNumber of firmsCheatingRecessionPotential entryLegal obstacles: antitrust law
The OPEC Cartel
Source: A. T. Kearney, Foreign Policy
Iran 3,843,000Kuwait 2,538,000Venezuela 2,368,000Iraq 2,297,000Nigeria 2,183,000UAE 2,117,000Angola 1,804,000Libya 1,737,000Algeria 1,417,000Qatar 848,000Indonesia 843,000Ecuador 530,000
Daily oil production (barrels) , November 2008
Saudi Arabia 8,904,000
Price Leadership Model Leadership tactics Infrequent price changes Communications Limit pricing Breakdowns in price leadership:
Price wars
Advertising Prevalent in monopolistic
competition and oligopoly Capture market share Better than a price cut Information for consumers Manipulation
Oligopoly and AdvertisingThe Largest U.S. Advertisers, 2006
CompanyAdvertising Spending
Millions of $
Proctor and GambleAT&TGeneral MotorsTime WarnerVerizonFord MotorGlaxoSmithKlineWalt DisneyJohnson & JohnsonUnilever
$4898334532963089282225772444232022912098
Source: Advertising Age
World’s Top 10 Brand Names, 2007
Source: Interbrand
Coca-ColaMicrosoftIBMGeneral ElectricNokiaToyotaIntelMcDonald’sDisneyMercedes-Benz
Oligopoly and Advertising
Oligopoly and Efficiency
Not productively efficient Not allocatively efficient Tendency to share the monopoly
profit Qualifications
Increased foreign competitionLimit pricingTechnological advance