13 Monopolistic Competition and Oligopoly Mc GrawHillIrwin Copyright

13 Monopolistic Competition and Oligopoly Mc. Graw-Hill/Irwin Copyright © 2012 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

• • LO 1 Monopolistic Competition Relatively large number of sellers • Small market shares • No collusion • Independent action • Some control over price Differentiated products • Product attributes • Service, location • Brand-names, packaging

Monopolistic Competition • Easy entry and exit • Advertising • Nonprice competition LO 1

Price and Output in Monopolistic Comp • Demand is more elastic than pure • LO 2 monopoly because there are more rivals and substitutes Demand is less elastic than pure competition because there are fewer rivals and imperfect substitutes

Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO 2

Oligopoly • A few large producers • Homogeneous or differentiated • • • LO 3 products Limited control over price • Mutual interdependence • Strategic behavior Entry barriers Mergers

Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be oligopoly • Shortcomings • Localized markets • Inter-industry competition • World price • Dominant firms – Herfindahl Index LO 3

High Concentration Industries (1) Industry Primary copper (2) 4 -Firm Concentration Ratio (3) Herfindahl Index 99 ND (1) Industry (2) 4 -Firm Concentration Ratio (3) Herfindahl Index Petrochemicals 85 2662 83 1901 Cane sugar refining 99 ND Small arms ammunition Cigarettes 95 ND Motor vehicles 81 2321 80 2515 Household laundry equipment 93 ND Men’s slacks and jeans Beer 91 ND Aircraft 81 ND Electric light bulbs 89 2582 Breakfast cereals 78 2521 78 2096 Glass containers 88 2582 Household vacuum cleaners Turbines and generators 88 ND Phosphate fertilizers 78 1853 Tires 77 1807 Electronic computers 76 Alcohol distilleries 71 Household refrigerators and freezers 85 1986 Primary aluminum 85 ND LO 1 2662 1609

3 Oligopoly Models • Kinked Demand Curve • Collusive Pricing • Price Leadership • Reasons for 3 models • Diversity of oligopolies • Complications of interdependence LO 5

Kinked Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO 6

Overt Collusion • Collusion reduces uncertainty, • • LO 6 improves control of price, profits rise, and prevents entry of firms Cartels - a group of firms or nations that collude • Formally written agreement • Sets output levels and price for members OPEC

Covert Collusion • Gentleman’s agreements • Informal understandings often in social settings between firms about price and output LO 6

Obstacles to Collusion • Demand cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles • Golden Balls LO 6

Global Perspective LO 6

Price Leadership Model • Price Leadership • Dominant firm initiates price • • LO 6 changes • Communicates price change • Other firms follow the leader Use limit pricing to block entry of new firms Possible price war

Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > min. ATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO 7