CHAPTER 13 Monopolistic Competition and Oligopoly Monopolistic Competition

CHAPTER 13 Monopolistic Competition and Oligopoly

Monopolistic Competition • Monopolistic competition • • LO 1 Relatively large number of sellers Product differentiation Easy entry and exit Nonprice competition like advertising 13 -2

Monopolistically Competitive Industries ■ Industry concentration ■ Measured by 4 -firm output concentration ratio of four largest ■ Percentage of sales by 4 largest firms total output in the 4 -firm CR industry ■=Herfindahl index ■ Sum of squared market shares LO 1 HI = (%S 1)2 + (%S 2)2 + (%S 3)2 + …. + (%Sn)2 13 -3

Price and Output in Monopolistic Competition ■ Demand is highly elastic ■ Short run profit or loss – Produce where MR = MC ■ Long run only a normal profit – Entry and exit LO 2 13 -4

Monopolistic Competition and Efficiency • Monopolistic competition inefficient • Productive inefficiency because P > min ATC • Allocative inefficiency because P > MC • LO 3 Excess capacity 13 -5

Product Variety ■ The firm constantly manages price, product, and advertising – Better product differentiation – Better advertising ■ The consumer benefits by greater array of choices and better products – Types and styles – Brands and quality LO 4 13 -6

Oligopoly • Oligopoly • A few large producers • Homogeneous oligopolystandardized • Differentiated oligopoly • Limited control over price • Entry barriers • Mergers LO 5 13 -7

Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be an oligopoly LO 5 • Shortcomings • Localized markets • Interindustry competition • Import competition • Dominant firms 13 -8

Oligopoly Behavior • Oligopolies display strategic behavior • Mutual interdependence- depends on rival price and strategy • Collusion • Incentive to cheat • Game theory • Prisoner’s dilemma LO 6 13 -9

Game Theory Overview Rare. Air’s price strategy LO 6 High Uptown’s price strategy • 2 competitors • 2 price strategies • Each strategy has a payoff matrix • Greatest combined profit • Independent actions stimulate a response A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 13 -10

Game Theory Overview Rare. Air’s price strategy LO 6 High Uptown’s price strategy • Independently lowered prices in expectation of greater profit leads to worst combined outcome • Eventually low outcomes make firms return to higher prices. A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 13 -11

Three Oligopoly Models • Kinked-demand curve • Collusive pricing • Price leadership • Reasons for 3 models • Diversity of oligopolies • Complications of interdependence LO 7 13 -12

Kinked-Demand Theory ■ Noncollusive oligopoly ■ Uncertainty about rivals reactions – Rivals match any price change – Rivals ignore any price change ■ Assume combined strategy – Match price reductions – Ignore price increases LO 7 13 -13

Cartels and Other Collusion Price and costs MC ATC P 0 A 0 Economic profit MR=MC Q 0 LO 7 MR D Quantity 13 -14

Overt Collusion • A cartel is a group of firms or nations that collude • Formally agreeing to the price • Sets output levels for members LO 7 • Collusion is illegal in the United States • OPEC 13 -15

Obstacles to Collusion ■ Demand cost differences ■ Number of firms ■ Cheating ■ Recession ■ New entrants ■ Legal obstacles LO 7 13 -16

Price Leadership Model ■ Price leadership – Dominant firm initiates price changes – Other firms follow the leader ■ Use limit pricing to block entry of new firms ■ Possible price war LO 7 13 -17

Oligopoly and Advertising ■ Oligopolies commonly compete though product development and advertising – Less easily duplicated than a price change – Financially able to advertise LO 8 13 -18

Positive Effects of Advertising ■ Low-cost way of providing information to consumers ■ Enhances competition ■ Speeds up technological progress ■ Can help firms obtain economies of scale LO 8 13 -19

Oligopoly and Efficiency ■ Oligopolies are inefficient – Productively inefficient because P > min ATC – Allocatively inefficient because P > MC ■ Qualifications – Increased foreign competition – Limit pricing – Technological advance LO 9 13 -20