Monopolistic Competition and Efficiency Oligopoly Game Theory Three

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms 23 Monopolistic Competition and Oligopoly End Show 23 -1 Copyright 2008 The Mc. Graw-Hill Companies

Chapter Objectives Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -2 • Characteristics of Monopolistic Competition • Why Monopolistic Competitors Earn Only a Normal Profit in the Long-Run • Characteristics of Oligopoly • How Game Theory Relates to Oligopoly • Why the Demand Curve of the Oligopolist May Be Kinked • Incentives and Obstacles to Collusion Among Oligopolists • Potential Positive and Negative Effects of Advertising Copyright 2008 The Mc. Graw-Hill Companies

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -3 • Characteristics – Small Market Shares – No Collusion – Independent Action • Differentiated Products – Product Attributes – Service – Location – Brand Names and Packaging – Some Control Over Price Copyright 2008 The Mc. Graw-Hill Companies O 23. 1

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word • Easy Entry and Exit • Advertising –Nonprice Competition • Monopolistically Competitive Industries Key Terms End Show 23 -4 Copyright 2008 The Mc. Graw-Hill Companies O 23. 1

Price and Output Determination In Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word • The Firm’s Demand Curve • The Short Run: –Profit or Loss • The Long Run: –Only a Normal Profit –Profits: Firms Enter –Losses: Firm’s Leave • Complications Key Terms –Product Variety End Show 23 -5 Copyright 2008 The Mc. Graw-Hill Companies G 23. 1

Price and Output Determination In Monopolistic Competition Key Terms Short-Run Profits MC Price and Costs Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word P 1 A 1 Economic Profit D 1 MR = MC MR 0 Q 1 Quantity End Show 23 -6 ATC Copyright 2008 The Mc. Graw-Hill Companies

Price and Output Determination In Monopolistic Competition Key Terms Short-Run Losses MC Price and Costs Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word A 2 P 2 Loss D 2 MR = MC MR 0 Q 2 Quantity End Show 23 -7 ATC Copyright 2008 The Mc. Graw-Hill Companies

Price and Output Determination In Monopolistic Competition Key Terms Long-Run Equilibrium MC ATC Price and Costs Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word P 3= A 3 D 3 MR = MC MR 0 Q 3 Quantity End Show 23 -8 Copyright 2008 The Mc. Graw-Hill Companies

Monopolistic Competition and Efficiency Recall: P=MC=Minimum ATC MC Price and Costs Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word ATC P 3= A 3 P 4 Price is Higher D 3 MR = MC Excess Capacity at Minimum ATC 0 Key Terms MR Q 3 Q 4 Quantity Monopolistic Competition is Not Efficient End Show 23 -9 Copyright 2008 The Mc. Graw-Hill Companies

Oligopoly Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word • Characteristics – A Few Large Producers – Homogeneous or Differentiated Products • Homogeneous Oligopoly • Differentiated Oligopoly – Control Over Price, But Mutual Interdependence • Strategic Behavior – Entry Barriers – Mergers Key Terms End Show 23 -10 Copyright 2008 The Mc. Graw-Hill Companies

Measures of Concentration Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms • Concentration Ratio • Localized Markets • Interindustry Competition • World Trade –Import Competition • Herfindahl Index W 23. 1 (%S 1)2 + (%S 2)2 + (%S 3)2 + … + (%Sn)2 End Show 23 -11 Copyright 2008 The Mc. Graw-Hill Companies

Game Theory Key Terms Rare. Air’s Price Strategy • 2 Competitors • 2 Price Strategies • Each Strategy Has a Payoff Matrix • Greatest Combined Profit • Independent Actions Stimulate a Response High Uptown’s Price Strategy Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Game Theory Model to Analyze Behavior A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 End Show O 23. 2 23 -12 Copyright 2008 The Mc. Graw-Hill Companies

Game Theory Key Terms Rare. Air’s Price Strategy • Independently Lowered Prices in Expectation of Greater Profit Leads to the Worst Combined Outcome • Eventually Low Outcomes Make Firms Return to Higher Prices High Uptown’s Price Strategy Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Game Theory Model to Analyze Behavior A $12 Low B $15 High $12 C $6 $6 D $8 Low $15 $8 End Show O 23. 2 23 -13 Copyright 2008 The Mc. Graw-Hill Companies

Game Theory Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word • Role of Mutual Interdependence • Collusive Tendencies – Collusion • Incentive to Cheat Key Terms End Show 23 -14 Copyright 2008 The Mc. Graw-Hill Companies G 23. 2

Three Oligopoly Models Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -15 • Kinked Demand Curve • Collusive Pricing • Price Leadership • Diversity of Oligopolies • Complications of Interdependence Copyright 2008 The Mc. Graw-Hill Companies

Kinked-Demand Curve Noncollusive Oligopoly Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms • Strategies –Match Price Changes –Ignore Price Changes • A Combined Strategy • Price Inflexibility • The Kinked-Demand Curve Graphically… End Show 23 -16 Copyright 2008 The Mc. Graw-Hill Companies

Kinked-Demand Curve Noncollusive Oligopoly Rivals Ignore Price Increase P 0 e f D 2 Rivals Match g Price Decrease 0 Q 0 MR 1 Quantity MR 2 Price and Costs Competitor and Rivals Strategize Versus Each Other Consumers Effectively Have 2 Partial Demand Curves and Each Part Has Its Own Marginal Revenue Part Price Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word MC 1 D 2 P 0 MR 2 e f MC 2 g D 1 0 Q 0 MR 1 Quantity Resulting in a Kinked-Demand Curve to the Consumer – Price and Output Are Optimized at the Kink Key Terms End Show 23 -17 Copyright 2008 The Mc. Graw-Hill Companies

Kinked-Demand Curve Noncollusive Oligopoly Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -18 • Criticisms of the Model –Doesn’t Explain How Price Gets to the Kink (P 0) –Oligopoly Prices Are Not As Rigid During Instability as the Model Indicates –Possibility of Price Wars Copyright 2008 The Mc. Graw-Hill Companies

MC Price and Costs Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Cartels and Other Collusion • Price and Output –Collusion and Tendency Toward Joint-Profit Maximization P 0 ATC A 0 MR=MC Economic Profit Key Terms Effectively Sharing The Monopoly Profit D MR Q 0 End Show Quantity 23 -19 Copyright 2008 The Mc. Graw-Hill Companies

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -20 Cartels and Other Collusion • Overt Collusion – Cartels – The OPEC Cartel GLOBAL PERSPECTIVE The 11 OPEC Nations Daily Oil Production, May 2006 Country Saudi Arabia Iran Venezuela UAE Nigeria Kuwait Iraq Libya Indonesia Algeria Qatar Copyright 2008 The Mc. Graw-Hill Companies Barrels of Oil 9, 099, 000 4, 110, 000 3, 233, 000 2, 444, 000 2, 306, 000 2, 247, 000 1, 903, 000 1, 500, 000 1, 451, 000 894, 000 726, 000 Source: OPEC

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms Cartels and Other Collusion • Covert Collusion –Tacit Understandings • Obstacles to Collusion –Demand Cost Differences –Number of Firms –Cheating –Recession –Potential Entry –Legal Obstacles: • Antitrust Law End Show 23 -21 Copyright 2008 The Mc. Graw-Hill Companies

Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms Price Leadership Model • Leadership Tactics • Infrequent Price Changes • Communications • Limit Pricing • Breakdowns in Price Leadership: –Price Wars End Show 23 -22 Copyright 2008 The Mc. Graw-Hill Companies

Oligopoly and Advertising Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -23 • Advertising Prevalent in Monopolistic Competition and Oligopoly • Positive Effects of Advertising • Potential Negative Effects of Advertising Copyright 2008 The Mc. Graw-Hill Companies

Oligopoly and Advertising Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -24 The Largest U. S. Advertisers, 2005 Company Advertising Spending Millions of $ Proctor and Gamble General Motors Time Warner Verizon AT&T Ford Motor Walt Disney Johnson & Johnson Glaxo. Smith. Kline Daimler. Chrysler Copyright 2008 The Mc. Graw-Hill Companies $4609 4353 3494 2484 2471 2398 2279 2209 2194 2179 Source: Advertising Age

Oligopoly and Advertising Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word World’s Top 10 Brand Names GLOBAL PERSPECTIVE Coca-Cola Microsoft IBM General Electric Intel Nokia Toyota Disney Mc. Donalds Mercedes-Benz Key Terms End Show Source: Interbrand 23 -25 Copyright 2008 The Mc. Graw-Hill Companies

Oligopoly and Efficiency Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -26 • Productive and Allocative Efficiency P = MC = Minimum ATC – Neither Exists • Tendency to Share the Monopoly Profit • Qualifications – Increased Foreign Competition – Limit Pricing – Technological Advance Copyright 2008 The Mc. Graw-Hill Companies

Oligopoly in the Beer Industry Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word t • s a L d r o W Once Hundreds of Firms Now a Very Small Group • Demand Side Changes – Taste Shifts to Lighter Beers of Large Breweries – Shift From Tavern-Tap Consumption to Can or Bottles • Supply Side Changes – Technology Increased Minimum Efficient Scale Creating a Barrier to Entry – National Brands Enjoy Cost Advantages • Consolidation of Firms into Oligopoly Key Terms End Show 23 -27 Copyright 2008 The Mc. Graw-Hill Companies

Key Terms Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 23 -28 • monopolistic competition • product differentiation • nonprice competition • excess capacity • oligopoly • homogeneous oligopoly • differentiated oligopoly • strategic behavior • mutual interdependence • concentration ratio Copyright 2008 The Mc. Graw-Hill Companies • interindustry competition • import competition • Herfindahl index • game-theory model • collusion • kinked-demand curve • price war • cartel • tacit understandings • price leadership

Next Chapter Preview… Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Technology, R&D, And Efficiency Key Terms End Show 23 -29 Copyright 2008 The Mc. Graw-Hill Companies