Monopolistic Competition and Oligopoly 2003 SouthWesternThomson Learning The

Monopolistic Competition and Oligopoly © 2003 South-Western/Thomson Learning

The Concept of Imperfect Competition Imperfect competition: market structures between perfect competition and monopoly • more than one seller, but too few to create a perfectly competitive market • often violate other conditions of perfect competition, such as the requirement of a standardized product or free entry and exit

Monopolistic Competition • Monopolistic Competition in the Short Run • Monopolistic Competition in the Long Run • Excess Capacity Under Monopolistic Competition • Nonprice Competition

Monopolistic Competition A monopolistically competitive market has three fundamental characteristics: 1. Many buyers and sellers 2. No significant barriers to entry/exit 3. Differentiated products

Monopolistic Competition Because it produces a differentiated product, –a monopolistic competitor faces a downward-sloping demand curve –when it raises its price a modest amount, quantity demanded will decline –but not all the way to zero

Monopolistic Competition in the Short Run Under monopolistic competition, firms can earn positive or negative economic profit in the short run.

Monopolistic Competition in the Short Run Dollars $70 A MC ATC d 1 30 MR 1 250 Homes Serviced per Month

Monopolistic Competition in the Long Run But in the long run, free entry and exit will ensure that each firm earns zero economic profit, just as under perfect competition.

Monopolistic Competition in the Long Run In long run, a monopolistic competitor will operate with excess capacity - that is, it will produce too little output to achieve minimum cost per unit.

Monopolistic Competition in the Long Run Dollars MC ATC $40 E d MR 2 100 200 d 2 Homes Serviced per Month

Excess Capacity Under Monopolistic Competition In the long run, a monopolistic competitor will operate with excess capacity; it will produce too little output to achieve minimum cost per unit.

Nonprice Competition Any action a firm takes to increase the demand for its product, other than cutting its price.

Oligopoly • Oligopoly in the Real World • Why Oligopolies Exist • Oligopoly Behavior • Cooperative Behavior in Oligopoly • The Limits of Oligopoly

Oligopoly A market structure in which a small number of firms are strategically interdependent.

Why Oligopolies Exist • Economies of scale: natural oligopolies • Reputation as a barrier • Strategic barriers • Government-created barriers

Why Oligopolies Exist Minimum Efficient Scale (MES) The level of output at which economies of scale are exhausted and minimum LRATC is achieved.

Why Oligopolies Exist

Oligopoly Behavior Game Theory An approach to modeling the strategic interaction of oligopolists in terms of moves and countermoves

Oligopoly Behavior Payoff Matrix A table showing the payoffs to each of two players for each pair of strategies they choose

Oligopoly Behavior Colin’s Actions Confess Colin gets 20 years Confess Rose’s Actions Don’t Confess Rose gets 20 years Colin gets 30 years Rose gets 3 years Colin gets 3 years Rose gets 30 years Colin gets 5 years Rose gets 5 years

Oligopoly Behavior Dominant Strategy A strategy that is best for a firm no matter what strategy its competitor chooses

Oligopoly Behavior Duopoly An oligopoly market with only two sellers

Oligopoly Behavior Gus’s Actions Low Price Filip’s High Price Gus’s profit = $25, 000 Filip’s profit = $25, 000 Gus’s profit = –$10, 000 Filip’s profit = $75, 000 Gus’s profit = $75, 000 Filip’s profit = –$10, 000 Gus’s profit = $50, 000 Filip’s profit = $50, 000

Oligopoly Behavior Repeated Play A situation in which strategically interdependent sellers compete over many time periods

Cooperative Behavior in Oligopoly Explicit Collusion Cooperation involving direct communication between competing firms about setting prices

Cooperative Behavior in Oligopoly Cartel A group of firms that selects a common price that maximizes total industry profits

Cooperative Behavior in Oligopoly Tacit Collusion Any form of oligopolistic cooperation that does not involve an explicit agreement

Cooperative Behavior in Oligopoly Price Leadership A form of tacit collusion in which one firm sets a price that other firms copy

Cooperative Behavior in Oligopoly Tit for Tat A game-theoretic strategy of doing to another player this period what he has done to you in the previous period

When Is Cheating Likely? Cheating will be likely, and collusion least successful, under the following conditions: –Difficulty observing other firms’ prices –Unstable market demand –Large number of sellers

Limits to Oligopoly • Antitrust legislation and enforcement • Globalization of the marketplace • Technological change