Monopolistic Competition and Superio r Oligopoly Cheese CHAPTER

Monopolistic Competition and Superio r Oligopoly Cheese CHAPTER TWENTY-FIVE

Four Market Models Monopolistic Competition Pure Monopoly Pure Competition Market Structure Continuum

Monopolistic Competition Characteristics. . . • Relatively Large Numbers

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation Product Attributes

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation Product Attributes Services

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation Product Attributes Services Location

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation Product Attributes Services Location Brand Names and Packaging

Monopolistic Competition Characteristics. . . • Relatively Large Numbers Small Market Share No Collusion Independent Actions • Product Differentiation Product Attributes Services Location Brand Names and Packaging Some Control Over Price

Monopolistic Competition Characteristics. . . • Easy Entry and Exit

Monopolistic Competition Characteristics. . . • Easy Entry and Exit • Nonprice Competition

Monopolistic Competition Characteristics. . . • Easy Entry and Exit • Nonprice Competition • Advertising

Monopolistic Competition Characteristics. . . • Easy Entry and Exit • Nonprice Competition • Advertising • Monopolistically Competitive Industries

Short-Run Price and Output Determination Price and Costs P Monopolistic competitors have an elastic demand curve, but not perfectly elastic. . . Q Copyright Mc. Graw-Hill, Inc. , 1999

Short-Run Price and Output Determination Price and Costs P D Q Copyright Mc. Graw-Hill, Inc. , 1999

Short-Run Price and Output Determination Price and Costs P D MR Q Copyright Mc. Graw-Hill, Inc. , 1999

Short-Run Price and Output Determination MC Price and Costs P D MR Copyright Mc. Graw-Hill, Inc. , 1999 Q Q

Short-Run Price and Output Determination MC P Price and Costs ATC D MR Copyright Mc. Graw-Hill, Inc. , 1999 Q Q

Short-Run Price and Output Determination P Expect New Competitors MC Price and Costs ATC Economic Profits D MR Q Q

Short-Run Price and Output Determination Price and Costs P Expect New Competitors MC How would short-run losses Economic Profitsdifferent? be ATC D MR Q Q

Short-Run Price and Output Determination MC Price and Costs P ATC Economic Losses Expect Less Competitors D MR Q Q

Short-Run Price and Output Determination MC Price and Costs P How would Economic the long-run Losses Expect differ? Less Competitors ATC D MR Q Q

Short-Run Price and Output Determination P Expect New Competitors MC Price and Costs ATC Economic Profits D MR Q Q

Short-Run Price and Output Determination P Long-run equilibrium MC Price and Costs ATC P = MC D MR Q Q Q @ ATC Min ?

Monopolistic Competition and Economic Efficiency

Monopolistic Competition and Economic Efficiency • Not Productively Efficient

Monopolistic Competition and Economic Efficiency • Not Productively Efficient • Not Allocatively Efficient

Monopolistic Competition and Economic Efficiency • Not Productively Efficient • Not Allocatively Efficient • Excess Capacity

Monopolistic Competition and Economic Efficiency • Not Productively Efficient • Not Allocatively Efficient • Excess Capacity Nonprice Competition

Monopolistic Competition and Economic Efficiency • Not Productively Efficient • Not Allocatively Efficient • Excess Capacity Nonprice Competition • Product Differentiation

Monopolistic Competition and Economic Efficiency • Not Productively Efficient • Not Allocatively Efficient • Excess Capacity Nonprice Competition • Product Differentiation • Product Development

Features of a Monopolistic Competitive Markets: 1. Many sellers 2. Unique Products that have close or identical substitutes: Big Mac v Whopper 3. Small barrier to entry or exit 4. Some market power exists 5. Price is greater than MR, Separate DARP and MR curves 6. Non price competition and advertising exist 7. Profits maximized at the Quantity and Price where MC = MR 8. Excess or Economic Profits in the Short Run only (P>ATC) 9. Profits must be Normal in the Long Run (P=ATC) 10. Firms should shut down when P < AVC 11. Excess capacity exists in terms of potential output 12. Demand is relatively elastic by comparison to monopoly 13. Example market - Minimarts, Fast food at local franchises 14. This market is much closer to perfect competition than pure monopoly

Four Market Models Oligopoly Pure Competition Monopolistic Competition Market Structure Continuum Pure Monopoly

Oligopoly: Characteristics

Oligopoly: Characteristics • Oligopoly Defined

Oligopoly: Characteristics • Oligopoly Defined • Homogeneous or Differentiated Products

Oligopoly: Characteristics • Oligopoly Defined • Homogeneous or Differentiated Products • Control over Price

Oligopoly: Characteristics • Oligopoly Defined • Homogeneous or Differentiated Products • Control over Price • Mutual Interdependence

Oligopoly: Characteristics • Oligopoly Defined • Homogeneous or Differentiated Products • Control over Price • Mutual Interdependence • Entry Barriers

Oligopoly: Characteristics • Oligopoly Defined • Homogeneous or Differentiated Products • Control over Price • Mutual Interdependence • Entry Barriers • Mergers

Oligopoly: Characteristics • Concentration Ratios that look at what the concentration of firms are in the industry.

Oligopoly: Characteristics • Concentration Ratios - Herfindahl Index – The larger the index number the higher the concentration of the industry.

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Greatest Combined Profit

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Independent Actions Stimulate Response

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Independent Actions Stimulate Response Gravitating to the Worst Case

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Collusion Invites a Different Solution

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Collusion Invites a Different Solution

Oligopoly Behavior A Game Theory Overview. . . Rare. Air’s Price Strategy Uptown’s Price Strategy High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8 Collusion Invites a Different Solution But, the incentive to cheat is very real

Pay Off Matrix Oligopoly – Reasons for Collusion Ads Effect Sales (Q) and P x Q = TR so Ads effect Total Revenue! Low Cost Ads: 120 : 30 second Ads/week for $10, 000 High Cost Ads: 240 : 30 second Ads/week for $20, 000 TR - TC = TP Company A High Ads $100, 000 – 20, 000 = $80, 000 Low Ads $50, 000 – 10, 000 = $40, 000 Company B Low Ads $50, 000 – 10, 000 = $40, 000 High Ads $100, 000 – 20, 000 = $80, 000 Company A Low Ads $75, 000 – 10, 000 = $65, 000 High Ads $75, 000 – 20, 000 = $55, 000 Company B Low Ads $75, 000 – 10, 000 = $65, 000 High Ads $75, 000 – 20, 000 = $55, 000 If either duopolist begins running High Ads, its competitor will counter with High Ads! Games Theory and Collusion’s answer is an agreement by “both”to keep advertising low in order to maximize profits! Would their be incentive to Cheat?

Three Oligopoly Models No Standard Model due to. . .

Three Oligopoly Models No Standard Model due to. . . Diversity

Three Oligopoly Models No Standard Model due to. . . Diversity Interdependence

Three Oligopoly Models No Standard Model due to. . . Diversity Interdependence 1 - Kinked Demand Curve

Three Oligopoly Models No Standard Model due to. . . Diversity Interdependence 1 - Kinked Demand Curve 2 - Collusive Pricing

Three Oligopoly Models No Standard Model due to. . . Diversity Interdependence 1 - Kinked Demand Curve 2 - Collusive Pricing 3 - Price Leadership

Kinked Demand: Noncollusive Oligopoly P The firm’s demand marginal revenue curves when rivals follow pricing patterns. D 1 Quantity MR 1 Q

Kinked Demand: Noncollusive Oligopoly P The firms demand marginal revenue curves when rivals don’t follow pricing patterns. D 2 D 1 Quantity MR 1 MR 2 Q

Kinked Demand: Noncollusive Oligopoly P Rivals tend to follow a price cut D 2 D 1 Quantity MR 1 MR 2 Q

Kinked Demand: Noncollusive Oligopoly P Rivals tend to follow a price cut or ignore a price increase D 2 D 1 Quantity MR 1 MR 2 Q

Kinked Demand: Noncollusive Oligopoly P Effectively creating a kinked demand curve D 2 D 1 Quantity MR 1 MR 2 Q

Kinked Demand: Noncollusive Oligopoly P Effectively creating a kinked demand curve D 2 MC 1 MR 2 MC 2 D 1 Quantity MR 1 Q

Cartels and Collusion

Cartels and Collusion Oligopoly is conducive to collusion

Cartels and Collusion Oligopoly is conducive to collusion If a few firms face identical or highly similar demand costs. . .

Cartels and Collusion Oligopoly is conducive to collusion If a few firms face identical or highly similar demand costs. . . They will seek joint profit maximization. . .

Colluding Oligopolists Will Split the Monopoly Profits Price MC P ATC D MR = MC Economic Profit MR Q Quantity

Cartels and Collusion Overt Collusion

Cartels and Collusion Overt Collusion OPEC Cartel

Cartels and Collusion Overt Collusion OPEC Cartel Covert Collusion

Obstacles to Collusion

Obstacles to Collusion Demand & Cost Differences

Obstacles to Collusion Demand & Cost Differences Number of Firms

Obstacles to Collusion Demand & Cost Differences Number of Firms Cheating

Obstacles to Collusion Demand & Cost Differences Number of Firms Cheating Recession

Obstacles to Collusion Demand & Cost Differences Number of Firms Cheating Recession Potential Entry

Obstacles to Collusion Demand & Cost Differences Number of Firms Cheating Recession Potential Entry Legal Obstacles: Antitrust

Price Leadership

Price Leadership Tactics

Price Leadership Tactics Infrequent Changes

Price Leadership Tactics Infrequent Changes Communication

Price Leadership Tactics Infrequent Changes Communication Limit Pricing - sometimes smaller companies will wage price wars to knock the leader down.

Oligopoly & Advertising

Unit Costs Advertising Effects on Output & Average Costs ATC without advertising Copyright Mc. Graw-Hill, Inc. , 1999 Q Q

Advertising Effects on Output & Average Costs ATC Unit Costs with advertising ATC without advertising Copyright Mc. Graw-Hill, Inc. , 1999 Q Q

Advertising Effects on Output & Average Costs Advertising Costs ATC Unit Costs with advertising ATC without advertising Copyright Mc. Graw-Hill, Inc. , 1999 Q Q

Oligopoly and Economic Efficiency Recall. . . Allocative Efficiency (Price = MC)

Oligopoly and Economic Efficiency Recall. . . Allocative Efficiency (Price = MC) Productive Efficiency (Price = Minimum ATC)

Oligopoly and Economic Efficiency Recall. . . Allocative Efficiency (Price = MC) Productive Efficiency (Price = Minimum ATC) Neither is likely in an oligopoly market structure

Features of an Oligopolistic Markets: 1. Few sellers (Less than seven), Duopoly - two main sellers + the fringe firms 2. Unique Products but similar products Coke v Pepsi, Chevy v Ford 3. Large barrier to entry or exit 4. A large measure of market power exists 5. Price is greater than MR, Separate DARP and MR curves 6. Non price competition and advertising exist Procter & Gamble: $3, 277, 000 in Ads 1999 7. Profits maximized at the Quantity and Price where MC = MR 8. Excess or Economic Profits possible in the Long Run (P>ATC) 9. Interdependence, Collusion, Spies, Pay off Matrix Price and Innovative Leaders exist, Gamesmanship “A Beautiful Mind” 10. Firms should shut down when P < AVC 11. Excess capacity exists in terms of potential output 12. Demand is relatively inelastic 13. Theory of the Kinked Demand Curve and Price Stickiness results from collusion and gamesmanship 14. Example market - Automobiles, Soda, Beer, Steel, Tobacco Products may be differentiated (Toyota v Ford) or homogeneous (Steel)

Advertising Effects on Output & Average Costs Unit Costs Advertising Costs Questions and Discussion. . . Copyright Mc. Graw-Hill, Inc. , 1999 Q ATC with advertising ATC without advertising Q

u u u u monopolistic competition product differentiation nonprice competition excess capacity oligopoly homogeneous oligopoly differentiated u u u u interindustry competition import competition Herfindahl index game theory model collusion kinked demand curve price war cartel

Next. . . Technology, R&D, and Efficiency Chapter 26