Monopolistic Competition Monopolistic competition many sellers of similar

Monopolistic Competition • Monopolistic competition – many sellers of similar products. • Since a monopolistic competitor sells a product that is different than its competitors, it will have some degree of market power.

Product Differentiation • Product differentiation – the process of distinguishing a firm’s product from similar products. • 1. to increase the firm’s market power. • See Examples 1 A and 1 B on page 23 -1. • 2. to increase the demand for the firm’s product. • See Example 2 on page 23 -1.

Demand Marginal Revenue • A monopolistic competitor faces a downward sloping demand curve, with the degree of slope depending largely on product differentiation. • See Examples 3 A and 3 B on page 23 -2. • The marginal revenue curve will be twice as steeply downward sloping as the demand curve.

Profit-Maximization • A monopolistic competitor will maximize profits by producing the quantity of output where MR = MC.

Profit-Maximization

Monopolistic Competition versus Perfect Competition • Compared to perfect competition, monopolistic competition results in less output at a higher price.

Perfect Competition

Monopolistic Competition

Economic Inefficiency • Monopolistic competition is economically inefficient. • Monopolistic competition results in a quantity of output where price exceeds marginal cost, and thus where MSB exceeds MSC.

Economic Inefficiency

Monopolistic Competition in the Long Run • In the long run, economic profits (or losses) are eliminated by firms entering (or exiting) the industry. • See Example 5 on page 23 -3.

Oligopoly • Oligopoly – an industry dominated by a few mutually interdependent firms. • See Example 6 on page 23 -4. • Oligopoly usually results from barriers to entry, especially economies of scale.

Theories of Oligopoly • 1. Kinked demand curve theory. • 2. Unkinked demand curve theory. • 3. Cartel theory.

Kinked Demand Curve Theory • Assumes that other firms will match a price reduction, but will not match a price increase. • The different response to an increase in price versus a decrease in price will cause the demand curve to be kinked at its current price and quantity.

Kinked Demand Curve

Marginal Revenue Curve • The kink in the demand curve will result in a gap in the marginal revenue curve.

Marginal Revenue Curve

Profit-Maximization • Profit-maximization will occur where the marginal cost curve passes through the gap in the marginal revenue curve.

Profit-Maximization

Kinked Demand Curve Theory • The gap in the marginal revenue curve means that a change in marginal cost may result in no change in price or quantity. • The kinked demand curve theory predicts “sticky” prices for an oligopoly.

Change in Marginal Cost

Unkinked Demand Curve Theory • According to economist George Stigler, there is no kink in the demand curve for an oligopoly. • Unkinked demand curve theory asserts that oligopoly is similar to monopolistic competition.

Cartel Theory • A cartel is an organization through which members jointly make decisions about prices and production. • See Example 9 on page 23 -6. • A cartel sets output for the industry, as would a monopoly, and allocates production to the member firms.

Maintaining a Cartel • Cartels are difficult to maintain due to: • 1. Noncartel competition. • See Example 10 on page 23 -7. • 2. The tendency of cartel members to “cheat” on the agreement. • See Example 11 on page 23 -7.

Economic Inefficiency • Oligopoly is economically inefficient. • Oligopoly results in a quantity of output where price exceeds marginal cost, and thus where MSB exceeds MSC.

Game Theory • Game theory – a method for analyzing strategic behavior. • See the “prisoners’ dilemma” game in Example 13 on page 23 -8.

Payoff Matrix

Dominant Strategy • Dominant strategy – a strategy that always yields the best result regardless of the strategies of the other players. • The dominant strategy for both Bo and Luke is to confess.

Nash Equilibrium • Nash equilibrium – the outcome when each game player has chosen their best strategy, assuming that all other players have chosen their best strategies. • The Nash equilibrium in a cartel is for all members of the cartel to “cheat”. • See Example 14 on page 23 -9.

The NCAA Cartel • The NCAA is a buying cartel. • Its members have agreed to a maximum price for college athletes. • The big-revenue college sports can generate millions of dollars in revenue. • See Example 16 on page 23 -9.

The NCAA Cartel • As a result of the NCAA cartel, income is redistributed from the athletes in the bigrevenue sports to the athletic departments. • See Example 18 on page 23 -10.

The NCAA Cartel • As a cartel, the NCAA faces noncartel competition from the NFL and the NBA. • And there is a strong tendency for NCAA members to “cheat” on the cartel agreement. • See Example 19 on page 23 -10.