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Monopolistic Competition and Oligopoly

23. Monopolistic Competition and Oligopoly. Chapter Objectives. 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

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Monopolistic Competition and Oligopoly

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  1. 23 Monopolistic Competition and Oligopoly

  2. Chapter Objectives • 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

  3. O 23.1 Monopolistic Competition • Characteristics • Small Market Shares • No Collusion • Independent Action • Differentiated Products • Product Attributes • Service • Location • Brand Names and Packaging • Some Control Over Price

  4. O 23.1 Monopolistic Competition • Easy Entry and Exit • Advertising • Nonprice Competition • Monopolistically Competitive Industries

  5. G 23.1 Price and Output Determination In Monopolistic Competition • 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 • Product Variety

  6. Price and Output Determination In Monopolistic Competition Short-Run Profits ATC MC P1 A1 Price and Costs Economic Profit D1 MR = MC MR 0 Q1 Quantity

  7. Price and Output Determination In Monopolistic Competition Short-Run Losses ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR 0 Q2 Quantity

  8. Price and Output Determination In Monopolistic Competition Long-Run Equilibrium MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity

  9. MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity Monopolistic Competition and Efficiency Recall:P=MC=Minimum ATC P4 Price is Higher Excess Capacity at Minimum ATC Q4 Monopolistic Competition is Not Efficient

  10. Oligopoly • Characteristics • A Few Large Producers • Homogeneous or Differentiated Products • Homogeneous Oligopoly • Differentiated Oligopoly • Control Over Price, But Mutual Interdependence • Strategic Behavior • Entry Barriers • Mergers

  11. W 23.1 Measures of Concentration • Concentration Ratio • Localized Markets • Interindustry Competition • World Trade • Import Competition • Herfindahl Index (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2

  12. O 23.2 Game Theory Game Theory Model to Analyze Behavior RareAir’s Price Strategy • 2 Competitors • 2 Price Strategies • Each Strategy Has a Payoff Matrix • Greatest Combined • Profit • Independent Actions • Stimulate a Response High Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8

  13. O 23.2 Game Theory Game Theory Model to Analyze Behavior RareAir’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 Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8

  14. G 23.2 Game Theory • Role of Mutual Interdependence • Collusive Tendencies • Collusion • Incentive to Cheat

  15. Three Oligopoly Models • Kinked Demand Curve • Collusive Pricing • Price Leadership • Diversity of Oligopolies • Complications of Interdependence

  16. Kinked-Demand Curve Noncollusive Oligopoly • Strategies • Match Price Changes • Ignore Price Changes • A Combined Strategy • Price Inflexibility • The Kinked-Demand Curve Graphically…

  17. Price Price and Costs 0 0 Quantity Quantity Kinked-Demand Curve Noncollusive Oligopoly Competitor and Rivals Strategize Versus Each Other Consumers Effectively Have 2 Partial Demand Curves and Each Part Has Its Own Marginal Revenue Part Rivals Ignore Price Increase MC1 D2 e e P0 P0 MR2 f f D2 MC2 MR2 g Rivals Match Price Decrease g D1 D1 Q0 Q0 MR1 MR1 Resulting in a Kinked-Demand Curve to the Consumer – Price and Output Are Optimized at the Kink

  18. Kinked-Demand Curve Noncollusive Oligopoly • Criticisms of the Model • Doesn’t Explain How Price Gets to the Kink (P0) • Oligopoly Prices Are Not As Rigid During Instability as the Model Indicates • Possibility of Price Wars

  19. Price and Costs Quantity Cartels and Other Collusion • Price and Output • Collusion and Tendency Toward Joint-Profit Maximization Effectively Sharing The Monopoly Profit MC P0 ATC A0 MR=MC Economic Profit D MR Q0

  20. GLOBAL PERSPECTIVE Barrels of Oil Country Saudi Arabia Iran Venezuela UAE Nigeria Kuwait Iraq Libya Indonesia Algeria Qatar 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 Cartels and Other Collusion • Overt Collusion • Cartels • The OPEC Cartel The 11 OPEC Nations Daily Oil Production, May 2006

  21. Cartels and Other Collusion • Covert Collusion • Tacit Understandings • Obstacles to Collusion • Demand and Cost Differences • Number of Firms • Cheating • Recession • Potential Entry • Legal Obstacles: • Antitrust Law

  22. Price Leadership Model • Leadership Tactics • Infrequent Price Changes • Communications • Limit Pricing • Breakdowns in Price Leadership: • Price Wars

  23. Oligopoly and Advertising • Advertising Prevalent in Monopolistic Competition and Oligopoly • Positive Effects of Advertising • Potential Negative Effects of Advertising

  24. Advertising Spending Millions of $ Company Oligopoly and Advertising The Largest U.S. Advertisers, 2005 Proctor and Gamble General Motors Time Warner Verizon AT&T Ford Motor Walt Disney Johnson & Johnson GlaxoSmithKline DaimlerChrysler $4609 4353 3494 2484 2471 2398 2279 2209 2194 2179 Source: Advertising Age

  25. Coca-Cola Microsoft IBM General Electric Intel Nokia Toyota Disney McDonalds Mercedes-Benz GLOBAL PERSPECTIVE Source: Interbrand Oligopoly and Advertising World’s Top 10 Brand Names

  26. Oligopoly and Efficiency • Productive and Allocative Efficiency P = MC = Minimum ATC • Neither Exists • Tendency to Share the Monopoly Profit • Qualifications • Increased Foreign Competition • Limit Pricing • Technological Advance

  27. Oligopoly in the Beer Industry Last Word • 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

  28. monopolistic competition product differentiation nonprice competition excess capacity oligopoly homogeneous oligopoly differentiated oligopoly strategic behavior mutual interdependence concentration ratio interindustry competition import competition Herfindahl index game-theory model collusion kinked-demand curve price war cartel tacit understandings price leadership Key Terms

  29. Next Chapter Preview… Technology, R&D, And Efficiency Chapter 24!

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