Monopolistic Competition & Oligopoly

1. Monopolistic Competition & Oligopoly ECO 2023 Chapter 11 Fall 2007

2. Monopolistic Competition • A market structure with many firms selling products that are substitutes but different enough that each firm’s demand curve slopes downward, firm entry is relatively easy

3. Characteristics • Relatively large number of sellers • Differentiated product • Ease of entry and exit • Low barriers to entry • Price makers • Advertising

4. Monopolistic Competition • Product Differentiation • Physical differences • Differences in appearance and qualities • Evian vs Dasani • Location • The number and variety of locations where a product is available are other ways • Services • Product image

5. Monopolistic Competition • Short-run Profit Maximization • Because each monopolistic competitor offers a product that differs somewhat from what others supply • Each has some control over the price charged • Demand curve slopes downward • Elastic demand • Marginal revenue = marginal cost

6. Price Profit Marginal Cost Average Total Cost Price Cost Demand Marginal Revenue Q Monopolistic Competition – Short run Profit

7. Price Loss Marginal Cost Average Total Cost Cost Price Demand Marginal Revenue Q Monopolistic Competition – Short run Loss

8. Long run Economic Profit • If short run has economic profit • Firms enter the industry • Output increases • Price decreases • Profit in long run disappears • If short run economic loss • Firms exit the industry • Output decreases • Price increases • Loss disappears

9. Long run No economic Profits or Losses

10. Oligopoly • Market structure characterized by a few firms whose behavior is interdependent

11. Characteristics • A few large producers • Homogeneous or differentiated products • Control over Price • Mutual interdependence and strategic behavior • Barriers to entry • Mergers

12. Mergers • Oligopolists have a tendency to merge and become monopolists • Increases market share • Greater economies of scale • Caused by desire for monopoly power

13. Measures of Industry Concentration • oligopolistic industries are concentrated in the hands of their largest firms • Concentration ratios • Reveals the percentage of total output produced and sold by an industry’s largest firms. • When largest four firms control over 40% then it is oligopoly • Automotive 81% • Sugar cane 99% • Shortcomings • Localized markets • Interindustry competition • World trade • Herfindahl Index • The index is the sum of squared percentage market shares of all firms in the industry. • Larger the index, the more market power within the industry

14. Oligopoly • Models of Oligopoly • There is no general theory but rather a set of theories • Each based on the diversity of observed behavior in an interdependent market • Collusion • an agreement among firms to increase economic profit by dividing the market or fixing the price • CARTELS are created

15. Oligopoly • Collusion • Cartel • A group of firms that agree to coordinate their production and pricing decisions to act like a monopolist • Problems with Collusion and Cartels • Differences in Average Cost • Number of firms in the cartel • New entry into the industry

16. Oligopoly • Price Leadership • A firm whose price is adopted by other firms in the industry • Tacit form of collusion • Typically a dominant firm in the industry • Set prices and others follow avoiding competition • Violates antitrust laws

17. Oligopoly • Game Theory • An approach that analyzes ologopolistic behavior as a series of strategic moves and countermoves by rival firms • Outcome is achieved when each player’s choice does not depend on what the other player does