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Chapter 9 Monopolistic Competition and Oligopoly

Chapter 9 Monopolistic Competition and Oligopoly. Survey of Economics Irvin B. Tucker. Lecture Slides. What will I learn in this chapter?. The theories of price and output decisions in the real-world markets of monopolistic competition and oligopoly. What is monopolistic competition?.

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Chapter 9 Monopolistic Competition and Oligopoly

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  1. Chapter 9Monopolistic Competitionand Oligopoly Survey of EconomicsIrvin B. Tucker Lecture Slides

  2. What will I learn in this chapter? • The theories of price and output decisions in the real-world markets of monopolistic competition and oligopoly

  3. What is monopolistic competition? A market structure characterized by: 1. many small sellers 2. differentiated product 3. easy entry and exit

  4. What are examples of monopolistic competition? • grocery stores • hair salons • gas stations • video rental stores • restaurants

  5. How many is many small sellers? • The many sellers condition is met when each firm is so small relative to the total market that its pricing decisions have a negligible effect on the market price

  6. What isproduct differentiation? • The process of creating real or apparent differences between goods and services

  7. What does easy entry and easy exit mean? • There are low barriers to entry, but entry is not quite as easy as in a perfectly competitive market because monopolistically competitive firms sell differentiated products.

  8. What is a barrier to entry in monopolistic competition? • Firms can differentiate themselves from their competitors in ways other than price (nonprice competition).

  9. What isnonprice competition? • A firm competes using reputation, location, advertising, packaging, product development, and better service rather than lower prices

  10. Why is a monopolistic competitive firm a price maker? • Product differentiationgives the firm some control over its price

  11. How does the elasticity of demand curve for a monopolistically competitive firm compare to a perfectly competitive firm and a monopolist? • It is less elastic (steeper) than for a perfectly competitive firm and more elastic (flatter) than for a monopolist

  12. What effect does advertising have on average costs? • It raises the long-run average cost curve

  13. The Effect of Advertising 4.00 With advertising 3.50 3.00 LRAC2 2.50 Cost per unit(dollars) 2.00 1.50 LRAC1 1.00 Without advertising 0.50 0 2 4 6 8 10 12 14 16 18 Quantity of Output (units per month)

  14. How does a firm decide what price to charge and how many units to produce? MR = MC

  15. Exhibit 9.1 A Monopolistically Competitive Firm in Short Run 40 MC ATC 35 30 25 Price, Costs, and Revenue(dollars) 18 Profit=$1,800 15 D 10 5 MR MR=MC 0 1 2 3 4 5 7 8 9 10 11 12 6 Quantity of Seafood Meals (hundreds per week)

  16. What happens in the long run when economic profits are being made in the short run? • With easy entry, firms will enter the industry, and the demand curve for each firm shifts leftward because each firm’s market share declines. • The market price declines, and economic profits are eliminated.

  17. What happens to a firm’s costs in the long run? • In addition to decreased demand from new entrants sharing the market, the cost curve for firms increases from increasing advertising and other expenses to compete against the new competition.

  18. Zeroeconomic profit Firm’s LRAC curve increases Firm increases advertising expenses Firm’s demand curve decreases New firms enter

  19. Exhibit 9.2 Monopolistic Competition Firm in the Long Run 40 MC 35 LRAC 30 Minimum LRAC 25 Price, Costs, and Revenue(dollars) 20 17 15 D MR=MC 10 5 MR 0 5 6 8 9 1 2 4 3 7 Quantity of Seafood Meals (hundreds per week)

  20. How does monopolistic competition compare to perfect competition in the long run? • Price is lower and quantity is greater in perfect competition compared to monopolistic competition

  21. Why isprice higher and quantity lower in monopolistic competition compared to perfect competition? • Because firms in monopolistic competition face a downward sloping demand curve and a MR curve beneath it which is more steeply sloped

  22. How efficient is monopolistic competition? • Less resources are used and a higher price is charged than would be the case under perfect competition

  23. Exhibit 9.3 A Comparison of Monopolistic Competition and Perfect Competition in the Long Run 23

  24. What is oligopoly? A market structure characterized by: 1. Few sellers 2. Homogeneous or differentiated product 3. Difficult entry

  25. How few are a few sellers? • When the firms are so large relative to the total market that they can affect the market price

  26. What is mutual interdependence? • A condition of oligopoly in which an action by one firm may cause a reaction from other firms

  27. What are examples of homogeneous and differentiated product oligopolies? • Homogeneous or standardized product industries include steel, oil, and aluminum • Differentiated product industries include automobile, detergents, and breakfast cereals

  28. What are some examples of difficult entry? • Similar to monopoly, formidable barriers to entry exist • Examples include financial requirements, control over an essential resource, patents, and economies of scale

  29. What are different possible oligopoly models? • Nonprice competition • Price leadership • Cartel • Game theory

  30. What isnonprice competition? • Because of a differentiated product, there is competition in ways other than price, such as developing new products and advertising

  31. What isprice leadership? • A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow

  32. What is a cartel? • A group of firms formally agreeing to control the price and output of a product

  33. What are examples of cartels? • Organization of Petroleum Exporting Countries (OPEC) • International Telephone Cartel (ITU) • International Airline Cartel (IATA)

  34. What isformal collusion? • A group of firms openly agree to control the price and output of a product

  35. Is formal collusion legal? • No, it is against the law in the U.S. for firms to come together and agree on the price or output for products. But this is not true outside the U.S.

  36. What isinformal collusion? • Companies find alternative ways to agree on a price without any tacit communication. For example, firms follow established rules of an industry.

  37. What is the major weakness of a cartel? • As long as the benefits exceed the costs, cheatingcan threaten formal or informal agreements among oligopolists to maximize joint profits

  38. Exhibit 9.4 Why Cartel Members May Cheat MC 120 LRAC 110 100 MR2 90 Profit without cheating=$80 million Extra profit from cheating=$80 million 80 Price per barrel(dollars) 70 60 MR1 50 40 30 20 10 4 0 1 2 3 5 6 7 8 9 10 11 Quantity of Oil (millions of barrels per day)

  39. What is game theory? • A model of the strategic moves and countermoves of rivals

  40. What are two pricing methods in game theory? • Tit for tat • Price leadership

  41. What is tit-for-tat? • Under this informal approach, a player will do whatever the other player did the last time

  42. What is game theory price leadership? • Another informal approach is to play “follow the leader” in which firms set whatever price the leader sets

  43. What if cartels were legal? • Another approach would be for firms to make a formal agreement • To avoid cheating, rivals could agree on a penalty for cheaters

  44. Exhibit 9.5 A Two-Firm Payoff Matrix

  45. What conclusion can be drawn from oligopolies? • The price charged for the product will be higher than under perfect competition • More money is spent on forms of nonprice competition

  46. Exhibit 9.6

  47. END

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