Chapter 13

Monopolistic Competition and Oligopoly

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13-2

Monopolistic Competition

• Monopolistic competition• Relatively large number of sellers• Product differentiation• Easy entry and exit• Nonprice competition like advertising

LO1

13-3

Monopolistically Competitive Industries

• Industry concentration• Measured by 4-firm concentration ratio• Percentage of sales by 4 largest firms

• Herfindahl index• Sum of squared market shares

4-firm CR = output of four largest firms total output in the industry

HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2

LO1

13-4

Low Concentration Industries

(1)Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

Index(1)

Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

Index

Textile machinery 30 360 Wood trusses 15 102

Women’s dresses 28 328 Metal stamping 14 88

Textile bags 28 318Metal windows and door 13 109

Plastic bags 27 299 Wood pallets 11 51

Ready-mix concrete 23 313 Sheet metal work 7 30

Jewelry 23 230 Signs 7 28

Asphalt paving 22 188 Stone products 7 23

Plastic pipe 21 187 Quick printing 4 8

Sawmills 15 98 Retail bakeries 4 7

Curtains and draperies 14 85 Bolts, nuts, and rivets 4 6

13-5

Price and Output in Monopolistic Competition

• Demand is highly elastic• Short run profit or loss• Produce where MR = MC

• Long run only a normal profit• Entry and exit

LO2

13-6

The Short Run: Profit or Loss

Quantity

Pric

e an

d co

sts

MR = MC

MC

MR

D1

ATC

Economicprofit

Q1

A1

P1

0

LO2

13-7

The Short Run: Profit or Loss

Quantity

Pric

e an

d co

sts

MC

MR

D2

ATC

Loss

Q2

A2

P2

0

MR = MC

LO2

13-8

The Long Run: Only a Normal Profit

Quantity

Pric

e an

d co

sts

MC

MR

D3

ATC

Q3

P3= A3

0

MR = MC

LO2

13-9

Monopolistic Competition and Efficiency

• Monopolistic competition inefficient• Productive inefficiency because P > min ATC• Allocative inefficiency because P > MC

• Excess capacity

LO3

13-10

Monopolistic Competition and Efficiency

P4

Q4

Price is lower

Excess capacity atminimum ATC

LO3

13-11

Product Variety

• The firm constantly manages price, product, and advertising• Better product differentiation• Better advertising

• The consumer benefits by greater array of choices and better products• Types and styles• Brands and quality

LO4

13-12

Oligopoly

• Oligopoly• A few large producers• Homogeneous oligopoly• Differentiated oligopoly• Limited control over price• Entry barriers• Mergers

LO5

13-13

Oligopolistic Industries

• Four-firm concentration ratio• 40% or more to be an oligopoly

• Shortcomings• Localized markets• Interindustry competition• Import competition• Dominant firms

LO5

13-14

High Concentration Industries

(1)Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

Index(1)

Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

IndexPrimary copper 99 ND Petrochemicals 80 2,535

Cane sugar refining 95 ND Breakfast cereals 80 2,426

Cigarettes 98 ND Small-arms ammunition 79 2,447

Household laundry equipment 98 ND Primary aluminum 77 2,250

Household refrigerators and freezers 92 ND Men’s slacks and jeans 76 2,015

Beer 90 ND Electric light bulbs 75 2,258

Glass containers 87 2,507 Tires 73 1,540

Electronic computers 87 NDHousehold vacuum cleaners 71 1,519

Phosphate fertilizers 83 ND

Alcohol distilleries 70 1,915

Turbines and generators 68 1,937

Aircraft 81 ND Motor vehicles 68 1,744

13-15

Oligopoly Behavior

• Oligopolies display strategic behavior• Mutual interdependence• Collusion• Incentive to cheat• Game theory• Prisoner’s dilemma

LO6

13-16

Game Theory Overview

RareAir’s price strategy

Upt

own’

s pr

ice

stra

tegy

A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low•2 competitors•2 price strategies•Each strategy has

a payoff matrix•Greatest

combinedprofit

•Independent actionsstimulate a response

LO6

13-17

Game Theory Overview

RareAir’s price strategy

Upt

own’

s pr

ice

stra

tegy

A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low•Independently lowered prices in expectation of greater profit leads to worst combined outcome

•Eventually low outcomes make firms return to higher prices.

LO6

13-18

Three Oligopoly Models

• Kinked-demand curve• Collusive pricing• Price leadership• Reasons for 3 models• Diversity of oligopolies• Complications of interdependence

LO7

13-19

Kinked-Demand Theory

• Noncollusive oligopoly• Uncertainty about rivals reactions• Rivals match any price change• Rivals ignore any price change

• Assume combined strategy• Match price reductions• Ignore price increases

LO7

13-20

Kinked-Demand Curve

P0

MR2

D2

D1

MR1

e

f

g

Rivals ignoreprice increase

Rivals matchprice decrease

Q0

MR2

D2

D1

MR1Q0

MC1

MC2

P0

e

f

g

LO7

13-21

Kinked-Demand Curve

• Criticisms• Explains inflexibility, not price• Prices are not that rigid• Price war

LO7

13-22

Cartels and Other Collusion

D

MR=MC

ATC

MC

MR

P0

A0

Q0

Economicprofit

LO7

13-23

Overt Collusion

• A cartel is a group of firms or nations that collude• Formally agreeing to the price• Sets output levels for members

• Collusion is illegal in the United States• OPEC

LO7

13-24

Global Perspective

LO7

13-25

Obstacles to Collusion

• Demand and cost differences• Number of firms• Cheating• Recession• New entrants• Legal obstacles

LO7

13-26

Price Leadership Model

• Price leadership• Dominant firm initiates price changes• Other firms follow the leader

• Use limit pricing to block entry of new firms• Possible price war

LO7

13-27

Oligopoly and Advertising

• Oligopolies commonly compete though product development and advertising• Less easily duplicated than a price change• Financially able to advertise

LO8

13-28

Positive Effects of Advertising

• Low-cost way of providing information to consumers

• Enhances competition• Speeds up technological progress• Can help firms obtain economies of scale

LO8

13-29

Oligopoly and Advertising

The Largest U.S. Advertisers, 2011

CompanyAdvertising Spending

Millions of $Proctor & Gamble $4,971.5

General Motors 3,055.7

Verizon 2,523.0

Comcast 2,465.4

AT&T 2,359.0

JP Morgan Chase 2,351.8

Ford Motor 2,141.3

American Express 2,125.3

L’Oréal 2,124.6

Walt Disney 2,112.2LO8

13-30

Negative Effects of Advertising

• Can be manipulative• Contain misleading claims that confuse

consumers• Consumers may pay high prices for a good

while forgoing a better, lower priced, unadvertised version of the product

LO8

13-31

Global Perspective

LO8

13-32

Oligopoly and Efficiency

• Oligopolies are inefficient• Productively inefficient because P > min ATC• Allocatively inefficient because P > MC

• Qualifications• Increased foreign competition• Limit pricing• Technological advance

LO9

13-33

Internet Oligopolies

• The Internet became accessible to the average person in the mid 1990’s

• Today it is dominated by a few very large firms• Google, Facebook, Amazon, Microsoft, Apple• Not satisfied with just revenues generated in

their respective sectors• Compete for advertising $s• Compete with their own electronic devices