chapter 9 monopolistic competition and oligopoly 1 part two: microeconomics of product markets...

CHAPTER 9

Monopolistic Competition and Oligopoly

1

Part Two: Microeconomics of Product Markets

Slides prepared by Bruno Fullone, George Brown College. Edited by

Laura Lamb©2010 McGraw-Hill Ryerson Ltd.

2Slides prepared by Bruno Fullone, George Brown College

9.1 Characteristics of Monopolistic Competition

• Relatively Large Number of Sellers– Small Market Shares– No Collusion– Independent Action

©2010 McGraw-Hill Ryerson Ltd.

3Slides prepared by Bruno Fullone,

George Brown College

Characteristics of Monopolistic Competition

Differentiated ProductsProduct Attributes

Service

Location

Brand Names and Packaging

Some Control Over Price


Short-Run Profits

Quantity

Pri

ce a

nd

Cos

ts

MR = MC

MC

MR

D1

ATC

EconomicProfit

Q1

A1

P1

0

Figure 9-2 Monopolistic Competition



Short-Run Losses

Quantity

Pri

ce a

nd

Cos

ts

MR = MC

MC

MR

D2

ATC

Loss

Q2

A2

P2

0

Monopolistic Competition



Long-Run Equilibrium

Quantity

Pri

ce a

nd

Cos

ts

MR = MC

MC

MR

D3

ATC

Q3

P3= A3

0

Monopolistic Competition



Complicating factors

• Some firms may earn economic profits greater than zero in the long run.

– Why?


Slides prepared by Bruno Fullone, George Brown College



Monopolistic Competition and Efficiency

1. Allocative Efficiency

P > MC

Too little is produced

2. Productive Efficiency

Costs high

Excess capacity




Product VarietyBenefits

Better match to consumer tastes

Better products

Tradeoff between variety and efficiency

Further ComplexityPrice, product, and advertising must be juggled to achieve maximum profit



9.3 Oligopoly: Characteristics

A Few Large ProducersHomogeneous or Differentiated Products Control Over Price, but Mutual InterdependenceEntry Barriers

Economies of scaleHigh capital costsOwnership of raw materials

Mergers©2010 McGraw-Hill Ryerson Ltd.

Two ways to measure industry concentration

1. Concentration ratio

• The four-firm concentration ratio gives the percentage of total industry sales accounted for by the four largest firms.




0 20 40 60 80 100

steel pipe & tube

frozen f ruit & vegetables

biscuit industry

tea & cof fee

motor vehicles

potato chip, pretzel & popcorn

brewery products

tobacco products

% of industry output

Figure 9-4% of Output Produced by the Four Largest Firms in

Selected High-Concentration Industries

4775

4365

3481

2453

2273

2069

1965

1038

Herfindahl Index




9.4 Game Theory OverviewOligopolists must make plans in light of the actions and expected reactions of their rivals

Basic concepts:Players

Rules

Strategies

Payoffs

Equilibrium©2010 McGraw-Hill Ryerson Ltd.



Prisoner’s Dilemma

Two prisoners cannot communicate

Difficult to cooperate, even when mutually beneficial



Prisoner’s Dilemma Payoff Matrix

ConfessConfess Not confessNot confess

ConfessConfess

NotNot confessconfess

Al’s strategiesAl’s strategiesB

run

o’s

B

run

o’s

st

rate

gie

sst

rate

gie

s

AA BB

CC DD

44 1212

11 22

44 11

1212 22

Figure 9-5



Profit Payoff for a Two-Firm Oligopoly

HighHigh LowLow

HighHigh

LowLow

RareAir’s price strategyRareAir’s price strategy

Up

tow

n’s

pri

ce

Up

tow

n’s

pri

ce

stra

teg

yst

rate

gy

AA BB

CC DD

$12$12 $15$15

$6$6 $8$8

$12$12 $6$6

$15$15 $8$8

If both If both firmsfirms

choose a choose a high-price high-price strategy, strategy,

each each earns $12 earns $12 million in million in

profitprofit

If both If both firmsfirms

choose a choose a high-price high-price strategy, strategy,

each each earns $12 earns $12 million in million in

profitprofit

Collusive

Collusive

tendencies

tendencies

Collusive

Collusive

tendencies

tendencies



9.5 The Incentives and Obstacles to Collusion: Two Oligopoly Strategies

• Two distinct pricing strategies:1. Collusive pricing

2. Price leadership

• There is no one simple model to predict outcomes due to:

– Diversity of oligopolies– Complications of interdependence



Cartels and Other Collusion: Cooperative Strategies

• Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition

• Each firm acts as if it were a pure monopolist

Illustrated…©2010 McGraw-Hill Ryerson Ltd.


QQ

DD

MCMC

ATCATC

MRMR

PP

MR=MCMR=MCPri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

QQ00

AA00

PP00Economic profitEconomic profit

Collusion and Joint-Profit Maximization

Figure 9-7



Cartels and Other Collusion: Cooperative Strategies

• Three identical firms

• Each firm finds it most profitable to charge P0, but only if its rivals do

• The answer: collude and agree on price P0




Overt Collusion – The OPEC Cartel




Obstacles to Collusion

Demand and Cost Differences

Number of Firms

Cheating

Recession

Potential Entry

Legal Obstacles: Competition Policy




Price Leadership Model

Dominant firm leads the way

Leadership strategy:Infrequent Price Changes

Communications

Limit Pricing

Breakdowns in price leadership: price wars




9.6 Oligopoly and Advertising

Oligopolists prefer not to compete on price

Product development and advertising preferred:

Less easily duplicated

Oligopolists have sufficient financial resources




Positive Effects of Advertising

1. Low cost source of information

2. Can diminish monopoly power

3. Can speed up technological progress




Potential Negative Effects of Advertising

1. Only persuasion

2. Misleading claims

3. Barrier to entry

4. Self-cancelling advertising




Global Perspective 9.2




Oligopoly and Efficiency

Impossible to say anything definitive

Outcomes could be identical to monopoly

Unlikely because of:

1. Increased foreign competition

2. Limit pricing

3. Technological advance©2010 McGraw-Hill Ryerson Ltd.



The Last Word: Oligopoly in the Beer Industry

Since WW II degree of concentration has been increasing, mostly due to mergers

Today 80% of production controlled by 2 major companies

However, imports and microbreweries are starting to eat away at market share of majors


chapter 9 monopolistic competition and oligopoly 1 part two: microeconomics of product markets...

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