microeconomics: theory & applications chapter 13 monopolistic competition and oligopoly by edgar...

MICROECONOMICS: Theory & Applications

Chapter 13 Monopolistic Competition and Oligopoly

By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College

Copyright 2006John Wiley & Sons, Inc.13-2

Learning Objectives

Explain how price and output are determined under monopolistic competition.

Understand the characteristics of oligopoly. Explore several key non-cooperative oligopoly

models: Cournot, Stackelberg, and dominant firm. Show how price and output are determined under the

cooperative oligopoly model of cartels.


Price and Output Under Monopolistic Competition

Monopolistic competition – a market characterized by:

– unrestricted entry and exit– a large number of independent sellers producing

differentiated products

Differentiated product – a product that consumers view as different from other similar products.


Determination of Market Equilibrium

The demand curve facing each firm is downward-sloping but fairly elastic.

Long-run equilibrium is attained as a result of firms entering (or leaving) the industry in response to profit incentives.

Figure 13.1


Monopolistic Competition and Efficiency

Excess capacity – the result of firms failing to produce at lowest possible average cost

Figure 13.2


Is Government Intervention Warranted?

3 reasons why government intervention is probably not warranted:

Any deadweight loss is likely to be small, due to the presence of competing firms and free entry.

Any possible inefficiency cost must be weighed against the product variety produced and the benefits of such variety to consumers.

The costs of intervention must be balanced against the potential gain from expanding output.


Oligopoly

Oligopoly – an industry structure characterized by:

– a few firms producing all or most of the output of some good that may or many not be differentiated

– mutual interdependence: a firm’s actions have an effect on its rivals and induce a react by the rivals

– barriers to entry which can influence pricing behavior


The Cournot Model

Duopoly – an industry with two firms

Cournot Model – a model of oligopoly that assumes each firm determines its output based on the assumption that any other firms will not change their outputs.

Figure 13.3


Reaction Curves

Reaction Curve – a relationship showing one firm’s most profitable output as a function of the output chosen by other firms

Figure 13.4


Evaluation of the Cournot Model

The assumption that each firm takes the output of a rival firm as constant is implausible if the market is adjusting toward equilibrium.

The assumption is more plausible the larger the number of firms in the market.


Other Oligopoly Models

The Stackelberg Model – a model of oligopoly in which a leader firm selects its output first, taking the reactions of follower firms into account

Dominant Firm Model – a model of oligopoly in which the leader or dominant firm assumes its rivals behave like competitive firms in determining their output


The Stackelberg Model

Residual demand curve – a firm’s demand curve based on the assumption that the firm knows how much output rivals will produce for each output the firm may choose

Figure 13.5


The Dominant Firm Model

Also known as “the dominant firm with a competitive fringe” model

At any price, the dominant firm can sell an amount equal to the total quantity demanded at that price minus the quantity the fringe firms produce.

Figure 13.6


Comparison Between Oligopoly Models

Different assumption about rival behavior– In the Stackelberg model, the leader firm assumes

Cournot behavior on the part of rivals.– In the dominant firm model, the leader firm

assumes competitive behavior.

The dominant firm model is more appropriate when there are a sufficiently large number of fringe firms.


The Elasticity of the Dominant Firm’s Demand Curve

ηD = ηM (1/MS) + εSF((1/MS) – 1)

where:

ηD = elasticity of the dominant firm’s demand

ηM = elasticity of the market demand

MS = the dominant firm’s market share

εSF = elasticity of supply of the fringe firms


Cartels and Collusion

Cartel – an agreement among independent producers to coordinate their decisions so each of them will earn monopoly profit

Collusion – coordinated decisions among independent producers in an industry

Cartels are illegal under antitrust laws in the United States.


Cartelization of a Competitive Industry [Figure 13.7]


Why Cartels Fail

Each firm has a strong incentive to cheat on the cartel agreement.

Members of the cartel will disagree over appropriate cartel policy regarding pricing, output, allowable market shares, and profit sharing.

Profits of the cartel members will encourage entry into the industry.


Oligopolies and Collusion

Firms in an oligopolistic industry can increase their profits by colluding.

– The limited number of firms makes it easier to reach agreements.

– When few firms are involved, it is easier to detect cheaters. Factors that inhibit the formation and maintenance of

cartels:– Incentive to cheat– Higher price achieved by collusion prompts entry by new firms

It is not necessary for all firms in the industry to participate in the cartel for it to be worthwhile.


Copyright 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.

microeconomics: theory & applications chapter 13 monopolistic competition and oligopoly by edgar...

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