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    Monopolistic Competition and Oligopoly: By: Dr. Ali Fallahchay

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    Jacq RYP
    This document discusses monopolistic competition and oligopoly. Monopolistic competition is characterized by many sellers offering differentiated products, easy entry and exit into the market, and firms using advertising. In the short run, firms may earn economic profits or losses, but in the long run normal profits are achieved. Oligopoly is characterized by a few large firms producing either homogeneous or differentiated products with strategic interdependence and barriers to entry. The document analyzes industry concentration, efficiency, product variety, and provides an overview of game theory and models of oligopolistic competition including kinked demand theory.

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    Monopolistic Competition and Oligopoly: By: Dr. Ali Fallahchay

    Uploaded by

    Jacq RYP
    44 views33 pages
    This document discusses monopolistic competition and oligopoly. Monopolistic competition is characterized by many sellers offering differentiated products, easy entry and exit into the market, and firms using advertising. In the short run, firms may earn economic profits or losses, but in the long run normal profits are achieved. Oligopoly is characterized by a few large firms producing either homogeneous or differentiated products with strategic interdependence and barriers to entry. The document analyzes industry concentration, efficiency, product variety, and provides an overview of game theory and models of oligopolistic competition including kinked demand theory.

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    This document discusses monopolistic competition and oligopoly. Monopolistic competition is characterized by many sellers offering differentiated products, easy entry and exit into the market, and firms using advertising. In the short run, firms may earn economic profits or losses, but in the long run normal profits are achieved. Oligopoly is characterized by a few large firms producing either homogeneous or differentiated products with strategic interdependence and barriers to entry. The document analyzes industry concentration, efficiency, product variety, and provides an overview of game theory and models of oligopolistic competition including kinked demand theory.

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    44 views33 pages

    Monopolistic Competition and Oligopoly: By: Dr. Ali Fallahchay

    Uploaded by

    Jacq RYP
    This document discusses monopolistic competition and oligopoly. Monopolistic competition is characterized by many sellers offering differentiated products, easy entry and exit into the market, and firms using advertising. In the short run, firms may earn economic profits or losses, but in the long run normal profits are achieved. Oligopoly is characterized by a few large firms producing either homogeneous or differentiated products with strategic interdependence and barriers to entry. The document analyzes industry concentration, efficiency, product variety, and provides an overview of game theory and models of oligopolistic competition including kinked demand theory.

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    You are on page 1of 33

    Monopolistic

    Competition and
    Oligopoly
    By:

    Dr. Ali Fallahchay


    Monopolistic Competition

    • Relatively large number of sellers

    • Differentiated products

    • Easy entry and exit

    • Advertising
    Monopolistically Competitive
    • Industry concentration measured by:
    • Four-firm concentration ratios
    • Percentage of 4 largest firms
    4-Firm CR = Output of four largest firms
    Total output in the industry
    • Herfindahl index
    • Sum of squared market shares
    HI = (%S1)2 + (%S2)2 + (%S3)2 + …. +
    (%Sn)2
    Low Concentration Industries
    (1) (2) (3) (1) (2) (3)
    Industry 4-Firm Herfindahl Industry 4-Firm Herfindahl
    Concentration Concentration
    Ratio Index Ratio Index
    Wood containers
    Adhesives 23 235 and pallets 11 51
    Textile bags and
    Ready-mix concrete 23 313 canvas 10 68
    Metal working
    Asphalt paving 22 188 machinery 9 33
    Bolts, nuts, and
    rivets 21 162 Apparel 8 44
    Plastics and rubber
    Plastic pipe 21 187 products 8 31

    Sawmills 15 98 Sheet metal work 7 30

    Wood trusses 14 102 Signs 7 28

    Metal stamping 14 88 Stone products 7 23


    Curtains and
    draperies 14 85 Quick printing 4 8
    Metal windows and
    doors 13 109 Retail bakeries 4 7
    Price and Output in Monopolistic
    Competition
    • Demand is highly elastic

    • Short run profit or loss

    • Produce where MR=MC

    • Long run normal profit


    • Entry and exit

    • Inefficient

    • Product variety
    The Short Run: Profit or Loss

    MC ATC
    Price and Costs

    P1
    A1

    Economic D1
    Profit
    MR = MC

    MR

    0
    Q1
    Quantity
    The Short Run: Profit or Loss

    MC ATC

    A2
    Price and Costs

    P2

    Loss
    D2

    MR = MC

    MR

    0
    Q2
    Quantity
    The Long Run: Only a Normal Profit

    MC
    ATC
    Price and Costs

    P3= A3

    D3

    MR = MC

    MR

    0
    Q3
    Quantity
    Monopolistic Competition: Efficiency
    • Inefficient
    • Productive inefficiency
    • P > ATC
    • Allocative inefficiency
    • P > MC

    LO2
    Monopolistic Competition: Efficiency
    P=MC=Min ATC for pure competition (recall)
    MC

    ATC
    Price and Costs

    P3= A3
    P4

    Price is Lower

    D3
    MR = MC
    Excess Capacity at
    Minimum ATC MR
    0 Q3 Q4
    Quantity
    Monopolistic competition is not efficient
    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
    Oligopoly
    • A few large producers
    • Homogeneous or differentiated
    products
    • Limited control over price
    • Mutual interdependence
    • Strategic behavior
    • Entry barriers
    • Mergers
    Oligopolistic Industries

    • Four-firm concentration ratio


    • 40% or more to be oligopoly
    • Shortcomings
    • Localized markets
    • Inter-industry competition
    • World price
    • Dominant firms
    High Concentration Industries
    (1) (2) (3) (1) (2) (3)
    Industry 4-Firm Herfindahl Industry 4-Firm Herfindahl
    Concentration Concentration
    Ratio Index Ratio Index
    Primary copper 99 ND Phosphate fertilizers 83 ND
    Household laundry
    equipment 98 ND Aircraft 81 ND

    Cigarettes 98 ND Breakfast cereals 80 2426

    Cane sugar refining 95 ND Petrochemicals 80 2535


    Household Small-arms
    refrigerators/freezers 92 ND ammunition 79 2447

    Beer 90 ND Primary aluminum 77 2250

    Glass containers 87 2507 Metal cans 77 1786


    Electronic
    computers 87 ND Burial caskets 74 1979
    Women’s handbags
    and purses 86 ND Tires 73 1540
    Light trucks and Household vacuum
    utility vehicles 84 2680 cleaners 71 1519
    Game Theory Overview
    • Oligopolies display strategic pricing
    behavior
    • Mutual interdependence
    • Collusion
    • Incentive to cheat
    • Prisoner’s dilemma
    Game Theory Overview

    RareAir’s Price Strategy


    • 2 competitors High Low
    • 2 price

    Uptown’s Price Strategy


    strategies A B
    $12 $15
    • Each strategy
    has a payoff High
    matrix $12 $6
    • Greatest
    combined
    C D
    profit $6 $8
    • Independent Low
    actions $15 $8
    stimulate a
    response
    Game Theory Overview

    RareAir’s Price Strategy


    • Independently High Low
    lowered prices in

    Uptown’s Price Strategy


    expectation of A B
    $12 $15
    greater profit
    leads to worst High
    combined $12 $6
    outcome
    • Eventually low
    C D
    outcomes make $6 $8
    firms return to Low
    higher prices. $15 $8
    3 Oligopoly Models

    • Kinked Demand Curve


    • Collusive Pricing
    • Price Leadership
    • Reasons for 3 models
    • Diversity of oligopolies
    • Complications of interdependence
    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
    Kinked Demand Curve

    Rivals Ignore
    Price Increase

    Price and Costs


    D2 MC1
    e e
    P0 P0
    Price

    MR2 f
    f
    D2 MC2

    MR2
    Rivals Match g
    Price Decrease g
    D1 D1
    0 Q0 MR1 0 Q0 MR1
    Quantity Quantity
    Kinked Demand Curve

    • Criticisms
    • Explains inflexibility, not price
    • Prices are not that rigid
    • Price wars
    Cartels and Other Collusion

    MC
    Price and Costs

    P0 ATC

    A0
    MR=MC
    Economic
    Profit MR D
    Q0
    Quantity
    Global Perspective
    Overt Collusion

    • Cartels - 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
    Obstacles to Collusion

    • Demand and cost differences


    • Number of firms
    • Cheating
    • Recession
    • New entrants
    • Legal obstacles
    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
    Oligopoly and Advertising
    • Prevalent to compete with product
    development and advertising
    • Less easily duplicated than a price
    change
    • Financially able to advertise
    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
    Oligopoly and Advertising
    The Largest U.S. Advertisers, 2010
    Advertising Spending
    Company Millions of $
    Procter & Gamble $3124
    General Motors $2131
    AT&T $2093
    Verizon $1823
    News Corp $1368
    Pfizer $1229
    Time Warner $1194
    Johnson & Johnson $1140
    Ford Motor $1132
    L’Oreal $1112

    Source: Kantar Media, www.kantarmedia.com


    Negative Effects of Advertising
    • Can be manipulative
    • Contains misleading claims that
    confuse consumers
    • Consumers pay high prices for a
    good while forgoing a better, lower
    priced, unadvertised version of the
    product.
    Global Perspective
    Oligopoly and Efficiency

    • Oligopolies are inefficient


    • Productively inefficient P > min ATC
    • Allocatively inefficient P > MC
    • Qualifications
    • Increased foreign competition
    • Limit pricing
    • Technological advance
    Oligopoly in the U.S. Beer Industry
    • The U.S. beer industry is now an
    oligopoly
    • Changes in demand
    • Change in tastes
    • Consumed at home and mass
    produced
    • Changes in supply
    • Technological advance
    • Economies of scale

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