Chapter 13. Monopolistic Competition and Oligopoly

Chapter 13Monopolistic Competition and OligopolyCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Monopolistic CompetitionMonopolistic competitionRelatively large number of sellersProduct differentiationEasy entry and exitNonprice competition like advertisingLO1Monopolistically Competitive IndustriesIndustry concentrationMeasured by 4-firm concentration ratioPercentage of sales by 4 largest firmsHerfindahl indexSum of squared market shares4-firm CR = output of four largest firms total output in the industryHI = (%S1)2 + (%S2)2 + (%S3)2 + . + (%Sn)2LO1Price and Output in Monopolistic CompetitionDemand is highly elasticShort run profit or lossProduce where MR = MCLong run only a normal profitEntry and exitLO2Monopolistic Competition and EfficiencyMonopolistic competition inefficientProductive inefficiency because P > min ATCAllocative inefficiency because P > MCExcess capacityLO3Product VarietyThe firm constantly manages price, product, and advertisingBetter product differentiationBetter advertisingThe consumer benefits by greater array of choices and better productsTypes and stylesBrands and qualityLO4OligopolyOligopolyA few large producersHomogeneous oligopolyDifferentiated oligopolyLimited control over priceEntry barriersMergersLO5Oligopolistic IndustriesFour-firm concentration ratio40% or more to be an oligopolyShortcomingsLocalized marketsInterindustry competitionImport competitionDominant firmsLO5Oligopoly BehaviorOligopolies display strategic behaviorMutual interdependenceCollusionIncentive to cheatGame theoryPrisoner’s dilemmaLO6Game Theory OverviewRareAir’s price strategyUptown’s price strategyABCD$12$12$15$6$8$8$6$15HighHighLowLow2 competitors2 price strategiesEach strategy has a payoff matrixGreatest combined profitIndependent actions stimulate a responseLO6Game Theory OverviewRareAir’s price strategyUptown’s price strategyABCD$12$12$15$6$8$8$6$15HighHighLowLowIndependently lowered prices in expectation of greater profit leads to worst combined outcomeEventually low outcomes make firms return to higher prices.LO6Three Oligopoly ModelsKinked-demand curveCollusive pricingPrice leadershipReasons for 3 modelsDiversity of oligopoliesComplications of interdependenceLO7Kinked-Demand TheoryNoncollusive oligopolyUncertainty about rivals reactionsRivals match any price changeRivals ignore any price changeAssume combined strategyMatch price reductionsIgnore price increasesLO7Cartels and Other CollusionDMR=MCATCMCMRP0A0Q0EconomicprofitLO7Overt CollusionA cartel is a group of firms or nations that colludeFormally agreeing to the priceSets output levels for membersCollusion is illegal in the United StatesOPECLO7Obstacles to CollusionDemand and cost differencesNumber of firmsCheatingRecessionNew entrantsLegal obstaclesLO7Price Leadership ModelPrice leadershipDominant firm initiates price changesOther firms follow the leaderUse limit pricing to block entry of new firmsPossible price warLO7Oligopoly and AdvertisingOligopolies commonly compete though product development and advertisingLess easily duplicated than a price changeFinancially able to advertiseLO8Positive Effects of AdvertisingLow-cost way of providing information to consumersEnhances competitionSpeeds up technological progressCan help firms obtain economies of scaleLO8Oligopoly and EfficiencyOligopolies are inefficientProductively inefficient because P > min ATCAllocatively inefficient because P > MCQualificationsIncreased foreign competitionLimit pricingTechnological advanceLO9