Monopolistic Competition and OligopolyChapter 11McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter ObjectivesCharacteristics of monopolistic competitionNormal profit in the long runCharacteristics of oligopolyGame theory The oligopolists kinked demand curveCollusion among oligopolistsThe effects of advertising11-*

Monopolistic CompetitionLarge number of sellersSmall market sharesNo collusionIndependent actionDifferentiated ProductsProduct attributesServiceLocationBrand names and packagingSome control over price11-*

Easy entry and exitNeed for advertisingNonprice CompetitionWhich industries?Degree of concentrationFour-firm concentration ratioHerfindahl indexMonopolistic CompetitionMonopolistic Competition11-*

Firms demand curveHighly elasticShort run profit or lossProduce where MR=MCLong run normal profitEntry and exitInefficientProduct varietyMonopolistic Competition11-*

Short-Run ProfitsQuantityPrice and CostsMR = MCMCMRD1ATCEconomicProfitQ1A1P10Monopolistic Competition11-*

Short-Run LossesQuantityPrice and CostsMR = MCMCMRD2ATCLossQ2A2P20Monopolistic Competition11-*

Long-Run EquilibriumQuantityPrice and CostsMR = MCMCMRD3ATCQ3P3= A30Monopolistic Competition11-*

P=MC=Min ATC for pure competition (recall)P4Q4Price is LowerExcess Capacity atMinimum ATCMonopolistic competition is not efficientMonopolistic Competition11-*

OligopolyA few large producersHomogeneous or differentiated productsControl over priceMutual interdependenceStrategic behaviorEntry barriersMergers11-*

OligopolyFour-firm concentration ratioNeeds to be more than 40%Half of U.S. manufacturingLocalized marketsInterindustry competitionWorld tradeImport CompetitionHerfindahl index

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Game TheoryRareAirs Price StrategyUptowns Price StrategyABCD$12$12$15$6$8$8$6$15HighHighLowLow2 competitors2 price strategiesEach strategy has a payoff matrixGreatest combinedprofitIndependent actionsstimulate a response11-*

Game TheoryRareAirs Price StrategyUptowns Price StrategyABCD$12$12$15$6$8$8$6$15HighHighLowLowIndependently lowered prices in expectation of greater profit leads to the worst combined outcomeEventually low outcomes make firms return to higher prices 11-*

Game TheoryMutual interdependencePricing policyCollusionEnhances profitIncentive to cheatPrisoners dilemma

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Three Oligopoly ModelsKinked-demand curveCollusive pricingPrice leadershipWhy three models?Diversity of oligopoliesComplications of interdependence11-*

Kinked-Demand CurveNoncollusive oligopolyStrategiesMatch price changesIgnore price changesCombined strategyPrice inflexibilityThe kinked-demand curve11-*

P0MR2D2D1MR1efgRivals IgnorePrice IncreaseRivals MatchPrice DecreaseQ0Competitor and rivals strategize versus each otherConsumers effectively have 2 partial demand curves and each part has its own marginal revenue partMR2D2D1MR1Q0MC1MC2P0Resulting in a kinked-demand curve to the consumer price and output are optimized at the kinkefgKinked-Demand Curve11-*

Criticisms of the modelHow does price get to P0Explains inflexibility, not pricePrices are not that rigidPrice wars Kinked-Demand Curve11-*

Cartels and Other CollusionPrice and outputJoint profit maximizationDMR=MCATCMCMRP0A0Q0EconomicProfitEffectively SharingThe Monopoly Profit11-*

The OPEC CartelSource: A. T. Kearney, Foreign PolicyIran3,843,000Kuwait2,538,000Venezuela2,368,000Iraq2,297,000Nigeria2,183,000UAE2,117,000Angola1,804,000Libya1,737,000Algeria1,417,000Qatar 848,000Indonesia 843,000Ecuador 530,000Daily oil production (barrels) , November 2008 Saudi Arabia8,904,00011-*

Cartels and Other CollusionCovert collusionTacit understandingsObstacles to collusionDemand and cost differencesNumber of firmsCheatingRecessionPotential entryLegal obstacles: antitrust law11-*

Price Leadership ModelLeadership tacticsInfrequent price changesCommunicationsLimit pricingBreakdowns in price leadership:Price wars11-*

AdvertisingPrevalent in monopolistic competition and oligopolyCapture market shareBetter than a price cutInformation for consumersManipulation 11-*

Oligopoly and AdvertisingThe Largest U.S. Advertisers, 2006Proctor and GambleAT&TGeneral MotorsTime WarnerVerizonFord MotorGlaxoSmithKlineWalt DisneyJohnson & JohnsonUnilever$4898334532963089282225772444232022912098Source: Advertising Age11-*

Worlds Top 10 Brand Names, 2007Oligopoly and Advertising11-*

Oligopoly and EfficiencyNot productively efficientNot allocatively efficientTendency to share the monopoly profitQualificationsIncreased foreign competitionLimit pricingTechnological advance11-*

Oligopoly in the Beer IndustryFrom hundreds to a few firms Demand side changesTaste shifts to lighter beers Shift from tap to cans or bottlesSupply side changesTechnological change increased minimum efficient scaleNational brands enjoy cost advantagesConsolidation into oligopoly11-*

Key Termsmonopolistic competitionproduct differentiationnonprice competitionfour-firm concentration ratioHerfindahl indexexcess capacityoligopolyhomogeneous oligopolydifferentiated oligopolystrategic behaviormutual interdependenceinterindustry competitionimport competitiongame theorycollusionkinked-demand curveprice warcartelprice leadership11-*

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