chapter 12yamamoto/files/jul_6.pdf · lr mr lr q sr p sr q lr p lr ... competitive equilibrium (lr)...
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Chapter 12
Monopolistic Competitionand Oligopoly
Chapter 12 2©2005 Pearson Education, Inc.
Topics to be Discussed
�Monopolistic Competition
�Oligopoly
�Price Competition
�Competition Versus Collusion: ThePrisoners’ Dilemma
Chapter 12 3©2005 Pearson Education, Inc.
Monopolistic Competition
� Characteristics1. Many firms
2. Free entry and exit
3. Differentiated product
Chapter 12 4©2005 Pearson Education, Inc.
Monopolistic Competition
� The amount of monopoly power dependson the degree of differentiation
�Examples of this very common marketstructure include:�Toothpaste
�Soap
�Cold remedies
Chapter 12 5©2005 Pearson Education, Inc.
Monopolistic Competition
� Toothpaste� Crest and monopoly power
� Procter & Gamble is the sole producer of Crest
� Consumers can have a preference for Crest –taste, reputation, decay-preventing efficacy
� The greater the preference (differentiation) thehigher the price
Chapter 12 6©2005 Pearson Education, Inc.
Monopolistic Competition
� Two important characteristics�Differentiated but highly substitutable
products
�Free entry and exit
A Monopolistically CompetitiveFirm in the Short and Long Run
Quantity
$/Q
Quantity
$/QMC
AC
MC
AC
DSR
MRSR
DLR
MRLR
QSR
PSR
QLR
PLR
Short Run Long Run
Chapter 12 8©2005 Pearson Education, Inc.
A Monopolistically CompetitiveFirm in the Short and Long Run
�Short run�Downward sloping demand – differentiated
product
�Demand is relatively elastic – goodsubstitutes
�MR < P
�Profits are maximized when MR = MC
�This firm is making economic profits
Chapter 12 9©2005 Pearson Education, Inc.
A Monopolistically CompetitiveFirm in the Short and Long Run
� Long run�Profits will attract new firms to the industry
(no barriers to entry)
�The old firm’s demand will decrease to DLR
�Firm’s output and price will fall
�Industry output will rise
�No economic profit (P = AC)
�P > MC � some monopoly power
Deadweight lossMC AC
Monopolistically and PerfectlyCompetitive Equilibrium (LR)
$/Q
Quantity
$/Q
D = MR
QC
PC
MC AC
DLR
MRLR
QMC
P
Quantity
Perfect Competition Monopolistic Competition
Chapter 12 11©2005 Pearson Education, Inc.
Monopolistic Competition andEconomic Efficiency
� The monopoly power yields a higherprice than perfect competition. If pricewas lowered to the point where MC = D,consumer surplus would increase by theyellow triangle – deadweight loss.
�With no economic profits in the long run,the firm is still not producing at minimumAC and excess capacity exists.
Chapter 12 12©2005 Pearson Education, Inc.
Monopolistic Competition andEconomic Efficiency
� Firm faces downward sloping demand sozero profit point is to the left of minimumaverage cost
�Excess capacity is inefficient becauseaverage cost would be lower with fewerfirms�Inefficiencies would make consumers worse
off
Chapter 12 13©2005 Pearson Education, Inc.
Monopolistic Competition
� If inefficiency is bad for consumers,should monopolistic competition beregulated?� Market power is relatively small. Usually
there are enough firms to compete withenough substitutability between firms –deadweight loss small.
� Inefficiency is balanced by benefit ofincreased product diversity – may easilyoutweigh deadweight loss.
Chapter 12 14©2005 Pearson Education, Inc.
The Market for Colas and Coffee (Ex12-1)
�Each market has much differentiation inproducts and tries to gain consumersthrough that differentiation�Coke vs. Pepsi
�Maxwell House vs. Folgers
�How much monopoly power do each ofthese producers have?�How elastic is demand for each brand?
Chapter 12 15©2005 Pearson Education, Inc.
Elasticities of Demand for Brands ofColas and Coffee (Ex 12-1)
Chapter 12 16©2005 Pearson Education, Inc.
The Market for Colas and Coffee (Ex12-1)
� The demand for Royal Crown is moreprice inelastic than for Coke
� There is significant monopoly power inthese two markets
� The greater the elasticity, the lessmonopoly power and vice versa
Chapter 12 17©2005 Pearson Education, Inc.
Oligopoly – Characteristics
�Small number of firms in a market�Product differentiation may or may not
exist�Barriers to entry
�Scale economies�Patents�Technology�Name recognition�Strategic action
Chapter 12 18©2005 Pearson Education, Inc.
Oligopoly
�Examples�Automobiles
�Steel
�Aluminum
�Petrochemicals
�Electrical equipment
Chapter 12 19©2005 Pearson Education, Inc.
Oligopoly
�Management Challenges�Strategic actions to deter entry
� Threaten to decrease price against newcompetitors by keeping excess capacity
�Rival behavior� Because only a few firms, each must consider
how its actions will affect its rivals and in turnhow their rivals will react
Chapter 12 20©2005 Pearson Education, Inc.
Oligopoly – Equilibrium
� If one firm decides to cut their price, theymust consider what the other firms in theindustry will do�Could cut price some, the same amount, or
more than firm
�Could lead to price war and drastic fall inprofits for all
�Actions and reactions are dynamic,evolving over time
Chapter 12 21©2005 Pearson Education, Inc.
Oligopoly – Equilibrium
� Defining Equilibrium�Firms are doing the best they can and have no
incentive to change their output or price
�All firms assume competitors are taking rivaldecisions into account
� Nash Equilibrium�Each firm is doing the best it can given what its
competitors are doing
� We will focus on duopoly�Markets in which two firms compete
Chapter 12 22©2005 Pearson Education, Inc.
Oligopoly
� The Cournot Model�Oligopoly model in which firms produce a
homogeneous good, each firm treats theoutput of its competitors as fixed, and allfirms decide simultaneously how much toproduce
�Firm will adjust its output based on what itthinks the other firm will produce
Chapter 12 23©2005 Pearson Education, Inc.
���������������� �������������
French philosopher,mathematician and economist,Augustin Cournot has beenrightly hailed as one of thegreatest of the Proto-Marginalists . The uniqueinsights of his majoreconomics work, ����� ����� ������ �����������é���������������é� ������� ���������(1838)were without parallel. Although neglected in his time,the impact of Cournot work onmodern economics can hardlybe overstated.
Chapter 12 24©2005 Pearson Education, Inc.
MC1
50
MR1(75)
D1(75)
12.5
If Firm 1 thinks Firm 2 will produce 75 units, its demand curve is
shifted to the left by this amount.
Firm 1’s Output Decision
Q1
P1
D1(0)
MR1(0)
Firm 1 and market demand curve,D1(0), if Firm 2 produces nothing.
D1(50)MR1(50)
25
If Firm 1 thinks Firm 2 will produce 50 units, its demand curve is
shifted to the left by this amount.
Chapter 12 25©2005 Pearson Education, Inc.
Oligopoly
� The Reaction Curve�The relationship between a firm’s profit-
maximizing output and the amount it thinksits competitor will produce
�A firm’s profit-maximizing output is adecreasing schedule of the expected outputof Firm 2
Chapter 12 26©2005 Pearson Education, Inc.
Firm 2’s ReactionCurve Q*2(Q1)
Firm 2’s reaction curve shows how much itwill produce as a function of how much
it thinks Firm 1 will produce.
Reaction Curves and CournotEquilibrium
Q2
Q1
25 50 75 100
25
50
75
100
Firm 1’s ReactionCurve Q*1(Q2)
x
x
x
x
Firm 1’s reaction curve shows how much itwill produce as a function of how much it thinks Firm 2 will produce. The x’s
correspond to the previous model.
Chapter 12 27©2005 Pearson Education, Inc.
Firm 2’s ReactionCurve Q*2(Q1)
Reaction Curves and CournotEquilibrium
Q2
Q1
25 50 75 100
25
50
75
100
Firm 1’s ReactionCurve Q*1(Q2)
x
x
x
x
In Cournot equilibrium, eachfirm correctly assumes how
much its competitors willproduce and thereby
maximizes its own profits.
CournotEquilibrium
Chapter 12 28©2005 Pearson Education, Inc.
Cournot Equilibrium
�Each firm’s reaction curve tells it howmuch to produce given the output of itscompetitor
�Equilibrium in the Cournot model, inwhich each firm correctly assumes howmuch its competitor will produce and setsits own production level accordingly
Chapter 12 29©2005 Pearson Education, Inc.
Oligopoly
� Cournot equilibrium is an example of aNash equilibrium (Cournot-NashEquilibrium)
� The Cournot equilibrium says nothingabout the dynamics of the adjustmentprocess� Since both firms adjust their output, neither
output would be fixed
Chapter 12 30©2005 Pearson Education, Inc.
The Linear Demand Curve
�An Example of the Cournot Equilibrium�Two firms face linear market demand curve
�We can compare competitive equilibrium andthe equilibrium resulting from collusion
�Market demand is P = 30 - Q
�Q is total production of both firms:
Q = Q1 + Q2
�Both firms have MC1 = MC2 = 0
Chapter 12 31©2005 Pearson Education, Inc.
Oligopoly Example
� Firm 1’s Reaction Curve � MR = MC
111 )30( QQPQR −== :Revenue Total
12211
1211
30
)(30
QQQQ
QQQQ
−−=
+−=
Chapter 12 32©2005 Pearson Education, Inc.
Oligopoly Example
�An Example of the Cournot Equilibrium
12
21
11
21111
2115
2115
0
230
MCMR
QQQRMR
−=
−=
==
−−=ΔΔ=
Curve Reaction s2' Firm
Curve Reaction s1' Firm
Chapter 12 33©2005 Pearson Education, Inc.
Oligopoly Example
�An Example of the Cournot Equilibrium
1030
20
10)2115(2115
21
1
1
=−=
=+=
=−−
=
QP
QQQ
Q
QQ 2:mEquilibriu Cournot
Chapter 12 34©2005 Pearson Education, Inc.
Duopoly ExampleQ1
Q2
Firm 2’sReaction Curve
30
15
Firm 1’sReaction Curve
15
30
10
10
Cournot Equilibrium
The demand curve is P = 30 - Q andboth firms have 0 marginal cost.
Chapter 12 35©2005 Pearson Education, Inc.
Chapter 12 36©2005 Pearson Education, Inc.