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Page 1: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Monopolistic Competition and Oligopoly

11

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Monopolistic Competition

• Relatively large number of sellers

• Differentiated products

• Easy entry and exit

• Advertising

LO1 11-2

Page 3: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Monopolistically Competitive

• Industry concentration

• Measured by:

• Four-firm concentration ratios

•Percentage of 4 largest firms

• Herfindahl index

• Sum of squared market shares

LO1

4-Firm CR = Output of four largest firmsTotal output in the industry

HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2

11-3

Page 4: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Low Concentration Industries(1)

Industry(2)

4-Firm Concentration

Ratio

(3)Herfindahl

Index

(1)Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

Index

Asphalt paving 25 207Metal windows and doors 14 114

Plastic pipe 24 262 Women’s dresses 13 84

Textile bags 24 263 Ready mix concrete 11 63

Bolts, nuts, and rivets 24 205 Wood trusses 10 50

Plastic bags 23 240 Stone products 10 59

Quick printing 22 319 Metal stamping 8 31

Textile machinery 20 206 Wood pallets 7 24

Sawmills 18 117 Sheet metal work 6 25

Jewelry 16 117 Signs 5 19

Curtains and draperies 16 111 Retail bakeries 4 7

LO1 11-4

Page 5: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Price and Output in Monopolistic Comp

• Demand is highly elastic

• Short run profit or loss

• Produce where MR=MC

• Long run normal profit

• Entry and exit

• Inefficient

• Product variety

LO2 11-5

Page 6: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

The Short Run: Profit or Loss

LO2

Quantity

Pri

ce

an

d C

os

ts

MR = MC

MC

MR

D1

ATC

EconomicProfit

Q1

A1

P1

0

11-6

Page 7: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

The Short Run: Profit or Loss

LO2

Quantity

Pri

ce

an

d C

os

ts

MC

MR

D2

ATC

Loss

Q2

A2

P2

0

MR = MC

11-7

Page 8: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

The Long Run: Only a Normal Profit

LO2

Quantity

Pri

ce

an

d C

os

ts

MC

MR

D3

ATC

Q3

P3= A3

0

MR = MC

11-8

Page 9: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Monopolistic Competition: Efficiency

• Inefficient

• Productive inefficiency

•P > ATC

• Allocative inefficiency

•P > MC

LO2 11-9

Page 10: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Monopolistic Competition: Efficiency

LO2

P=MC=Min ATC for pure competition (recall)

P4

Q4

Price is Lower

Excess Capacity atMinimum ATC

Monopolistic competition is not efficient11-10

Page 11: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO2 11-11

Page 12: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopoly

• A few large producers

• Homogeneous or differentiated products

• Limited control over price

• Mutual interdependence

• Strategic behavior

• Entry barriers

• Mergers

LO3 11-12

Page 13: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopolistic Industries

• Four-firm concentration ratio

• 40% or more to be oligopoly

• Shortcomings

• Localized markets

• Inter-industry competition

• World price

• Dominant firms

LO3 11-13

Page 14: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

High Concentration Industries(1)

Industry(2)

4-Firm Concentration

Ratio

(3)Herfindahl

Index

(1)Industry

(2)4-Firm

Concentration Ratio

(3)Herfindahl

Index

Primary copper 99 ND Petrochemicals 85 2662

Cane sugar refining 99 NDSmall arms ammunition 83 1901

Cigarettes 95 ND Motor vehicles 81 2321

Household laundry equipment 93 ND

Men’s slacks and jeans 80 2515

Beer 91 ND Aircraft 81 ND

Electric light bulbs 89 2582 Breakfast cereals 78 2521

Glass containers 88 2582Household vacuum cleaners 78 2096

Turbines and generators 88 ND Phosphate fertilizers 78 1853

Household refrigerators and freezers 85 1986

Tires 77 1807

Electronic computers 76

2662

Primary aluminum 85 ND Alcohol distilleries 71 1609

LO1 11-14

Page 15: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Game Theory Overview

• Oligopolies display strategic pricing behavior

• Mutual interdependence

• Collusion

• Incentive to cheat

• Prisoner’s dilemma

LO4 11-15

Page 16: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Game Theory Overview

LO4

RareAir’s Price Strategy

Up

tow

n’s

Pri

ce

Str

ate

gy A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low•2 competitors•2 price strategies

•Each strategy has a payoff matrix

•Greatest combinedprofit

• Independent actionsstimulate a response

11-16

Page 17: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Game Theory Overview

LO4

RareAir’s Price Strategy

Up

tow

n’s

Pri

ce

Str

ate

gy A B

C D

$12

$12

$15

$6

$8

$8

$6

$15

High

High

Low

Low• Independently lowered prices in expectation of greater profit leads to worst combined outcome

•Eventually low outcomes make firms return to higher prices.

11-17

Page 18: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

3 Oligopoly Models

• Kinked Demand Curve

• Collusive Pricing

• Price Leadership

• Reasons for 3 models

• Diversity of oligopolies

• Complications of interdependence

LO5 11-18

Page 19: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO5 11-19

Page 20: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Kinked Demand Curve

LO5

P0

MR2

D2

D1

MR1

e

f

g

Rivals IgnorePrice Increase

Rivals MatchPrice Decrease

Q0

MR2

D2

D1

MR1Q0

MC1

MC2

P0

e

f

g

11-20

Page 21: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Kinked Demand Curve

• Criticisms

• Explains inflexibility, not price

• Prices are not that rigid

• Price wars

LO6 11-21

Page 22: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Cartels and Other Collusion

LO6

D

MR=MC

ATC

MC

MR

P0

A0

Q0

EconomicProfit

11-22

Page 23: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Global Perspective

LO6 11-23

Page 24: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO6 11-24

Page 25: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Obstacles to Collusion

• Demand and cost differences

• Number of firms

• Cheating

• Recession

• New entrants

• Legal obstacles

LO6 11-25

Page 26: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO6 11-26

Page 27: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopoly and Advertising

• Prevalent to compete with product development and advertising

• Less easily duplicated than a price change

• Financially able to advertise

LO7 11-27

Page 28: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO7 11-28

Page 29: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopoly and Advertising

LO7

The Largest U.S. Advertisers, 2008

CompanyAdvertising Spending Millions of $

Procter & Gamble $4831

Verizon $3700

AT&T $3073

General Motors $2901

Johnson & Johnson $2529

Unilever $2423

Walt Disney $2218

Time Warner $2208

General Electric $2019

Sears $1865

Source: Advertising Age http://www.adage.com

11-29

http://www.adage.com/
http://www.adage.com/
Page 30: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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.

LO7 11-30

Page 31: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Global Perspective

LO7 11-31

Page 32: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopoly and Efficiency

• Oligopolies are inefficient

• Productively inefficient P > minATC

• Allocatively inefficient P > MC

• Qualifications

• Increased foreign competition

• Limit pricing

• Technological advance

LO7 11-32

Page 33: Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Oligopoly in the Beer Industry

• The 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

11-33


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