12858579 Ch 10 Monopolistic Competition and Oligopoly
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Transcript of 12858579 Ch 10 Monopolistic Competition and Oligopoly
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Chapter 10
Monopolistic Competitionand Oligopoly
2009 South-Western/ Cengage Learning
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Monopolistic Competition
Characteristics Many producers
Low barriers to entry
Slightly different products A firm that raises prices: lose some
customers to rivals
Some control over price Price makers Downward sloping D curve
Act independently
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Monopolistic Competition
Product differentiation Physical differences
Appearance; quality
Location Spatial differentiation
Services
Product image Promotion; advertising
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Short-Run Profit Max. or Loss Min.
Demand D Marginal revenue MR
Average total cost ATC
Average variable cost AVC Marginal cost MC
Maximize profit
Produce the quantity: MR=MC
Price: on D curve
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Max. Profit or Min. Loss in Short-Run
If p>ATC Economic profit
If ATC>p>AVC
Economic loss Produce in short run
If p
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Exhibit 1
Monopolistic competition in the short run
6
p
c
Dollarsperunit
Quantityper period
q0
MC
D
MR
ATC
e
Profit
(a) Maximizing short-run profit
The firm produces the output at which MR=MC (point e) and charges the price
indicated by point b on the downward sloping D curve.
(a) Economic profit = (p-c)q
p
c
Dollarsperunit
Quantityper period
q0
MC
D
MR
AVC
e
Loss
(b) Minimizing short-run loss
ATC
b
c
(b) Economic loss = (c-p)q
b
c
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Zero Economic Profit in the Long-Run
Short run economic profit New firms enter the market
Draw customers away from other firms
Reduce demand facing other firms Profit disappears in long run
Zero economic profit
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Zero Economic Profit in the Long-Run
Short run economic loss Some firms exit the market
Their customers switch to other firms
Increase demand facing the remainingfirms
Loss is erased in the long run
Zero economic profit
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Exhibit 2
Long-run equilibrium in monopolistic competition
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0 q Quantity per period
p
Dollars
perunit
D
MR
Economic profit in short run:
- new firms enter the industry in thelong run
- reduces the D facing each firm
- Each firms D shifts leftward until:
-MR=MC (point a) and
-D is tangent to ATC curve: point b
- Economic profit = 0 at output q
No more firms enter; the industry is inlong-run equilibrium.
MC
a
ATCb
The same long-run outcome occurs if firms suffer a short-run loss. Firmsleave until remaining firms earn just a normal profit.
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Fast forward to creative destruction
1970s, videocassettes, VCRs; expensive Video rental stores
Security deposits
Membership fees ($100) Little competition
Short run economic profit
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Fast forward to creative destruction
Supply of rental stores increased Faster than demand
Substitutes
Cable channels; pay-per-view; DVDs;
On-demand movies; download frominternet
Rental rates: $0.99;
No fees or deposits
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Fast forward to creative destruction
Online rental services Out with the old, in with the new
Creative destruction
Consumers benefit Wider choice
Lower prices
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Monopolistic vs. Perfect Competition
Both Zero economic profit in long run
MR=MC for quantity
where D is tangent to ATC Perfect competition
Firms demand: horizontal line
Produces at minimum average cost
Productive and allocative efficiency
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Monopolistic vs. Perfect Competition
Monopolistic competition Downward sloping D
Dont produce at minimum average cost
Excess capacity Could increase output
Lower average cost
Increase social welfare
Produces less, charges more
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Exhibit 3
Perfect competition versus monopolistic competition
in long-run equilibrium
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p
Dollarsperunit
Quantity
per periodq0
d=MR=AR
(a) Perfect competition
Cost curves are assumed the same. The monopolistically competitive firm producesless output and charges a higher price than does a perfectly competitive firm.
Neither earns economic profit in the long run.
(b) Monopolistic competition
p
D
ollarsperunit
Quantity
per periodq0
MC
D
MR
ATCATC
MC
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Oligopoly
Few sellers Barriers to entry
Economies of scale
Legal restrictions Brand names
Control over an essential resource
High cost of entry Start-up costs; advertising
Crowding out the competition16
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Exhibit 4
Economies of scale as a barrier to entry
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ca
Dollar
sperunit
cb
Autos per yearS0 M
Long-run average cost
At point b, an existing firm can produce M or more
automobiles at an average cost of cb.
A new entrant able to sell only S automobiles would incur a muchhigher average cost of ca at point a.
If automobile prices are below ca, a new entrant would suffer a loss.
In this case, economies of scale serve as a barrier to entry, insulating firmsthat have achieved minimum efficient scale from new competitors.
a
b
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Varieties of Oligopoly
Undifferentiated oligopoly Commodity
Interdependent firms
Differentiated oligopoly Product differentiation
Physical qualities
Sales location Services
Product image
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Models of Oligopoly
Interdependence Cooperation or Fierce competition
Collusion Price leadership
Game theory
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Collusion and Cartels
Collusion Agreement among firms to
Divide the market
Fix the price Cartel
Group of firms that agree to collude
Act as monopoly Increase economic profit
Illegal in U.S.20
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Exhibit 5
Cartel as a monopolist
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Quantity per periodQ0
MC
D
MR
p
Dollarsper
unit
c
A cartel acts as a monopolist.Here, D is the market demandcurve, MRthe associatedmarginal revenue curve, andMCthe horizontal sum of themarginal cost curves of cartelmembers (assuming all firms inthe market join the cartel).
Cartel profits are maximizedwhen the industry producesquantity Q and charges price p.
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Collusion and Cartels
Maximize profit Allocate output among cartel members
Same MC of the final unit produced
Difficulties to maintain a cartel: Differentiated product
Differences in average cost
Many firms in the cartel
Low barriers to entry
Cheating22
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Price Leadership
Informal, tacit collusion Price leader
Sets the price for the industry
Initiate price changes Followed by the other firms
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Price Leadership
Obstacles U.S. antitrust laws
Product differentiation
No guarantee others will follow Barriers to entry
Cheating
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Game Theory
Behavior of decision makers Series of strategic moves and
countermoves
Among rival firms Choices affect one another
General approach
Focus: each players incentives tocooperate or compete
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Game Theory
Prisoners dilemma Two thieves; cannot coordinate
Strategy
The players game plan Payoff matrix
Table listing the rewards
Dominant-strategy equilibrium
Each players action does not depend onwhat he thinks the other player will do
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Exhibit 6
The prisoners dilemma payoff matrix (years in jail)
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Jerry
Confess Clam up
Ben
Confess
Clam up
10
0
0
10
1
1
5
5
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Exhibit 7
Price-setting payoff matrix (profit per day)
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Exxon
Low price High price
Texaco
Low
price
Highprice
$200
$1,000
$1,000
$200
$700
$700
$500
$500
Nash Equilibrium: eachplayer maximizes profit,
given the price chosen bythe other.
Neither can increase profitby changing the price,given the price chosen by
the other.
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Exhibit 8
Cola war payoff matrix (annual profit in billions)
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Coke
Bigbudget
Moderatebudget
Pepsi
Bigbudget
Moderate
budget
$1
$4
$4
$1
$3
$3
$2
$2
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Game Theory
One-shot versus repeated games One-shot game Game is played just once
Repeated games Establish reputation for cooperation
Tit-fir-tat strategy
Highest payoff Coordination game
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Oligopoly vs. Perfect Competition
Oligopoly If firms collude or operate with excesscapacity
Higher price Lower output
If price wars
Lower price Higher profits in the long run
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Timely fashions boost profit for Zara
Zara Largest fashion retailer in Europe
Owns workshops and factories
designing, fabric dyeing, ironing
Real-time sales data
Direct shipments from factory to shops
New items twice a week
Prime store location
Word of mouth 32
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Exhibit 9
Comparison of market structures
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Perfect
competition
Monopoly Monopolistic
competition
Oligopoly
Number of firms Most One Many Few
Control over price None Complete Limited Some
Product differences None None Some None or some
Barriers to entry None Insurmountable Low Substantial
Examples Wheat Local electricity Convenience
stores
Automobile