Chapter 12Slide 1 Monopolistic Competition Characteristics 1)Many firms 2)Free entry and exit...
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Transcript of Chapter 12Slide 1 Monopolistic Competition Characteristics 1)Many firms 2)Free entry and exit...
Chapter 12 Slide 1
Monopolistic Competition Characteristics
1) Many firms
2) Free entry and exit
3) Differentiated product (but high degree of substitutability)
The amount of monopoly power depends on the degree of differentiation.
Examples of this common market structure include:Toothpaste; Soap; Cold remedies; Soft Drinks;
Coffee
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 Slide 3
Observations (short-run)Downward sloping demand - differentiated
product
Demand is relatively elastic - good substitutes
MR < P
Profits are maximized when MR = MC
This firm is making economic profits
Monopolistic Competition in the SR
Chapter 12 Slide 4
Observations (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 fallIndustry output will riseNo economic profit (P = AC)P > MC -- some monopoly power
Monopolistic Competition in the LR
Deadweight lossMC AC
Comparison of Monopolistically CompetitiveEquilibrium and Perfectly Competitive Equilibrium
$/Q
Quantity
$/Q
D = MR
QC
PC
MC AC
DLR
MRLR
QMC
P
Quantity
Perfect Competition Monopolistic Competition
Chapter 12 Slide 6
Monopolistic Competition
Reduction in Economic EfficiencyThe monopoly power (differentiation) yields
a higher price than perfect competition. If price was lowered to the point where MC = D, total surplus would increase by the yellow triangle.
Although there are no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists.
Chapter 12 Slide 7
Oligopoly
Characteristics
Small number of firms
Product differentiation may or may not exist
Barriers to entry
Examples: Automobiles, Steel, Aluminum, Petrochemicals, Electrical equipment, Computers
Chapter 12 Slide 8
Oligopoly
Barriers to entry include:Scale economies; Patents; Technology; Name
recognition
Strategic action: Flooding the market; Controlling an essential input
Management ChallengesStrategic actions
Rival behavior
Chapter 12 Slide 9
Oligopoly
Equilibrium in an Oligopolistic MarketIn perfect competition, monopoly, and
monopolistic competition the producers did not have to consider a rival’s response when choosing output and price.
In oligopoly the producers must consider the response of competitors when choosing output and price.
Chapter 12 Slide 10
Oligopoly
Equilibrium in an Oligopolistic MarketDefining Equilibrium
Firms do the best they can and have no incentive to change their output or price
All firms assume competitors are taking rival decisions into account.
Nash EquilibriumEach firm is doing the best it can given what its
competitors are doing.
Chapter 12 Slide 11
Quantity Competition: Cournot
The Cournot ModelDuopoly
Two firms competing with each otherHomogeneous goodThe output of the other firm is assumed
to be fixed
Chapter 12 Slide 12
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)
If Firm 1 thinks Firm 2 will produce nothing, its demand
curve, D1(0), is the market demand curve.
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 Slide 13
Firm 2’s ReactionCurve Q2*(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 Cournot Equilibrium
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 example.
In Cournot equilibrium, eachfirm correctly assumes how
much its competitors willproduce and thereby
maximizes its own profits.
CournotEquilibrium
Chapter 12 Slide 14
Price Competition: Bertrand
Competition in an oligopolistic industry may occur with price instead of output.
The Bertrand Model is used to illustrate price competition in an oligopolistic industry with homogenous goods.
How will consumers respond to a price differential? (Hint: Consider homogeneity)
Chapter 12 Slide 15
Price Competition
Why not charge a higher price to raise profits?
How does the Bertrand outcome compare to the Cournot outcome?
The Bertrand model demonstrates the importance of the strategic variable (price versus output).
Bertrand ModelBertrand Model
Chapter 12 Slide 16
Price Competition
Price Competition with Differentiated ProductsMarket shares are now determined not just
by prices, but by differences in the design, performance, and durability of each firm’s product.
Chapter 12 Slide 17
Firm 1’s Reaction Curve
Nash Equilibrium in Prices
P1
P2
Firm 2’s Reaction Curve
$4
$4
Nash Equilibrium
Chapter 12 Slide 18
Competition Versus Collusion:Payoff Matrix for Pricing Game
Firm 2
Firm 1
Charge $4 Charge $6
Charge $4
Charge $6
$12, $12 $20, $4
$16, $16$4, $20
Chapter 12 Slide 19
These two firms are playing a noncooperative game.Each firm independently does the best it can
taking its competitor into account.
QuestionWhy will both firms both choose $4 when $6 will
yield higher profits?
An example in game theory, called the Prisoners’ Dilemma, illustrates the problem oligopolistic firms face.
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 20
ScenarioTwo prisoners have been accused of
collaborating in a crime.
They are in separate jail cells and cannot communicate.
Each has been asked to confess to the crime.
Competition Versus Collusion:The Prisoners’ Dilemma
Chapter 12 Slide 21
-5, -5 -1, -10
-2, -2-10, -1
Payoff Matrix for Prisoners’ Dilemma
Prisoner A
Confess Don’t confess
Confess
Don’tconfess
Prisoner B
Would you choose to confess?
Chapter 12 Slide 22
Payoff Matrix for the Prisoners’ Dilemma
Conclusions: Oligopolistic Markets
1) Collusion will lead to greater profits
2) Explicit and implicit collusion is possible
3) Once collusion exists, the profit motive to break and lower price is significant
Chapter 12 Slide 23
Charge $1.40 Charge $1.50
Charge$1.40
Unilever and Kao
Charge$1.50
P&G
$12, $12 $29, $11
$3, $21 $20, $20
Payoff Matrix for the P&G Pricing Problem
What price should P & G choose?
Chapter 12 Slide 24
Implications of the Prisoners’Dilemma for Oligopolistic Pricing
Price Signaling: Implicit collusion in which a firm announces a price increase in the hope that other firms will follow suit.
Price Leadership: Pattern of pricing in which one firm regularly announces price changes that other firms then match.
Price Signaling & Price LeadershipPrice Signaling & Price Leadership