chapter ten Monopolistic Competition and Oligopoly Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien After studying this chapter, you should be able to: 1 …the coffeehouse market is monopolistically competitive, rather than perfectly competitive. LEARNING OBJECTIVES CHAPTER 10: Monopolistic Competition and Oligopoly Starbucks: Growth through Product Differentiation 2 3 4 5 6 Explain why a monopolistically competitive firm has a downward-sloping demand curve. Explain how a monopolistically competitive firm decides the quantity to produce and the price to charge. Analyze the situation of a monopolistically competitive firm in the long run. Compare the efficiency of monopolistic competition and perfect competition. Show how barriers to entry explain the existence of oligopolies. Use game theory to analyze oligopolistic firms. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 2 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Monopolistic Competition and Oligopoly Monopolistic competition A market structure in which barriers to entry are low, and many firms compete by selling similar, but not identical, products. Oligopoly A market structure in which a small number of firms compete. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 3 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly 1 LEARNING OBJECTIVE Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market The Demand Curve for a Monopolistically Competitive Firm 10 - 1 The Downward-Sloping Demand for Caffe Lattès at a Starbucks © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 4 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Marginal Revenue for a Firm with a Downward-Sloping Demand Curve 10 – 1 Demand and Marginal Revenue at a Starbucks CAFFÈ LATTES SOLD PER WEEK (Q) 0 1 2 3 4 5 6 7 8 9 10 PRICE (P) $6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 TOTAL REVENUE (TR = P x Q) AVERAGE REVENUE (AR – TR/Q) MARGINAL REVENUE (MR = ΔTR/ΔQ) $0.00 5.50 10.00 13.50 16.00 17.50 18.00 17.50 16.00 13.50 10.00 $5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 $5.50 4.50 3.50 2.50 1.50 0.50 -0.50 -1.50 -2.50 -3.50 © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 5 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Marginal Revenue for a Firm with a Downward-Sloping Demand Curve 10 - 2 How a Price Cut Affects a Firm’s Revenue © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 6 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Demand and Marginal Revenue for a Firm in a Monopolistically Competitive Market Marginal Revenue for a Firm with a Downward-Sloping Demand Curve 10 - 3 The Demand and Marginal Revenue Curves for a Monopolistically Competitive Firm © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 7 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly 2 LEARNING OBJECTIVE How a Monopolistically Competitive Firm Maximizes Profits in the Short Run 10 - 4 Maximizing Profit in a Monopolistically Competitive Market © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 8 of 30 3 LEARNING OBJECTIVE CHAPTER 10: Monopolistic Competition and Oligopoly What Happens to Profits in the Long Run? How Does Entry of New Firms Affect the Profits of Existing Firms? 10 - 5 How Entry of New Firms Eliminates Profits Don’t Confuse Zero Economic Profit with Zero Accounting Profit © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 9 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly What Happens to Profits in the Long Run? Is Zero Economic Profit Inevitable in the Long Run? A firm’s profits will be eliminated in the long run only if the firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 10 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly 4 LEARNING OBJECTIVE Comparing Perfect Competition and Monopolistic Competition 10 - 6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 11 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Comparing Perfect Competition and Monopolistic Competition Excess Capacity under Monopolistic Competition The profit-maximizing level of output for a monopolistically competitive firm comes at a level of output where price is greater than marginal cost and the firm is not at the minimum point of its average total cost curve. How Consumers Benefit from Monopolistic Competition Consumers benefit from being able to purchase a product that is differentiated and more closely suited to their tastes. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 12 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Oligopoly and Barriers to Entry Barriers to Entry 10-7 Economies of Scale Help Determine the Extent of Competition in an Industry Economies of scale Economies of scale exist when a firm’s long-run average costs fall as it increases output. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 13 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Oligopoly and Barriers to Entry Barriers to Entry In addition to economies of scale, other barriers to entry include: • Ownership of a key input • Government–Imposed Barriers • Patent The exclusive right to a product for a period of 20 years from the date the product was invented. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 14 of 30 6 LEARNING OBJECTIVE CHAPTER 10: Monopolistic Competition and Oligopoly Using Game Theory to Analyze Oligopoly Game theory The study of how people make decisions in situations where attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms. Key characteristics of all games: 1. Rules that determine what actions are allowable. 2. Strategies that players employ to attain their objectives in the game. 3. Payoffs that are the results of the interaction among the players’ strategies. Business strategy Actions taken by a business firm to achieve a goal, such as maximizing profits. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 15 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly 13 - 1 A Beautiful Mind: Game Theory Goes to the Movies In the film, A Beautiful Mind, Russell Crowe played John Nash, winner of the Nobel Prize in Economics. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 16 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Using Game Theory to Analyze Oligopoly Firm Behavior and the Prisoners’ Dilemma Cooperative equilibrium An equilibrium in a game in which players cooperate to increase their mutual payoff. Noncooperative equilibrium An equilibrium in a game in which players do not cooperate but pursue their own self-interest. Prisoners’ dilemma A game where pursuing dominant strategies results in noncooperation that leaves everyone worse off. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 17 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Using Game Theory to Analyze Oligopoly Cartels: The Case of OPEC 10-10 World Oil Prices Cartel A group of firms that colludes by agreeing to restrict output to increase prices and profits. Sustaining high prices has been difficult because members often exceed their output quotas. © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 18 of 30 CHAPTER 10: Monopolistic Competition and Oligopoly Barrier to entry Business strategy Cartel Collusion Cooperative equilibrium Dominant strategy Economies of scale Game theory Monopolistic competition Nash equilibrium Noncooperative equilibrium Oligopoly Patent Payoff matrix Prisoners’ dilemma © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 19 of 30