Monopolistic Competition
and
Oligopoly
• Somewhere between the two extremes of
monopoly and perfect competition
• Two forms
– Monopolistic Competition
– Oligopoly
• Monopolistic Competition
– Many sellers, but
– Product Differentiation
– So face a downward sloping demand curve
– Not Price Takers
• Oligopoly
– Only a few seller
– Offer similar or identical products
Monopolistic Competition
• Key Points
• Like a monopoly
– Faces a downward sloping demand curve
– Sets its own price
– Marks up price over quantity
• But not
– Not really a monopoly
– Almost because it tries to make its product
different
– But its not different, so can’t push the monopoly
mindset too far, because people will go to other
close substitutes
• Profit in the long run?
– If firms making lots of profit maybe more firms
come in with close substitutes
– This would lower the firms demand and MR curve
and also profits
– Could this lead then to zero LR profits?
– If they haven’t sufficiently differentiated their
product, yes
– But if they have, no
– Because consumers might feel there are no real
substitutes
– Think Athletic Shoes
Monopolistic Competition and
Advertising
• If a firm is selling a differentiated product and
making a profit (price > MC)
• Then there is an incentive to advertise
– To attract more buyers (increase demand and MR
curve)
– And to keep their product differentiated
• Is advertising bad?
– Manipulates people’s tastes
– Psychological, not informative
– Impedes competition
– Differentiating products that are really the same
(brand loyalty)
• Is it good?
– Gives information
– Fosters competition (consumers take advantage of
price differences among similar products)
– Allows new firms to enter easier
• Does it make sense that consumers buy brand
names?
• Essentially the same product as store brands,
but cost more, partly because they advertise
• But maybe they are higher quality, and they
have an incentive to keep higher quality to
defend the brand
Oligopoly
•
•
•
•
Only a few sellers
Similar or identical products
Interdependent
Game Theory
– How people behave in strategic situations
– If only a few, I need to consider how they’ll
respond to my actions
• Tension between cooperating and competing
• Best off cooperating and acting like a
monopoly
– Produce small amount
– P > MC
• But each only cares about own self interest
– Incentive to compete
Duopoly Example
•
•
•
•
•
Only two firms
Same product
Each decides quantity to sell
Price is set by the market demand
Thus the combination of both seller’s choice
of Q leads to the price and so their profits
• They could collude and act as a monopoly
– Come to an agreement on price or quantity
– But generally explicit collusion is illegal (but can
still act strategically)
• Thus forming a Cartel
– Think of OPEC
Economics of Cooperation
• Prisoner’s Dilemma
– A “game”
– Illustrates why cooperation can be hard even if
both would benefit
• Dominant Strategy
– A strategy that is best for a player in a game
regardless of what others do
A
Confess
Don’t
A gets 8 yrs
prison
A gets 20 yrs
prison
Confess
B gets 8 yrs
prison
B goes free
B
A gets 1 yrs
prison
A goes free
Don’t
B gets 20 yrs
prison
B gets 8 yrs
prison
• Regardless of what A does it is better for B to
confess
– Dominant Strategy
• Regardless of what B does if is better for A to
confess
– Dominant Strategy
• So they both confess and both get 8 yrs
instead of both getting off
• Of course this is if they can’t collude
• This is similar to the situation face by two
firms in a duopoly
•
•
•
•
Two firms in a duopoly face a similar “game”
If colluded could reach higher profits
But can’t directly collude
Becomes a strategic game
Demand Schedule and Profit
Gallons
Market Price
Total Revenue
(Total Profit)
0
$120
$0
10
110
1,100
20
100
2,000
30
90
2,700
40
80
3,200
50
70
3,500
60
60
3,600
70
50
3,500
80
40
3,200
90
30
2,700
100
20
2,000
Duopoly “Game”
A
High Production
40 Gallons
Low Production
30 Gallons
A gets $1.6K
profit
A gets $1.5K
profit
High P
40 G
B gets $1.6K
profit
B gets $2K profit
B
A gets $1.8K
profit
A gets $2K profit
Low P
30 G
B gets $1.5K
profit
B gets $1.8K
profit
Application to OPEC
• Organization of Petroleum Exporting Countries
• Control about ¾ of worlds oil reserves
• Tries to set production limits to keep price of
oil sufficiently high (but not too high to cause
long term shift in demand)
• Each country then has incentive to deviate a
bit
– Because still get benefit of higher price but also
get to sell more, but if all do this then price falls
– Success at setting high price in 70’s and early 80’s
but since then not so much
Arms Race Example
• Cold war arms race between US and Soviet
Union
• Two strategies
– Arm
– Disarm
• Dominant Strategy
– Arm
Cold War “Game”
US
Arm
Disarm
US at risk
US at risk and
weak
Arm
Soviet at risk
Soviet safe and
strong
Soviet
US safe
US safe and
strong
Disarm
Soviet at risk and
weak
Soviet safe
• Game’s implication for welfare
• Noncooperative Equilibrium
– Dominant Strategy
– Could be good for society
• Gets away from monopoly production
– Could be bad
• Gets us a world full of nuclear warheads
How to Still Get Cooperation
• Repeated Games
– Dominant strategy is such because game only
played once
• Start out at best position
• Penalize players for deviating
– Tit for Tat
Public Policy
• Anti Trust Laws
• Sherman Act, 1890
– Made agreements between oligopolists a crime
• Clayton Act, 1914
– Strengthened anti trust laws
• Prevent Certain Mergers
• Prevent Collusion
Predatory Pricing
• Selling below cost in order to drive out a
competitor
• Then when competitor gone can act as a
monopoly
• Illegal under anti trust policies
• Deemed anticompetitive
• Rockefeller strategy in oil (Cincinnati/Chicago)
• Lower price in Cincinnati to drive out
competition, but raise price in Chicago where
competition had already been driven out