11
Monopolistic Competition and Oligopoly
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Market Models
Characteristics of the Four Basic Market Models
Characteristic
Pure
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Number of firms
A very large
number
Many
Few
One
Type of product
Standardized
Differentiated
Standardized or
differentiated
Unique; no
close subs.
Control over
price
None
Some, but within rather
narrow limits
Limited by mutual
inter-dependence;
considerable with
collusion
Considerable
Conditions of
entry
Very easy, no
obstacles
Relatively easy
Significant
obstacles
Blocked
Nonprice
competition
None
Considerable emphasis
on advertising, brand
names, trademarks
Typically a great
deal, particularly
with product
differentiation
Mostly public
relation
advertising
Examples
Agriculture
Retail trade, dresses,
shoes
Steel, auto, farm
implements
Local utilities
LO1
11-2
Monopolistic Competition
• Relatively large number of sellers
• Differentiated products
• Easy entry and exit
• Advertising
LO1
11-3
Monopolistically Competitive
• Industry concentration
• Measured by:
• Four-firm concentration ratios
• Percentage of 4 largest firms
4-Firm CR =
Output of four largest firms
Total output in the industry
• Herfindahl index
• Sum of squared market shares
HI = (%S1)2 + (%S2)2 + (%S3)2 + …. +
(%Sn)2
LO1
11-4
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
The Short Run: Profit or Loss
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
LO2
11-6
The Short Run: Profit or Loss
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
LO2
11-7
The Long Run: Only a Normal Profit
MC
Price and Costs
ATC
P3= A3
D3
MR = MC
MR
0
Q3
Quantity
LO2
11-8
Monopolistic Competition: Efficiency
• Inefficient
• Productive inefficiency
• P > ATC
• Allocative inefficiency
• P > MC
LO2
11-9
Monopolistic Competition: Efficiency
P=MC=Min ATC for pure competition (recall)
Price and Costs
MC
ATC
P3= A3
P4
Price is Lower
D3
MR = MC
Excess Capacity at
Minimum ATC
0
Q3
MR
Q4
Quantity
Monopolistic competition is not efficient
LO2
11-10
Product Variety
• The firm constantly manages price,
•
LO2
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
11-11
Oligopoly
• A few large producers
• Homogeneous or differentiated
•
•
•
LO3
products
Limited control over price
• Mutual interdependence
• Strategic behavior
Entry barriers
Mergers
11-12
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
Game Theory Overview
• Oligopolies display strategic pricing
behavior
• Mutual interdependence
• Collusion
• Incentive to cheat
• Prisoner’s dilemma
LO4
11-14
Game Theory Overview
RareAir’s Price Strategy
LO4
High
Uptown’s Price Strategy
• 2 competitors
• 2 price
strategies
• Each strategy
has a payoff
matrix
• Greatest
combined
profit
• Independent
actions
stimulate a
response
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-15
Game Theory Overview
RareAir’s Price Strategy
LO4
High
Uptown’s Price Strategy
• Independently
lowered prices in
expectation of
greater profit
leads to worst
combined
outcome
• Eventually low
outcomes make
firms return to
higher prices.
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-16
Three Oligopoly Models
• Kinked-demand curve
• Collusive pricing
• Price leadership
• Reasons for 3 models
• Diversity of oligopolies
• Complications of interdependence
LO5
11-17
Kinked-Demand Curve
Rivals Ignore
Price Increase
MC1
e
P0
f
D2
Q0
Quantity
LO5
P0
e
MR2
f
MC2
MR2
Rivals Match g
Price Decrease
0
Price
Price
D2
g
D1
MR1
D1
0
Q0
MR1
Quantity
11-18
Kinked-Demand Curve
• Criticisms
• Explains inflexibility, not price
• Prices are not that rigid
• Price wars
LO6
11-19
Cartels and Other Collusion
Price and Costs
MC
P0
ATC
A0
MR=MC
Economic
Profit
Q0
LO6
D
MR
Quantity
11-20
Overt Collusion
• Cartels - a group of firms or nations
•
•
LO6
that collude
• Formally agreeing to the price
• Sets output levels for members
Collusion is illegal in the United
States
OPEC
11-21
Obstacles to Collusion
• Demand and cost differences
• Number of firms
• Cheating
• Recession
• New entrants
• Legal obstacles
LO6
11-22
Price Leadership Model
• Price Leadership
• Dominant firm initiates price
•
•
LO6
changes
• Other firms follow the leader
Use limit pricing to block entry of new
firms
Possible price war
11-23
Oligopoly and Advertising
• Prevalent to compete with product
development and advertising
• Less easily duplicated than a price
change
• Financially able to advertise
LO7
11-24
Advertising
Positive Effects
Negative Effects
Low-cost way of providing
information to consumers
Can be manipulative
Enhances competition
Contains misleading claims that
confuse consumers
Speeds up technological progress Consumers pay high prices for a
good while forgoing a better, lower
priced, unadvertised version of the
product
Can help firms obtain economies
of scale
LO7
11-25
Oligopoly and Efficiency
• Oligopolies are inefficient
• Productively inefficient P > minATC
• Allocatively inefficient P > MC
• Qualifications
• Increased foreign competition
• Limit pricing
• Technological advance
LO7
11-26
