Monopolistic Competition and Oligopoly: Mcgraw-Hill/Irwin

11

Monopolistic Competition and Oligopoly

McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopolistic Competition
Relatively large number of sellers Differentiated products Easy entry and exit Advertising
LO1
11-2
Monopolistically Competitive
Industry concentration Measured by: Four-firm concentration ratios Percentage of 4 largest firms
4-Firm CR =
Herfindahl index Sum of squared market shares

HI = (%S1)2 + (%S2)2 + (%S3)2 + . + (%Sn)2
LO1
Output of four largest firms Total output in the industry
11-3
Low Concentration Industries

(1) Industry (2)
4-Firm Concentration Ratio
(3) Herfindahl Index

207 262 263 205 240 319 206 117
(1) Industry
Metal windows and doors Womens dresses Ready mix concrete Wood trusses Stone products Metal stamping Wood pallets Sheet metal work
(2)

114 84 63 50 59 31 24 25
Asphalt paving Plastic pipe Textile bags
25 24 24 24 23 22 20 18
14 13 11 10 10 8 7 6
Bolts, nuts, and rivets

Plastic bags Quick printing Textile machinery Sawmills
Jewelry
Curtains and draperies
16
16
117
111
Signs
Retail bakeries
5
4
19
7
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

MC ATC
Price and Costs
P1 A1
Economic Profit
MR = MC
D1
MR
0
Quantity
Q1
LO2
11-6
The Short Run: Profit or Loss

MC ATC
Price and Costs
A2 P2
Loss
D2 MR = MC
MR
0
Quantity
Q2
LO2
11-7
The Long Run: Only a Normal Profit

MC
ATC
Price and Costs
P3= A3
D3 MR = MC
MR
0
Quantity
Q3
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)

MC
Price and Costs
ATC
P3= A3
P4
Price is Lower D3 MR = MC Excess Capacity at Minimum ATC 0 Q3
MR Q4
Quantity
11-10
Monopolistic competition is not efficient

LO2
Product Variety
The firm constantly manages price,

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
LO2
Oligopoly
A few large producers Homogeneous or differentiated

products Limited control over price Mutual interdependence Strategic behavior Entry barriers Mergers
11-12

LO3
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
High Concentration Industries

(1) Industry
Primary copper Cane sugar refining Cigarettes Household laundry equipment Beer Electric light bulbs Glass containers Turbines and generators
(2)

ND ND ND ND ND 2582 2582 ND
(1) Industry
Petrochemicals Small arms ammunition Motor vehicles Mens slacks and jeans Aircraft Breakfast cereals Household vacuum cleaners Phosphate fertilizers Tires Electronic computers Alcohol distilleries
(2)

2662 1901 2321 2515 ND 2521 2096 1853 1807 2662 1609 11-14
99 99 95 93 91 89 88 88
85 83 81 80 81 78 78 78 77 76 71
Household refrigerators and freezers

Primary aluminum
LO1
85 85
1986 ND
Game Theory Overview
Oligopolies display strategic pricing

behavior Mutual interdependence Collusion Incentive to cheat Prisoners dilemma
LO4
11-15

RareAirs Price Strategy 2 competitors 2 price strategies Each strategy has a payoff matrix Greatest combined profit Independent actions stimulate a response
High Low B
Uptowns Price Strategy
A High $12
$12
$15
$6
C Low $15
$6
$8 $8
LO4
11-16

RareAirs Price Strategy Independently lowered prices in expectation of greater profit leads to worst combined outcome Eventually low outcomes make firms return to higher prices.
High Low B
Uptowns Price Strategy
A High $12
$12
$15
$6
C Low $15
$6
$8 $8
LO4
11-17
3 Oligopoly Models
Kinked Demand Curve Collusive Pricing Price Leadership Reasons for 3 models Diversity of oligopolies Complications of interdependence
LO5
11-18
Kinked-Demand Theory
Noncollusive oligopoly Uncertainty about rivals reactions Rivals match any price change Rivals ignore any price change Assume combined strategy Match price reductions Ignore price increases
LO5
11-19
Kinked Demand Curve
Rivals Ignore Price Increase Price and Costs D2 P0 e MR2 f MC2
MC1
Price
P0 f
e D2 MR2 D1
Rivals Match g Price Decrease 0 MR1 Quantity Q0
g
D1 0 Q0 MR1 Quantity
LO5
11-20
Kinked Demand Curve
Criticisms Explains inflexibility, not price Prices are not that rigid Price wars
LO6
11-21
Cartels and Other Collusion

MC
Price and Costs
P0
ATC
A0
MR=MC
Economic Profit
Q0
MR
Quantity
LO6
11-22
Global Perspective
LO6
11-23
Overt Collusion
Cartels - a group of firms or nations

that collude Formally agreeing to the price Sets output levels for members Collusion is illegal in the United States OPEC
11-24
LO6
Obstacles to Collusion
Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles
LO6
11-25
Price Leadership Model
Price Leadership Dominant firm initiates price

changes Other firms follow the leader Use limit pricing to block entry of new firms Possible price war
11-26
LO6
Oligopoly and Advertising
Prevalent to compete with product

development and advertising Less easily duplicated than a price change Financially able to advertise
LO7
11-27
Positive Effects of Advertising
Low-cost way of providing information

to consumers Enhances competition Speeds up technological progress Can help firms obtain economies of scale
LO7
11-28
Oligopoly and Advertising

The Largest U.S. Advertisers, 2008 Company Procter & Gamble Verizon AT&T Advertising Spending Millions of $ $4831 $3700 $3073
General Motors
Johnson & Johnson Unilever Walt Disney Time Warner General Electric Sears
$2901
$2529 $2423 $2218 $2208 $2019 $1865
Source: Advertising Age http://www.adage.com

LO7
11-29
Negative Effects of Advertising
Can be manipulative Contains misleading claims that

confuse consumers Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product.
LO7
11-30
Global Perspective
LO7
11-31
Oligopoly and Efficiency
Oligopolies are inefficient Productively inefficient P > minATC Allocatively inefficient P > MC Qualifications Increased foreign competition Limit pricing Technological advance
LO7
11-32
Oligopoly in the Beer Industry
The beer industry is now an oligopoly. Changes in demand Change in tastes Consumed at home and mass
produced Changes in supply Technological advance Economies of scale
11-33

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11

Monopolistic Competition and Oligopoly

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Herfindahl index Sum of squared market shares

Output of four largest firms Total output in the industry

Low Concentration Industries

(3) Herfindahl Index

(3) Herfindahl Index

Asphalt paving Plastic pipe Textile bags

Bolts, nuts, and rivets

Price and Output in Monopolistic Comp

The Short Run: Profit or Loss

Price and Costs

The Short Run: Profit or Loss

Price and Costs

The Long Run: Only a Normal Profit

Price and Costs

Monopolistic Competition: Efficiency

Inefficient Productive inefficiency P > ATC Allocative inefficiency P > MC

Monopolistic Competition: Efficiency P=MC=Min ATC for pure competition (recall)

Price and Costs

Monopolistic competition is not efficient

The firm constantly manages price,

A few large producers Homogeneous or differentiated

High Concentration Industries

(3) Herfindahl Index

(3) Herfindahl Index

Household refrigerators and freezers

Game Theory Overview

Oligopolies display strategic pricing

Game Theory Overview

Uptowns Price Strategy

Game Theory Overview

Uptowns Price Strategy

Kinked Demand Curve

Rivals Ignore Price Increase Price and Costs D2 P0 e MR2 f MC2

Rivals Match g Price Decrease 0 MR1 Quantity Q0

Kinked Demand Curve

Cartels and Other Collusion

Price and Costs

Cartels - a group of firms or nations

Price Leadership Model

Price Leadership Dominant firm initiates price

Oligopoly and Advertising

Prevalent to compete with product

Positive Effects of Advertising

Low-cost way of providing information

Oligopoly and Advertising

Source: Advertising Age http://www.adage.com

Negative Effects of Advertising

Can be manipulative Contains misleading claims that

Oligopoly and Efficiency

Oligopoly in the Beer Industry

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