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Monopolistic Competition and Oligopoly
Part Two: Microeconomics of Product Markets CHAPTER 9 Monopolistic Competition and Oligopoly Slides prepared by Bruno Fullone, George Brown College. Edited by Laura Lamb 1 ©2010 McGraw-Hill Ryerson Ltd.
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9.1 Characteristics of Monopolistic Competition
Relatively Large Number of Sellers Small Market Shares No Collusion Independent Action ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College 2
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Characteristics of Monopolistic Competition
Differentiated Products Product Attributes Service Location Brand Names and Packaging Some Control Over Price ©2010 McGraw-Hill Ryerson Ltd. 3 Slides prepared by Bruno Fullone, George Brown College
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Figure 9-2 Monopolistic Competition
Short-Run Profits ATC MC P1 A1 Price and Costs Economic Profit D1 MR = MC MR Q1 Quantity ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College 4
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Monopolistic Competition
Short-Run Losses ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR Q2 Quantity ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College 5
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Monopolistic Competition
Long-Run Equilibrium MC ATC P3= A3 Price and Costs D3 MR = MC MR Q3 Quantity ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College 6
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Slides prepared by Bruno Fullone, George Brown College
Complicating factors Some firms may earn economic profits greater than zero in the long run. Why? ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Monopolistic Competition and Efficiency
1. Allocative Efficiency P > MC Too little is produced 2. Productive Efficiency Costs high Excess capacity ©2010 McGraw-Hill Ryerson Ltd. 8 Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
Product Variety Benefits Better match to consumer tastes Better products Tradeoff between variety and efficiency Further Complexity Price, product, and advertising must be juggled to achieve maximum profit ©2010 McGraw-Hill Ryerson Ltd. 9 Slides prepared by Bruno Fullone, George Brown College
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9.3 Oligopoly: Characteristics
A Few Large Producers Homogeneous or Differentiated Products Control Over Price, but Mutual Interdependence Entry Barriers Economies of scale High capital costs Ownership of raw materials Mergers ©2010 McGraw-Hill Ryerson Ltd. 10 Slides prepared by Bruno Fullone, George Brown College
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Two ways to measure industry concentration
1. Concentration ratio The four-firm concentration ratio gives the percentage of total industry sales accounted for by the four largest firms. ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
4775 4365 Herfindahl Index 3481 2453 2273 2069 1965 1038 ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
9.4 Game Theory Overview Oligopolists must make plans in light of the actions and expected reactions of their rivals Basic concepts: Players Rules Strategies Payoffs Equilibrium ©2010 McGraw-Hill Ryerson Ltd. 13 Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
Prisoner’s Dilemma Two prisoners cannot communicate Difficult to cooperate, even when mutually beneficial ©2010 McGraw-Hill Ryerson Ltd. 14 Slides prepared by Bruno Fullone, George Brown College
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Prisoner’s Dilemma Payoff Matrix
Al’s strategies Figure 9-5 Confess Not confess A 4 B 12 Bruno’s strategies Confess 4 1 C 1 D 2 Not confess 12 2 ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Profit Payoff for a Two-Firm Oligopoly
RareAir’s price strategy If both firms choose a high-price strategy, each earns $12 million in profit Collusive tendencies High Low Uptown’s price strategy A $12 B $15 High $12 $6 C $6 D $8 Low $15 $8 ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
9.5 The Incentives and Obstacles to Collusion: Two Oligopoly Strategies Two distinct pricing strategies: Collusive pricing Price leadership There is no one simple model to predict outcomes due to: Diversity of oligopolies Complications of interdependence ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Cartels and Other Collusion: Cooperative Strategies
Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition Each firm acts as if it were a pure monopolist Illustrated… ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Collusion and Joint-Profit Maximization
MC Figure 9-7 Price and Costs ATC P0 Economic profit A0 D MR=MC MR Q Q0 ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Cartels and Other Collusion: Cooperative Strategies
Three identical firms Each firm finds it most profitable to charge P0, but only if its rivals do The answer: collude and agree on price P0 ©2010 McGraw-Hill Ryerson Ltd. Slides prepared by Bruno Fullone, George Brown College
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Overt Collusion – The OPEC Cartel
©2010 McGraw-Hill Ryerson Ltd. 21 Slides prepared by Bruno Fullone, George Brown College
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Obstacles to Collusion
Demand and Cost Differences Number of Firms Cheating Recession Potential Entry Legal Obstacles: Competition Policy ©2010 McGraw-Hill Ryerson Ltd. 22 Slides prepared by Bruno Fullone, George Brown College
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Price Leadership Model
Dominant firm leads the way Leadership strategy: Infrequent Price Changes Communications Limit Pricing Breakdowns in price leadership: price wars ©2010 McGraw-Hill Ryerson Ltd. 23 Slides prepared by Bruno Fullone, George Brown College
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9.6 Oligopoly and Advertising
Oligopolists prefer not to compete on price Product development and advertising preferred: Less easily duplicated Oligopolists have sufficient financial resources ©2010 McGraw-Hill Ryerson Ltd. 24 Slides prepared by Bruno Fullone, George Brown College
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Positive Effects of Advertising
Low cost source of information Can diminish monopoly power Can speed up technological progress ©2010 McGraw-Hill Ryerson Ltd. 25 Slides prepared by Bruno Fullone, George Brown College
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Potential Negative Effects of Advertising
Only persuasion Misleading claims Barrier to entry Self-cancelling advertising ©2010 McGraw-Hill Ryerson Ltd. 26 Slides prepared by Bruno Fullone, George Brown College
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Slides prepared by Bruno Fullone, George Brown College
Global Perspective 9.2 ©2010 McGraw-Hill Ryerson Ltd. 27 Slides prepared by Bruno Fullone, George Brown College
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Oligopoly and Efficiency
Impossible to say anything definitive Outcomes could be identical to monopoly Unlikely because of: Increased foreign competition Limit pricing Technological advance ©2010 McGraw-Hill Ryerson Ltd. 28 Slides prepared by Bruno Fullone, George Brown College
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The Last Word: Oligopoly in the Beer Industry
Since WW II degree of concentration has been increasing, mostly due to mergers Today 80% of production controlled by 2 major companies However, imports and microbreweries are starting to eat away at market share of majors ©2010 McGraw-Hill Ryerson Ltd. 29 Slides prepared by Bruno Fullone, George Brown College
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