Monopolistic Competition and Oligopoly 13 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Monopolistic Competition Relatively large number of sellers Small market shares No collusion Independent action Some control over price Differentiated products Product attributes Service, location Brand-names, packaging LO1

Monopolistic Competition Easy entry and exit Advertising Nonprice competition LO1

Price and Output in Monopolistic Comp Demand is more elastic than pure monopoly because there are more rivals and substitutes Demand is less elastic than pure competition because there are fewer rivals and imperfect substitutes LO2

Monopolistic Competition: Efficiency Inefficient Productive inefficiency P > ATC Allocative inefficiency P > MC LO2

Oligopoly A few large producers Homogeneous or differentiated products Limited control over price Mutual interdependence Strategic behavior Entry barriers Mergers LO3

Oligopolistic Industries Four-firm concentration ratio 40% or more to be oligopoly Shortcomings Localized markets Inter-industry competition World price Dominant firms – Herfindahl Index LO3

High Concentration Industries (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index Primary copper99NDPetrochemicals Cane sugar refining99ND Small arms ammunition Cigarettes95NDMotor vehicles Household laundry equipment93ND Men’s slacks and jeans Beer91NDAircraft81ND Electric light bulbs892582Breakfast cereals Glass containers Household vacuum cleaners Turbines and generators88NDPhosphate fertilizers Household refrigerators and freezers Tires Electronic computers Primary aluminum85NDAlcohol distilleries LO1

3 Oligopoly Models Kinked Demand Curve Collusive Pricing Price Leadership Reasons for 3 models Diversity of oligopolies Complications of interdependence LO5

Kinked Demand Curve Criticisms Explains inflexibility, not price Prices are not that rigid Price wars LO6

Overt Collusion Collusion reduces uncertainty, improves control of price, profits rise, and prevents entry of firms Cartels - a group of firms or nations that collude Formally written agreement Sets output levels and price for members OPEC LO6

Covert Collusion Gentleman’s agreements Informal understandings often in social settings between firms about price and output LO6

Obstacles to Collusion Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles Golden Balls LO6

Global Perspective LO6

Price Leadership Model Price Leadership Dominant firm initiates price changes Communicates price change Other firms follow the leader Use limit pricing to block entry of new firms Possible price war LO6

Oligopoly and Efficiency Oligopolies are inefficient Productively inefficient P > minATC Allocatively inefficient P > MC Qualifications Increased foreign competition Limit pricing Technological advance LO7