CHAPTER 23 MONOPOLISTIC COMPETITION AND OLIGOPOLY

Market Structure Continuum FOUR MARKET MODELS Pure Competition

Market Structure Continuum Pure Competition FOUR MARKET MODELS Imperfect Competition All Markets that are Not Purely Competitive

Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly

Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Monopolistic Competition

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition FOUR MARKET MODELS Oligopoly

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Monopolistic Competition: - Relatively Large Number of Sellers - Differentiated Products - Easy Entry and Exit

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Oligopoly: - A Few Large Producers - Homogeneous or Differentiated Products -Control Over Price, But Mutual Interdependence -Strategic Behavior -Entry Barriers

Comparing the Four Market Forms Perfect competition and pure monopoly are uncommon in reality. Many monopolistically competitive firms exist. Oligopoly firms account for the largest share of the economy’s output.

Comparing the Four Market Forms In equilibrium, MC = MR for the profit- maximizing firm under any market form. In the equilibrium of the oligopoly firm, MC may be unequal to MR.

Comparing the Four Market Forms Perfectly competitive firm and industry theoretically have efficient allocation of resources. Monopoly and monopolistic competition are likely to have inefficient allocation of resources. Under oligopoly, almost anything can happen, it is impossible to generalize about its vices or virtues.

D MR P1P1 ATC Price and Costs Q1Q1 Short-Run Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity AC 1 MC

D MR MC P2P2 ATC Price and Costs Q2Q2 Short-RunEconomicLosses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity AC 2

D MR MC P 3 = AC 3 ATC Price and Costs Q3Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium NormalProfitOnly

D1D1 MR 1 Quantity The firm’s demand and marginal revenue curves KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price

MR 2 D1D1 D2D2 MR 1 Quantity The rival’s demand and marginal revenue curves KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price

MR 2 D1D1 D2D2 MR 1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut

MR 2 D1D1 D2D2 MR 1 Quantity KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price Rivals tend to follow a price cut or ignore a price increase

MR 2 D1D1 D2D2 MR 1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price

D Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price

D MR 1 Quantity Effectively creating a kinked demand curve KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC 2 MC 1 MR 2

D Quantity Profit maximization MR = MC occurs at the kink KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC 2 MC 1 MR 2 MR 1

D Quantity This behavior can set off a price war. KINKED DEMAND THEORY: NONCOLLUSIVE OLIGOPOLY Price MC 2 MC 1 MR 2 MR 1

Colluding Oligopolists Will Split the Monopoly Profits D MC ATC MR Economic Profit MR = MC Price and costs Q0Q0 P0P0 A0A0 CARTELS AND OTHER COLLUSION

Using Game Theory Game theory can be used to describe a game when:Game theory can be used to describe a game when: –There are rules which govern actions; –There are two or more players; –There are choices of action where strategy matters; –The game has one or more outcomes; –The outcome depends on the strategies chosen by all players, i.e., there is strategic interaction.

Advertising Game COMPANY Y COMPANY Y COMPANY X Don’t Adv. Advertise 10,10 10,10 2,15 2,15 Advertise 15,2 15,2 7,7 7,7  Dominant strategies: Strategy 1 dominates Strategy 2 if every payoff from 2 is dominated by the respective payoff from 1. Nash equilibrium: a set of strategies, one for each player, such that no player has an incentive (in terms of improving his own payoff) to deviate from his strategy, i.e., each player can do no better given what the opposing player(s) does.