Copyright 2011 The McGraw-Hill Companies 8-1 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show 8 Monopolistic Competition and Oligopoly

Copyright 2011 The McGraw-Hill Companies 8-2 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Chapter Objectives Characteristics of Monopolistic Competition Why Monopolistic Competitors Earn Only a Normal Profit in the Long- Run Characteristics of Oligopoly How Game Theory Relates to Oligopoly Why the Demand Curve of the Oligopolist May Be Kinked Incentives and Obstacles to Collusion Among Oligopolists Potential Positive and Negative Effects of Advertising

Copyright 2011 The McGraw-Hill Companies 8-3 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Monopolistic Competition Characteristics –Small Market Shares –No Collusion –Independent Action Differentiated Products –Product Attributes –Service –Location –Brand Names and Packaging –Some Control Over Price 8.1

Copyright 2011 The McGraw-Hill Companies 8-4 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Monopolistic Competition Easy Entry and Exit Advertising –Nonprice Competition Monopolistically Competitive Industries 8.1

Copyright 2011 The McGraw-Hill Companies 8-5 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price and Output Determination The Firm’s Demand Curve The Short Run: –Profit or Loss The Long Run: –Only a Normal Profit –Profits: Firms Enter –Losses: Firm’s Leave Complications –Product Variety In Monopolistic Competition 8.1

Copyright 2011 The McGraw-Hill Companies 8-6 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price and Output Determination In Monopolistic Competition Short-Run Profits Quantity Price and Costs MR = MC MC MR D1D1 ATC Economic Profit Q1Q1 A1A1 P1P1 0

Copyright 2011 The McGraw-Hill Companies 8-7 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price and Output Determination In Monopolistic Competition Short-Run Losses Quantity Price and Costs MR = MC MC MR D2D2 ATC Loss Q2Q2 A2A2 P2P2 0

Copyright 2011 The McGraw-Hill Companies 8-8 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price and Output Determination In Monopolistic Competition Long-Run Equilibrium Quantity Price and Costs MR = MC MC MR D3D3 ATC Q3Q3 P3=A3P3=A3 0

Copyright 2011 The McGraw-Hill Companies 8-9 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Quantity Price and Costs MR = MC MC MR D3D3 ATC Q3Q3 P3=A3P3=A3 0 Monopolistic Competition and Efficiency Recall: P=MC=Minimum ATC P4P4 Q4Q4 Price is Higher Excess Capacity at Minimum ATC Monopolistic Competition is Not Efficient

Copyright 2011 The McGraw-Hill Companies 8-10 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Oligopoly Characteristics –A Few Large Producers –Homogeneous or Differentiated Products Homogeneous Oligopoly Differentiated Oligopoly –Control Over Price, But Mutual Interdependence Strategic Behavior –Entry Barriers –Mergers

Copyright 2011 The McGraw-Hill Companies 8-11 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Game Theory Game Theory Model to Analyze Behavior RareAir’s Price Strategy Uptown’s Price Strategy AB CD R12 R15 R6 R8 R6 R15 High Low 2 Competitors 2 Price Strategies Each Strategy Has a Payoff Matrix Greatest Combined Profit Independent Actions Stimulate a Response 8.2

Copyright 2011 The McGraw-Hill Companies 8-12 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Game Theory Game Theory Model to Analyze Behavior RareAir’s Price Strategy Uptown’s Price Strategy AB CD R12 R15 R6 R8 R6 R15 High Low Independently Lowered Prices in Expectation of Greater Profit Leads to the Worst Combined Outcome Eventually Low Outcomes Make Firms Return to Higher Prices 8.2

Copyright 2011 The McGraw-Hill Companies 8-13 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Game Theory Role of Mutual Interdependence Collusive Tendencies –Collusion Incentive to Cheat 8.2

Copyright 2011 The McGraw-Hill Companies 8-14 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Three Oligopoly Models Kinked Demand Curve Collusive Pricing Price Leadership Diversity of Oligopolies Complications of Interdependence

Copyright 2011 The McGraw-Hill Companies 8-15 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Kinked-Demand Curve Strategies –Match Price Changes –Ignore Price Changes A Combined Strategy Price Inflexibility The Kinked-Demand Curve Graphically… Noncollusive Oligopoly

Copyright 2011 The McGraw-Hill Companies 8-16 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price Price and Costs Quantity 0 0 Kinked-Demand Curve Noncollusive Oligopoly P0P0 MR 2 D2D2 D1D1 MR 1 e f g Rivals Ignore Price Increase Rivals Match Price Decrease Q0Q0 Competitor and Rivals Strategize Versus Each Other Consumers Effectively Have 2 Partial Demand Curves and Each Part Has Its Own Marginal Revenue Part MR 2 D2D2 D1D1 MR 1 Q0Q0 MC 1 MC 2 P0P0 Resulting in a Kinked-Demand Curve to the Consumer – Price and Output Are Optimized at the Kink e f g

Copyright 2011 The McGraw-Hill Companies 8-17 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Kinked-Demand Curve Noncollusive Oligopoly Criticisms of the Model –Doesn’t Explain How Price Gets to the Kink (P 0 ) –Oligopoly Prices Are Not As Rigid During Instability as the Model Indicates –Possibility of Price Wars

Copyright 2011 The McGraw-Hill Companies 8-18 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price and Costs Quantity Cartels and Other Collusion Price and Output –Collusion and Tendency Toward Joint-Profit Maximization D MR=MC ATC MC MR P0P0 A0A0 Q0Q0 Economic Profit Effectively Sharing The Monopoly Profit

Copyright 2011 The McGraw-Hill Companies 8-19 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Cartels and Other Collusion Overt Collusion –Cartels –The OPEC Cartel GLOBAL PERSPECTIVE The 11 OPEC Nations Daily Oil Production, May 2006 Saudi Arabia Iran Venezuela UAE Nigeria Kuwait Iraq Libya Indonesia Algeria Qatar Source: OPEC Country Barrels of Oil 9,099,000 4,110,000 3,83,000 2,444,000 2,306,000 2,247,000 1,903,000 1,500,000 1,451, , ,000

Copyright 2011 The McGraw-Hill Companies 8-20 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Cartels and Other Collusion Covert Collusion –Tacit Understandings Obstacles to Collusion –Demand and Cost Differences –Number of Firms –Cheating –Recession –Potential Entry –Legal Obstacles:

Copyright 2011 The McGraw-Hill Companies 8-21 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Price Leadership Model Leadership Tactics Infrequent Price Changes Communications Limit Pricing Breakdowns in Price Leadership: –Price Wars

Copyright 2011 The McGraw-Hill Companies 8-22 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Oligopoly and Advertising Advertising Prevalent in Monopolistic Competition and Oligopoly Positive Effects of Advertising Potential Negative Effects of Advertising

Copyright 2011 The McGraw-Hill Companies 8-23 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Oligopoly and Advertising World’s Top 10 Brand Names GLOBAL PERSPECTIVE Source: Interbrand Coca-Cola Microsoft IBM General Electric Intel Nokia Toyota Disney McDonalds Mercedes-Benz

Copyright 2011 The McGraw-Hill Companies 8-24 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Oligopoly and Efficiency Productive and Allocative Efficiency P = MC = Minimum ATC – Neither Exists Tendency to Share the Monopoly Profit Qualifications –Increased Foreign Competition –Limit Pricing –Technological Advance

Copyright 2011 The McGraw-Hill Companies 8-25 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Oligopoly in the Banking Industry Four big ones Market share –92% of Mortgage Loans –89% of bank financed installment sales Supply Side Changes –High levels of entry R250 million start up capital Licence granting by Registrar of banks Consolidation of Firms into Oligopoly Last Word

Copyright 2011 The McGraw-Hill Companies 8-26 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Key Terms monopolistic competitionmonopolistic competition product differentiationproduct differentiation nonprice competitionnonprice competition excess capacity oligopoly homogeneous oligopolyhomogeneous oligopoly differentiated oligopolydifferentiated oligopoly strategic behavior mutual interdependencemutual interdependence game-theory model collusion kinked-demand curvekinked-demand curve price war cartel tacit understandingstacit understandings price leadership

Copyright 2011 The McGraw-Hill Companies 8-27 Monopolistic Competition Monopolistic Competition and Efficiency Oligopoly Game Theory Three Oligopoly Models Kinked Demand Curve Cartels and Other Collusion Price Leadership Model Oligopoly and Efficiency Last Word Key Terms End Show Next Chapter Preview… Labour and Money