1. Chapter 10 Monopolistic Competition and Oligopoly
Lecture Slides
Economics for Today Irvin B. Tucker
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2. What will I learn in this chapter?
The theories of price and output decisions in the real-world markets of monopolistic competition and oligopoly
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3. What is monopolistic competition?
A market structure characterized by:
1. many small sellers
2. differentiated product
3. easy entry and exit
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4. What are examples of monopolistic competition?
grocery stores
hair salons
gas stations
video rental stores
restaurants
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5. How many is many small sellers?
The many sellers condition is met when each firm is so small relative to the total market that its pricing decisions have a negligible effect on the market price
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6. What is product differentiation?
The process of creating real or apparent differences between goods and services
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7. What does easy entry and easy exit mean?
There are low barriers to entry, but entry is not quite as easy as in a perfectly competitive market because monopolistically competitive firms sell differentiated products.
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8. What is a barrier to entry in monopolistic competition?
Firms can differentiate themselves from their competitors in ways other than price (nonprice competition).
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9. What is nonprice competition?
A firm competes using reputation, location, advertising, packaging, product development, and better service rather than lower prices
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10. Why is a monopolistic competitive firm a price maker?
Product differentiation gives the firm some control over its price
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11. © 2011 South-Western, a part of Cengage Learning
How does the elasticity of demand curve for a monopolistically competitive firm compare to a perfectly competitive firm and a monopolist?
It is less elastic (steeper) than for a perfectly competitive firm and more elastic (flatter) than for a monopolist
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12. What effect does advertising have on average costs?
It raises the long-run average cost curve
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13. Exhibit 1 The Effect of Advertising on Average Cost
4.00
3.50 C
3.00
2.50
Cost per unit (dollars)
With advertising
2.00 A
LRAC2 B
1.50
1.00
LRAC1
0.50
Without advertising 2 4 6 8 10 12 14 16 18 20 22
Quantity of frozen yogurt (thousands of dishes units per month) 13
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14. © 2011 South-Western, a part of Cengage Learning
How does a firm decide what price to charge and how many units to produce?
MR = MC
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15. Exhibit 2 A Monopolistically Competitive Firm in Short Run40 MC 35
ATC 30 25
Price, Costs, and Revenue (dollars) 18
Profit=$1,800 15 D 10 5
MR=MC MR 6
Quantity of Seafood Meals (hundreds per week) 15
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16. © 2011 South-Western, a part of Cengage Learning
What happens in the long run when economic profits are being made in the short run?
With easy entry, firms will enter the industry, and the demand curve for each firm shifts leftward because each firm’s market share declines.
The market price declines, and economic profits are eliminated.
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17. What happens to a firm’s costs in the long run?
In addition to decreased demand from new entrants sharing the market, the cost curve for firms increases from increasing advertising and other expenses to compete against the new competition.
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18. Zero economic profit New firms enter
Firm’s LRAC curve increases
Firm increases advertising expenses
Firm’s demand curve decreases
New firms enter
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19. Exhibit 3 Monopolistic Competition Firm in the Long Run40 MC 35 30
LRAC
Minimum LRAC 25
Price, Costs, and Revenue (dollars) 20 17 15 D
MR=MC 10 5 MR 1 2 3 4 5 6 7 8 9
Quantity of Seafood Meals (hundreds per week) 19
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20. © 2011 South-Western, a part of Cengage Learning
How does monopolistic competition compare to perfect competition in the long run?
Price is lower and quantity is greater in perfect competition compared to monopolistic competition
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21. © 2011 South-Western, a part of Cengage Learning
Why is price higher and quantity lower in monopolistic competition compared to perfect competition?
Because firms in monopolistic competition face a downward sloping demand curve and a MR curve beneath it which is more steeply sloped
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22. How efficient is monopolistic competition?
Less resources are used and a higher price is charged than would be the case under perfect competition
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23. © 2011 South-Western, a part of Cengage Learning
Exhibit 4 A Comparison of Monopolistic Competition and Perfect Competition in the Long Run 23
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24. © 2011 South-Western, a part of Cengage Learning
What is oligopoly?
A market structure characterized by:
1. Few sellers
2. Homogeneous or differentiated product
3. Difficult entry
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25. How few are a few sellers?
When the firms are so large relative to the total market that they can affect the market price
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26. What is mutual interdependence?
A condition of oligopoly in which an action by one firm may cause a reaction from other firms
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27. © 2011 South-Western, a part of Cengage Learning
What are examples of homogeneous and differentiated product oligopolies?
Homogeneous or standardized product industries include steel, oil, and aluminum
Differentiated product industries include automobile, detergents, and breakfast cereals
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28. What are some examples of difficult entry?
Similar to monopoly, formidable barriers to entry exist
Examples include financial requirements, control over an essential resource, patents, and economies of scale
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29. What are different possible oligopoly models?
Nonprice competition
Kinked demand curve
Price leadership
Cartel
Game theory
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30. What is nonprice competition?
Because of a differentiated product, there is competition in ways other than price, such as developing new products and advertising
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31. What does a kinked demand curve show?
It shows that rivals will match a firm’s price decrease, but ignore a price increase
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32. D D Exhibit 5 The Kinked Demand Curve X Y 1 1.5 2 4
30,000
Rivals ignore price increases D
27,250
25,000 Y
Price per automobile (dollars)
20,000
Rivals match price decreases
15,000 D 1
1.5 2 3
3.2 4
Quantity of automobiles (millions per year)
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33. © 2011 South-Western, a part of Cengage Learning
The Tucker
The Tucker was an advanced car briefly produced in 1948.
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34. What is price leadership?
A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow
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35. © 2011 South-Western, a part of Cengage Learning
What is a cartel?
A group of firms formally agreeing to control the price and output of a product
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36. What are examples of cartels?
Organization of Petroleum Exporting Countries (OPEC)
International Telephone Cartel (ITU)
International Airline Cartel (IATA)
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37. What is formal collusion?
A group of firms openly agree to control the price and output of a product
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38. Is formal collusion legal?
No, it is against the law in the U.S. for firms to come together and agree on the price or output for products. But this is not true outside the U.S.
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39. What is informal collusion?
Companies find alternative ways to agree on a price without any tacit communication. For example, firms follow established rules of an industry.
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40. What is the major weakness of a cartel?
As long as the benefits exceed the costs, cheating can threaten formal or informal agreements among oligopolists to maximize joint profits
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41. Price per barrel (dollars)
Exhibit 6 Why Cartel Members May Cheat
165 MC
LRAC
150
135
Price per barrel (dollars)
120
MR2
Profit without cheating=$80 million
Extra profit from cheating=$80 million
105 90 75
MR1 60 45 30 15 4
Quantity of Oil (millions of barrels per day) 41
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42. © 2011 South-Western, a part of Cengage Learning
What is game theory?
A model of the strategic moves and countermoves of rivals
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43. What are two pricing methods in game theory?
Tit for tat
Price leadership
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44. © 2011 South-Western, a part of Cengage Learning
What is tit-for-tat?
Under this informal approach, a player will do whatever the other player did the last time
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45. What is game theory price leadership?
Another informal approach is to play “follow the leader” in which firms set whatever price the leader sets
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46. What if cartels were legal?
Another approach would be for firms to make a formal agreement
To avoid cheating, rivals could agree on a penalty for cheaters
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47. Exhibit 7 A Two-Firm Payoff Matrix47
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48. What conclusion can be drawn from oligopolies?
The price charged for the product will be higher than under perfect competition
More money is spent on forms of nonprice competition
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49. © 2011 South-Western, a part of Cengage Learning
Exhibit 8
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50. END