1. Chapter Eleven Product Differentiation, Monopolistic Competition, and Oligopoly

2. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 2 Product Differentiation, Monopolistic Competition, Oligopoly Monopolistic Competition: A market structure characterized by many firms selling differentiated products in an industry in which there is free entry and exit. Oligopoly: An industry characterized by few firms selling the same product with limited entry of other firms (Can still affect market price).

3. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 3 Figure 11.1: Four types of Industries

4. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 4 Product Differentiation Product Differentiation: The effort by firms to produce goods that are slightly different from other types of goods. –Ex: Cars, Soft Drinks, Shoes, Bottled Water –Homogenous products: Exactly the same product –In centrally planned economies, no product differentiation –Aspirin was a new invention, coating it was product differentiation –Can also apply to capital goods – Caterpillar differentiates based on service

5. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 5 Intraindustry Trade Intraindustry trade: Trade between countries in goods from the same of similar industries (because of product differentiation). Interindustry trade: Trade between countries in goods from different industries. Product differentiation leads to advertising and Consumer Information Services. –Can alter: Physical characterisitcs Location Time

6. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 6 Optimal Amount of Product Differentiation at a Firm Product Differentiation is expensive. –Firms will attempt to differentiate their products if the additional revenue from differentiation is greater than the additional costs.

7. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 7 Figure 11.2: A Firm's Decision about Production Differentiation

8. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 8 Figure 11.3: Monopolistic Competition

9. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 9 Long-Run Monopolistically Competitive Equilibrium Excess Costs: Costs of production that are higher than the minimum average total cost. Excess Capacity: A situation in which a firm produces below the level that gives the minimum average total cost.

10. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 10 Figure 11.4: Excess Costs per Unit and Excess Capacity with Monopolistic Competition

11. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 11 Comparing Monopoly, Competition, and Monopolistic Competition TypePrice Deadweight Loss? ATC Minimized? Profit in Long Run? Competition P = MCNoYesNo Monopolistic Competition P > MCYesNo MonopolyP > MCYesNoYes

12. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 12 Oligopoly Oligopoly – A few firms –Each firm can have an influence on market price, even if the goods are homogenous EX: Saudi Arabia & Oil Strategic Behavior: Firm behavior that takes into account market power and reactions of other firms in the industry Game Theory: A branch of applied mathematics with many uses in Economics, including the analysis of the interaction of firms that take each other’s actions into account

13. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 13 Game Theory Game theory makes same assumptions as basic economics –Players in a game try to maximize their payoffs Prisoner’s Dilemma: A game in which individual incentives lead to a noncooperative outcome. If the players can credibly commit to cooperate, then they can achieve the best outcome Payoff matrix: A table containing strategies and payoffs for two players in a game

14. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 14 Figure 11.5: A payoff Matrix for Two Prisoners Facing a Prisoner's Dilemma

15. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 15 Game Theory Cooperative Outcome: The equilibrium in a game where the players agree to cooperate (Do NOT Confess) Noncooperative Outcome: An equilibrium in a game where the players cannot agree to cooperate and instead follow their individual incentives. Nash Equilibrium: A set of strategies from which no player would like to deviate unilaterally –No player can make his payoff better without hurting someone else.

16. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 16 Figure 11.6: Payoff Matrix for Jack and Jill

17. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 17 Duopoly = 2 firms Cournot Competition: Competing for Quantity, price is determined by market demand Bertrand Competition: Competing for Price Explicit Collusion: Open cooperation of firms to make mutually beneficial pricing or production decisions Cartel: A group of producers in the same industry who coordinate pricing and production decisions. Tacit Collusion: Implicit or unstated cooperation of firms to make mutually beneficial pricing or production decisions. Price Leader: The price-setting firm in a collusive industry in which other firms follow the leader.

18. Copyright © by Houghton Mifflin Company, Inc. All rights reserved11 - 18 Figure 11.7: Comparison of Monopoly, Duopoly, and Competitive Equilibria