1. 1/20/20161 Managerial Economics Eighth Edition Truett + Truett Chapter 9: Monopolistic Competition, Oligopoly, and Related Topics Slides by Jim Witsmeer John Wiley & Sons, Inc.

2. 1/20/20162 Introduction Should a monopoly advertise? Should a supplier in perfect competition advertise? Does either firm have to compete for market share? What is product differentiation is it real or perceived?

3. 1/20/20163 Definitions Oligopoly is a market with a few sellers of the same product actively competing for market share. Monopolistic competition is a market with many firms selling similar products with some differentiation. The difference relates to how much rivalry there is among firms.

4. 1/20/20164 Topics of Discussion Monopolistic Competition Oligopoly  Duopoly  Barriers to Entry  Price Rigidity Without Collusion  Price Leadership  Efficient firm  Dominant firm  Perfect Collusion: Cartels

5. 1/20/20165 Market Share Curve Market share curve ( M a ) is firm’s demand curve when all firms change price. DiDi MaMa MR i Equilibrium Point Firms operate at intersection of its demand and market share curves. In short run it may be possible for firm to move along D i, but eventually, similar conditions will result in similar prices for all firms.

6. 1/20/20166 Monopolistic Competition in the Short Run SMC d MR M Firm’s Short-Run Equilibrium Firm must adjust estimate of d so it intersects M where SMC=MR. If where d intersects M, firm’s SMC is not equal to MR, firm will have to make further adjustments (re- estimate d or, perhaps, make some changes in product differentiation to move M ).

7. 1/20/20167 Monopolistic Competition in the Long Run Long-Run Equilibrium of the Firm Free entry assures the firm’s economic profit will only be normal over the long run.

8. 1/20/20168 Duopoly: An Oligopoly with only two competitors Several economic theories have attempted to define the optimum strategy in a duopolistic competition (price war). Most scenarios in the long-run result in both competitors losing and one or both going out of business. In this situation a strategy of collusion or cooperative pricing for mutual benefit is optimal.

9. 1/20/20169 Barriers to Market Entry Entry-limit pricing Excess capacity and economies of scale Capital requirements Product differentiation or brand recognition Criminal intimidation Government controls Sales and distribution networks

10. 1/20/201610 Price Rigidity Without Collusion The kinked demand curve occurs when the competing firms follow a price decrease but not an increase. The kink is the equilibrium point. Firms with differing costs (profits) will operate at the same quantity/price.

11. 1/20/201611 Rising Prices with a kinked demand curve If costs rise to the extent shown here ( MC 2 ), then the firm must raise price to P2 To maximize profits and wait for the rest of the firms to follow which will move the kink to F and rotate the demand and MR curves adjusting the maximum profit and increasing sales to F.

12. 1/20/201612 Sample Problem Initial Equilibrium TR =Q  P=10  1000= $10,000  Maximum Profit TR = Q  P = 11  800 = $8,800 TC=1500+3  800+.0025  800 2 T  = $8,800-$5,500 = $3,300 T  = $10,000-$7,000 = $3,000

13. 1/20/201613 Tacit Collusion An informal type of coordination among firms. Formal Collusive agreements are illegal, although U. S. firms have been permitted to agree on export pricing. Firms may get away with informal collusion, but they could be prosecuted under antitrust laws.

14. 1/20/201614 Price Leadership Efficient Firm When the lead firm changes price others will follow shortly. Firm b has maximum profit at P b but must adjust to P a to sustain market share.

15. 1/20/201615 Price Leadership Dominant Firm The dominant share of the market is so large that competitors must accept the set market price as in perfect competition. The demand curve for the dominant firm is obtained by subtracting the quantity supplied by small firms from the total market quantity demanded. The dominant firm selects P e, which is the MR curve for small firms, who supply Q S ’. Dominant FirmEntire Market S s =  MC s

16. 1/20/201616 Entire MarketS DMDM Dominant Firm DLDL MR L MC L Sample Problem If small firm supply is: Q S =0.9 P +150 and market demand is: Q M =1403-2.6 P than demand for the dominant firm is Q L = Q M -Q S or Q L = 1253-3.5 P QLQL QLQL QSQS QMQM We can find TR = Q*P and MR = dTR/dQ. The MC is estimated to be constant at $260 so that the maximum profit for the dominant firm at MC=MR is at the point indicated and divides the market into 171.5 units for the dominant firm and 428 units for the small firms collectively.

17. 1/20/201617 The Cartel: Perfect Collusion To maximize profit, cartel managers must allocate production based on the rule of marginal cost, which dictates that MR = MC A = MC B = …= MC n for all participants. This is the ideal and is sometimes modified in the short run to maintain unity.

18. 1/20/201618 Sample Problem A three member cartel estimates the market demand function for its product to be Q c = 1660 – 200P c. The three members have marginal cost functions as follows: MC i =.25 +.000125Q i, MC s =. 60 +.0002Q s and MC u =.15 +.00015Q u. The sum of these equals the marginal cost function: MC c = 0.305 +.000508Q c. The cartel marginal revenue is: MR c = dTR/dQ = 8.3 -.001Q. Setting MR=MC and solving for Q c gives us a quantity of 5300 units and MR = 3.0. Substituting this value into the cartel demand equation yields a price of $5.65. This divides among the cartel by setting all of their marginal costs equal to 3.0 and solving for their respective quantity allocations.

19. 1/20/201619 MR u PcPc SMC u SAC u UWAQ MR s SMC s SAC s SHERAN PcPc PcPc MR i SMC i SAC i IRUN DcDc MR c MC c CARTEL Cartel Problem (graphically) Allocations are made to the members in accordance with the rule of marginal cost. The lower cost producers receive the largest allocation and the largest profit. PcPc QcQc QsQs PROFIT QiQi QuQu

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