macroeconomic mcgrowhill micro ch 11 19e use this one

11
Monopolistic Competition
and Oligopoly

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Objectives

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Key Terms

End Show
11-2

• 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 2008 The McGraw-Hill Companies


Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand

Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Key Terms

FOUR MARKET MODELS
Monopolistic Competition:

• Relatively Large
Number of Sellers
• Differentiated Products
• Easy Entry and Exit
Pure
Competition

Monopolistic
Competition

Oligopoly

Pure
Monopoly

Market Structure Continuum

End Show
11-3

Copyright 2008 The McGraw-Hill Companies


Monopolistically Competitive

• Industry concentration
• Measured by:
• Four-firm concentration ratios
• Percentage of 4 largest firms
4-Firm CR =

Output of four largest firms
Total output in the industry

• Herfindahl index
• Sum of squared market shares

HI = (%S1)2 + (%S2)2 + (%S3)2 + …. +
(%Sn)2
LO1

11-4


Low Concentration Industries
(1)

Industry

(2)
4-Firm
Concentration
Ratio

(3)
Herfindahl
Index

(1)
Industry

(2)
4-Firm
Concentration
Ratio

(3)
Herfindahl
Index

14

114

Asphalt paving

25

207

Metal windows and
doors

Plastic pipe

24

262

Women’s dresses

13

84

Textile bags

24

263

Ready mix concrete

11

63

Bolts, nuts, and
rivets

24

205

Wood trusses

10

50

Plastic bags

23

240

Stone products

10

59

Quick printing

22

319

Metal stamping

8

31

Textile machinery

20

206

Wood pallets

7

24

Sawmills

18

117

Sheet metal work

6

25

Jewelry

16

117

Signs

5

19

Curtains and
draperies

16

111

Retail bakeries

4

7

LO1

11-5

Monopolistic Competition
Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

• Easy Entry and Exit
• Advertising
–Nonprice Competition

• Monopolistically
Competitive Industries

Key Terms
End Show

11-6

Copyright 2008 The McGraw-Hill Companies

O 11.1


Monopolistic Competition
Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Key Terms
End Show
11-7

• Characteristics

– Small Market Shares
– No Collusion
– Independent Action

• Differentiated Products

– Product Attributes
– Service
– Location
– Brand Names and
Packaging
– Some Control Over Price

Copyright 2008 The McGraw-Hill Companies

O 11.1


Price and Output Determination
In Monopolistic Competition

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly

Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

• The Firm’s Demand
Curve – highly elastic
• The Short Run:
–Profit or Loss

• The Long Run:

–Only a Normal Profit
–Profits: Firms Enter
–Losses: Firm’s Leave
• Complications

Key Terms

–Product Variety

End Show

11-8

Copyright 2008 The McGraw-Hill Companies

G 11.1


Price and Output Determination
In Monopolistic Competition
Short-Run Profits
MC

Price and Costs

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E

fficiency
Last Word

ATC

P1
A1

Economic
Profit

D1
MR = MC

MR
Key Terms

0

Q1

Quantity

End Show
11-9

Copyright 2008 The McGraw-Hill Companies


Price and Output Determination

In Monopolistic Competition
Short-Run Losses
MC

Price and Costs

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

ATC

A2
P2

Loss
D2
MR = MC

MR
Key Terms

0

Q2

Quantity

End Show
11-10

Copyright 2008 The McGraw-Hill Companies


Price and Output Determination
In Monopolistic Competition
Long-Run Equilibrium
MC
ATC

Price and Costs

Monopolistic C
ompetition
Monopolistic Co

mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

P3=
A3
D3
MR = MC

MR
Key Terms

0

Q3

Quantity

End Show
11-11

Copyright 2008 The McGraw-Hill Companies


Monopolistic Competition
and Efficiency
Recall: P=MC=Minimum ATC
MC

Price and Costs

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency

Last Word

ATC
P3=
A3
P4

Price is Higher
D3
MR = MC

Excess Capacity at
Minimum ATC
0

Key Terms

MR
Q3

Q4

Quantity

Monopolistic Competition is Not Efficient

End Show
11-12

Copyright 2008 The McGraw-Hill Companies

Product Variety

• The firm constantly manages price,

•

LO2

product, and advertising.
• Better product differentiation
• Better advertising
The consumer benefits by greater array of
choices and better products.
• Types and Styles
• Brands and Quality

11-13


Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models

Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

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

Competition

Oligopoly

Pure
Monopoly

Key Terms

Market Structure Continuum

End Show
11-14

Copyright 2008 The McGraw-Hill Companies


Oligopoly

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

• Characteristics

– A Few Large Producers
– Homogeneous or
Differentiated Products
• Homogeneous Oligopoly
• Differentiated Oligopoly

– Control Over Price, But
Mutual Interdependence
• Strategic Behavior

Key Terms
End Show
11-15

– Entry Barriers
– Mergers
Copyright 2008 The McGraw-Hill Companies


Oligopolistic Industries

• Four-firm concentration ratio
• 40% or more to be oligopoly
• Shortcomings
• Localized markets
• Inter-industry competition
• World price

• Dominant firms
LO3

11-16


High Concentration Industries
(1)
Industry
Primary copper

4-Firm
Concentration
Ratio

(2)

(3)
Herfindahl
Index

99

ND

(1)
Industry

4-Firm
Concentration

Ratio

(2)

(3)
Herfindahl
Index

Petrochemicals

85

2662

83

1901

Cane sugar refining

99

ND

Small arms
ammunition

Cigarettes

95

ND

Motor vehicles

81

2321

80

2515

Household laundry
equipment

93

ND

Men’s slacks and
jeans

Beer

91

ND

Aircraft

81

ND

Electric light bulbs

89

2582

Breakfast cereals

78

2521

78

2096

Glass containers

88

2582

Household vacuum
cleaners

Turbines and
generators

88

ND

Phosphate fertilizers

78

1853

Tires

77

1807

Electronic
computers

76

Alcohol distilleries

71

Household
refrigerators and

freezers

85

1986

Primary aluminum

85

ND

LO1

2662
1609
11-17


Measures of Concentration
Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand

Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

• Concentration Ratio
• Localized Markets
• Interindustry
Competition
• World Trade
–Import Competition

• Herfindahl Index

Key Terms

W 11.1

(%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2

End Show
11-18

Copyright 2008 The McGraw-Hill Companies

Game Theory

Key Terms

RareAir’s Price Strategy

• 2 Competitors
• 2 Price
Strategies
• Each Strategy
Has a Payoff
Matrix
• Greatest
Combined
Profit
• Independent
Actions
Stimulate a
Response

High

Uptown’s Price Strategy

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly

Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Game Theory Model to Analyze
Behavior
A

$12

Low
B

$15

High
$12

C

$6

$6

D

$8

Low
$15

$8

End Show

O 11.2
11-19

Copyright 2008 The McGraw-Hill Companies


Game Theory

Key Terms

RareAir’s Price Strategy

• Independently
Lowered Prices
in Expectation
of Greater

Profit Leads to
the Worst
Combined
Outcome
• Eventually Low
Outcomes
Make Firms
Return to
Higher Prices

High

Uptown’s Price Strategy

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E

fficiency
Last Word

Game Theory Model to Analyze
Behavior
A

$12

Low
B

$15

High
$12

C

$6

$6

D

$8

Low
$15

$8

End Show

O 11.2
11-20

Copyright 2008 The McGraw-Hill Companies


Game Theory
Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

•Role of Mutual
Interdependence
•Collusive Tendencies
– Collusion

•Incentive to Cheat

Key Terms
End Show
11-21

Copyright 2008 The McGraw-Hill Companies

G 11.2


Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh

ip Model
Oligopoly and E
fficiency
Last Word

Key Terms
End Show
11-22

Three Oligopoly Models
• Kinked Demand Curve
• Collusive Pricing
• Price Leadership
• Diversity of
Oligopolies
• Complications of
Interdependence
Copyright 2008 The McGraw-Hill Companies


Kinked-Demand Curve

Noncollusive Oligopoly
Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory

Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Key Terms

• Strategies
–Match Price Changes
–Ignore Price Changes

• A Combined Strategy
• Price Inflexibility
• The Kinked-Demand
Curve
Graphically…

End Show
11-23

Copyright 2008 The McGraw-Hill Companies

Kinked-Demand Curve

Noncollusive Oligopoly

Rivals Ignore
Price Increase
P0

e
f

D2

Rivals Match g
Price Decrease
0

Q0

MR1
Quantity

MR2

Price and Costs

Competitor and Rivals Strategize Versus Each Other
Consumers Effectively Have 2 Partial Demand Curves
and Each Part Has Its Own Marginal Revenue Part

Price

Monopolistic C
ompetition
Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

MC1

D2
P0

MR2

e
f

MC2

g

D1

D1
0

Q0
MR1
Quantity

Resulting in a Kinked-Demand Curve
to the Consumer – Price and Output
Are Optimized at the Kink

Key Terms
End Show
11-24

Copyright 2008 The McGraw-Hill Companies


Kinked-Demand Curve

Noncollusive Oligopoly
Monopolistic C
ompetition

Monopolistic Co
mpetition and E
fficiency
Oligopoly
Game Theory
Three Oligopol
y Models
Kinked Demand
Curve
Cartels and Oth
er Collusion
Price Leadersh
ip Model
Oligopoly and E
fficiency
Last Word

Key Terms
End Show
11-25

• Criticisms of the Model

–Doesn’t Explain How
Price Gets to the Kink
(P0)
–Oligopoly Prices Are Not
As Rigid During
Instability as the Model
Indicates

–Possibility of Price Wars

Copyright 2008 The McGraw-Hill Companies