Chapter 13 Monopolistic Competition and Oligopoly Monopolistic competition.

Chapter 13 Monopolistic Competition and Oligopoly  Monopolistic competition.

Chapter 13 Monopolistic Competition and Oligopoly Monopolistic competition. Output and price determination in SR and LR. Explain why advertising costs are high in a monopolistically competitive industry Oligopoly

Definition. Price and output determination game theory Cartels Anti-trust laws and regulation of markets Monopolistic Competition Characteristics of Monopolistic competition Large number of firms. limited market power (demand relatively elastic). Independent decision making Collusion impossible

Each firm produces a differentiated product. compete on product quality, price, and marketing. Firms are free to enter and exit the industry. Economic profits driven to zero in long run Monopolistic Competition Market Share in Monopolistic Competition Red=4 largest.

Green=5-8 Blue=9-20 Output and Price in Monopolistic Competition The Firms Short-Run Output and Price Decision Holding quality and marketing constant, profit maximization is achieved by choosing the price/quantity where MR = MC

SR Output and Price in Monopolistic Competition Use diagram to identify: profit maximizing P & Q Profit Socially efficient Q Deadweight loss Output and Price in Monopolistic Competition Long Run: Zero Economic Profit

In the long run, economic profit (loss) induces entry (exit). Entry (exit) causes demand curve for existing firms to shift downward (upward). Entry continues as long as firms in the industry earn an economic profitas long as (P > ATC). SR Output and Price in Monopolistic Competition Given the short run equilibrium described, why does entry occur?

As entry occurs, demand shifts leftward until profit equals zero. Output and Price in Monopolistic Competition LR equilibrium for monopolistically competitive firm.

economic profits Excess capacity socially efficient output deadweight loss Effect of elasticity on price mark-up (P vs MC) excess capacity Output and Price in Monopolistic Competition Contrast to LR

equilibrium for firms in perfect competition: Economic profits? Excess capacity? Socially efficient?

Deadweight loss? Source of difference: product differentiation. Product Development and Marketing Innovation and Product Development To keep earning an economic profit, a firm in monopolistic competition must be in a state of continuous product development. New product development allows a firm to gain a competitive edge, if only temporarily, before

competitors imitate the innovation. Product Development and Marketing Advertising Firms in monopolistic competition incur heavy advertising expenditures. Why? How can advertising be profitable? Changes in product

demand versus changes in ATC. Product Development and Marketing Advertising could increase product demand and also make it more elastic. Profits could rise or fall. If product demand becomes more elastic, (PMC) markup could fall. Product Development and Marketing

Advertising expenditure shifts the average total cost curve upward, but may increase profit maximizing sales allowing firm to take advantage of scale economies. What is Oligopoly? The distinguishing features of oligopoly are: Natural or legal barriers that prevent entry of new firms

A small number of firms compete causing interdependent decision making. What is Oligopoly? Barriers to Entry Either natural or legal barriers to entry can create oligopoly. With demand as drawn, there is a natural duopolya

market with two firms. How would answer change if demand increases? What is Oligopoly? Small Number of Firms With a small number of firms, each firms profit depends on every firms actions. Firms are interdependent and face a temptation to collude.

Cartel: group of firms acting together to limit output, raise price, and increase profit. Can be illegal. Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break down. What is Oligopoly? Examples of Oligopoly

An HHI that exceeds 1800 is generally regarded as an oligopoly by Department of Justice. An HHI below 1800 is generally regarded as monopolistic competition. Recall earlier caveats on HHI (e.g. geographic boundaries, entry barriers) Two Traditional Oligopoly Models

The Kinked Demand Curve Model. SKIP IT. Dominant Firm Oligopoly SKIP IT. Oligopoly Games Game theory a tool for studying strategic behavior, which is behavior that takes into account the expected behavior of others and the mutual recognition of interdependence. Oligopoly Games The Prisoners Dilemma

Each prisoner is told that both are suspected of committing a more serious crime. If one of them confesses, he gets a 1-year sentence for cooperating while his accomplice gets a 10-year sentence for both crimes. If both confess to the more serious crime, each receives 3 years in jail for both crimes. If neither confesses, each receives a 2-year sentence for the minor crime only. Oligopoly Games Nash equilibrium

first proposed by John Nash if a player makes a rational choice in pursuit of his own best interest, he chooses the action that is best for him, given any action taken by the other player. Whats the Nash Equilibrium? Whats the cooperative equilibrium? Oligopoly Games

An Oligopoly Price-Fixing Game: Cartels. MC S ATC 4.00 3.25 3 AVC

2 1 D MR 400 500 600 pounds per year 800

8 10 12 1000s of pounds per year Oligopoly Games

Based on above diagram: What is competitive price, firm output, industry output, profit? What is cartel (collusive agreement) price, output, profit? What is deadweight loss? Effect on consumer? Effect on producers? What is incentive to cheat? How is this like prisoners dilemma? How do each of following affect ability to enforce cartel? Entry restrictions. Ability to monitor each other.

Oligopoly Games Other Oligopoly Games Advertising and R & D games are prisoners dilemmas. An R & D Game Procter & Gamble and Kimberley Clark play an R & D game in the market for disposable diapers. Oligopoly Games Here is the payoff matrix for the Pampers Versus Huggies game.

Whats the Nash Equilibrium? Whats the collusive (cooperative) equilibrium? Anti-trust policy Measuring concentration.

DOJ formed merger guidelines in early 1980s. if post-merger HHI<1000==>industry competitive. if 1000merger scrutinized (gray area). if HHI>1800==> merger likely to be challenged (red zone). Difficulties in using concentration measures as indicators of competition for mergers. geographic scope of market product boundaries firms produce multiple products. Anti-trust policy

Likelihood of collusion and DOJ anti-trust policy. When HHI is in a questionable area, other factors are considered. Barriers to entry Ability to monitor each others behavior. Is the game repeated? Anti-trust policy Theories of regulation. Public interest theory political process generates regulations designed to

achieve socially efficient outcome. Capture theory regulations are designed to satisfy the demand of producers to maximize producer surplus. benefit producers (concentrated group) at expense of consumers (disperse group). Anti-trust policy Evidence on Deregulation of 1980s. AIRLINES prices fell and volume increased. consumer surplus increased $11.8 billion

producer surplus increased $4.9 billion. rapid change in structure of airline industry (hubs, excess capacity reduced, pricing changes, etc.) TRUCKING consumer surplus increased $15.4 billion producer surplus decreased $4.8 billion. truck drivers wages fell. Anti-trust policy Anti-trust policy. The Standard Oil Story: John D. Rockefeller owned standard oil.

Able to extract discounts from the railroads for shipping During the 1870s, Standard Oil increased its capacity from 10 to 90 percent of the U.S. total. In 1882, the independent members of standard oil contributed shares to a central trust Allowed a central body to manage all firms. The central body shut down some refineries, restricted production, and drove up oil prices. Anti-trust policy 1890: Sherman Act

passed partly in response to the monopolization of the oil industry. Law prohibited combination, trust, or conspiracy to restrict interstate or international trade. Sherman Act used in 1911 to break up Standard Oil (created Exxon, Sohio, Chevron, etc.) Anti-trust policy 1914: Clayton Act. prohibited interlocking directorates & tying

contracts 1914: Federal Trade Commission Act created FTC to prosecute unfair competition outlawed misleading advertising. Anti-trust policy 1936: Robinson-Patman Act (Chain store law) made quantity discounts illegal prevented stores from selling to public at unreasonably low prices. 1937: Miller-Tydings Act

allowed Resale Price Maintenace if state approved. arguments against RPM (cartel enforcement) argument for RPM (high quality service) McTravel Apple computer

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