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Monopolistic Competition and Oligopoly

9. Monopolistic Competition and Oligopoly. Monopolistic Competition. Relatively large number of sellers Differentiated products Easy entry and exit Advertising. LO1. Price and Output in Monopolistic Competition. Demand is highly elastic Short-run profit or loss Produce where MR = MC

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Monopolistic Competition and Oligopoly

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  1. 9 Monopolistic Competition and Oligopoly

  2. Monopolistic Competition • Relatively large number of sellers • Differentiated products • Easy entry and exit • Advertising LO1

  3. Price and Output in Monopolistic Competition • Demand is highly elastic • Short-run profit or loss • Produce where MR = MC • Long-run normal profit • Entry and exit • Inefficient • Product variety LO2

  4. The Short Run: Profit or Loss ATC MC P1 A1 Price and Costs Economic Profit D1 MR = MC MR 0 Q1 Quantity LO2

  5. The Short Run: Profit or Loss ATC MC A2 P2 Loss Price and Costs D2 MR = MC MR 0 Q2 Quantity LO2

  6. The Long Run: Only a Normal Profit MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity LO2

  7. Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO2

  8. Monopolistic Competition: Efficiency MC ATC P3= A3 Price and Costs D3 MR = MC MR 0 Q3 Quantity P = MC = min ATC for pure competition (recall) P4 Price is lower Excess capacity at minimum ATC Q4 Monopolistic competition is not efficient LO2

  9. Product Variety • The firm constantly manages price, 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 LO2

  10. Oligopoly • A few large producers • Homogeneous or differentiated products • Limited control over price • Mutual interdependence • Strategic behavior • Entry barriers • Mergers LO3

  11. Game Theory Overview • Oligopolies display strategic pricing behavior • Mutual interdependence • Collusion • Incentive to cheat • Prisoner’s dilemma LO4

  12. Game Theory Overview RareAir’s Price Strategy • 2 competitors • 2 price strategies • Each strategy has a payoff matrix • Greatest combined • profit • Independent actions stimulate a response High Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8 LO4

  13. Game Theory Overview RareAir’s Price Strategy • Independently lowered prices in expectation of greater profit leads to worst combined outcome • Eventually low outcomes make firms return to higher prices High Low A B $12 $15 High $12 $6 Uptown’s Price Strategy C D $6 $8 Low $15 $8 LO4

  14. Kinked-Demand Theory • Noncollusive oligopoly • Uncertainty about rivals’ reactions • Rivals match any price change • Rivals ignore any price change • Assume combined strategy • Match price reductions • Ignore price increases LO5

  15. Kinked-Demand Curve MC1 D2 e MR2 MC2 P0 f g D1 Q0 MR1 LO5

  16. Kinked-Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6

  17. Price Leadership Model • Price leadership • Dominant firm initiates price changes • Other firms follow the leader • Use limit pricing to block entry of new firms • Possible price war LO6

  18. Collusion • Cartel • Overt collusion • Covert collusion • Joint-profit maximization LO6

  19. Collusion Price and Costs Quantity MC P0 ATC A0 MR=MC Economic profit D MR Q0 LO6

  20. Overt Collusion • Cartels: a group of firms or nations that collude • Formally agree to the price • Set output levels for members • Collusion is illegal in the United States • OPEC LO6

  21. Obstacles to Collusion • Demand and cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles LO6

  22. Oligopoly and Advertising • Prevalent to compete with product development and advertising • Less easily duplicated than a price change • Financially able to advertise LO7

  23. Positive Effects of Advertising • Low-cost way of providing information to consumers • Enhances competition • Speeds up technological progress • Can help firms obtain economies of scale LO7

  24. Oligopoly and Advertising Source: Advertising Age, www.adage.com LO7

  25. Negative Effects of Advertising • Can be manipulative • Contains misleading claims that confuse consumers • Consumers pay high prices for a good while forgoing a better, lower-priced, unadvertised version of the product LO7

  26. Global Snapshot LO7

  27. Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > min ATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7

  28. Oligopoly in the Beer Industry • The beer industry is now an oligopoly • Changes in demand • Change in tastes • Consumed at home and mass produced • Changes in supply • Technological advance • Economies of scale LO2

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