Monopolistic Competition & Oligopoly

1. Monopolistic Competition& Oligopoly

2. Pure Monopoly Pure Competition Monopolistic Competition Oligopoly Market Structure Continuum FOUR MARKET MODELS Monopolistic Competition:

3. CHARACTERISTICS • Large Number of Sellers • Small Market Shares • No Collusion • Independent Action • Easy Entry and Exit • Advertising

4. CHARACTERISTICS • Differentiated Products • Product Attributes • Service • Location • Brand Names and Packaging • Some Control Over Price • Demand for Product is Highly Elastic

5. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

6. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC New competition providesother goods in the marketso demand for your good falls. P1 A1 Price and Costs Short-Run Economic Profits D MR Q1 Quantity

7. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC ATC A2 P2 Short-Run Economic Losses Price and Costs D MR Q2 Quantity

8. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC ATC With economic losses, firms will exit the market. Fewer competitorsmeans your demand will increase. A2 P2 Short-Run Economic Losses Price and Costs D MR Q2 Quantity

9. PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Long-Run Equilibrium Normal Profit Only ATC P3 = A3 Price and Costs D MR Q3 Quantity

10. MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient • P Minimum ATC • Not Allocatively Efficient • P  MC • Excess Capacity Graphically…

11. Price is Not = Minimum ATC Price  MC MONOPOLISTIC COMPETITION AND EFFICIENCY MC Long-Run Equilibrium ATC P3 = A3 Price and Costs D MR Q3 Quantity

12. Pure Monopoly Pure Competition Monopolistic Competition Oligopoly Market Structure Continuum FOUR MARKET MODELS Oligopoly: • Control Over Price • Mutual Interdependence • Strategic Behavior • Entry Barriers • Economies of Scale • Control of Resources

13. OLIGOPOLIES AND MERGERS • Many Oligopolies Created by Mergers • Measures of Industry Concentration • 4 Firm Concentration Ratio • 50 to 80% • Half of US Industries • Herfindahl Index

14. OLIGOPOLIES AND MERGERS Herfindahl Index Sum of the squared percentage market shares for all firms in the industry. (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2 A greater Herfindahl Index indicates a greater concentration of market power in the industry.

15. CARTELS AND OTHER COLLUSION Oligopoly is conducive to collusion. If a few firms face similar demand and costs they will seek joint profit maximization as a monopoly. Graphically…

16. Economic Profit MC P0 Price and costs ATC A0 D MR = MC MR Q0 CARTELS AND OTHER COLLUSION Colluding Oligopolists Will Split the Monopoly Profits.

17. CARTELS AND OTHER COLLUSION • Overt Collusion • Cartel • The OPEC Cartel • Covert Collusion • Illegal in the U.S. • Tacit Understandings – “Gentlemen’s Agreements”

18. CARTELS AND OTHER COLLUSION • Obstacles to Collusion • Demand and Cost Differences • Number of Firms • Cheating • Price Wars • Potential Entry • Antitrust Law

19. OLIGOPOLY AND EFFICIENCY • Not Productively Efficient • P Minimum ATC • Not Allocatively Efficient • P  MC

20. Game Theory Introduction to Game Theory…

21. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Uptown’s Price Strategy

22. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Greatest Combined Profit Uptown’s Price Strategy

23. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Independent Actions Stimulate Response Uptown’s Price Strategy

24. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Independent Actions Stimulate Response Uptown’s Price Strategy Gravitating to the Worst Case

25. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Collusion Invites a Different Solution. Uptown’s Price Strategy

26. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Collusion Invites a Different Solution. Uptown’s Price Strategy

27. High Low A B $12 $15 High $12 $6 D C $6 $8 Low $15 $8 OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy Collusion Invites a Different Solution. But, the incentive to cheat is very real. Uptown’s Price Strategy

28. Practical Uses of Game Theory Pricing Option 1 $59 Web Only $125 Print Only Pricing Option 2 $59 Web Only $125 Print Only $125 Web & Print 68% 32% 16% 0% 84%

29. Practical Uses of Game Theory • 1 Share of Federated stock is worth $100 • Macy’s is offering to buy it for $102 • Campeau’s Bid • If he gets less than 50% everyone gets $105 • For 50% through 100% he pays a blended rate which would max at $97.50 • If he gets more than 50% of the stock and you don’t sell he can buy your stock for $90

30. Practical Uses of Game Theory Possibility 1: Campeau gets less than 50% • Campeau = $105 • Macy’s = $102 • Hold = $100 • Dominant strategy is to sell to Campeau. Possibility 2: Campeau gets more than 50% • Campeau = $97.50 • Macy’s = $0 • Hold = $90 • Dominant strategy is to sell to Campeau.

31. Practical Uses of Game Theory • Did you get that? • Everybody had stock worth $100. • Everyone could sell to Macy's for $102. • Instead, everybody sold to Campeau for $97.50. • Game Theory explains why.