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CHAPTER TWENTY-FIVE. Superior Cheese. Monopolistic Competition and Oligopoly. Four Market Models. Monopolistic Competition. Pure Monopoly. Pure Competition. Market Structure Continuum. Monopolistic Competition. Characteristics. Relatively Large Numbers. Monopolistic Competition.

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slide2

Four Market Models

Monopolistic

Competition

Pure

Monopoly

Pure

Competition

Market Structure Continuum

slide3

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
slide4

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
slide5

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
slide6

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
slide7

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
slide8

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
  • Product Attributes
slide9

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
  • Product Attributes
  • Services
slide10

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
  • Product Attributes
  • Services
  • Location
slide11

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
  • Product Attributes
  • Services
  • Location
  • Brand Names and Packaging
slide12

Monopolistic Competition

Characteristics...

  • Relatively Large Numbers
  • Small Market Share
  • No Collusion
  • Independent Actions
  • Product Differentiation
  • Product Attributes
  • Services
  • Location
  • Brand Names and Packaging
  • Some Control Over Price
slide13

Monopolistic Competition

Characteristics...

  • Easy Entry and Exit
slide14

Monopolistic Competition

Characteristics...

  • Easy Entry and Exit
  • Nonprice Competition
slide15

Monopolistic Competition

Characteristics...

  • Easy Entry and Exit
  • Nonprice Competition
  • Advertising
slide16

Monopolistic Competition

Characteristics...

  • Easy Entry and Exit
  • Nonprice Competition
  • Advertising
  • Monopolistically Competitive Industries
slide17

Short-Run Price and Output Determination

P

Monopolistic competitors

have an elastic demand curve,

but not perfectly elastic...

Price and Costs

Q

Copyright McGraw-Hill, Inc., 1999

slide18

Short-Run Price and Output Determination

P

Price and Costs

D

Q

Copyright McGraw-Hill, Inc., 1999

slide19

Short-Run Price and Output Determination

P

Price and Costs

D

MR

Q

Copyright McGraw-Hill, Inc., 1999

slide20

Short-Run Price and Output Determination

MC

P

Price and Costs

D

MR

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide21

Short-Run Price and Output Determination

MC

P

ATC

Price and Costs

D

MR

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide22

Short-Run Price and Output Determination

Expect New Competitors

MC

P

ATC

Price and Costs

Economic

Profits

D

MR

Q

Q

slide23

How would

short-run losses

be different?

Short-Run Price and Output Determination

Expect New Competitors

MC

P

ATC

Price and Costs

Economic

Profits

D

MR

Q

Q

slide24

Short-Run Price and Output Determination

MC

P

ATC

Economic

Losses

Price and Costs

Expect

Less

Competitors

D

MR

Q

Q

slide25

How would

the long-run

differ?

Short-Run Price and Output Determination

MC

P

ATC

Economic

Losses

Price and Costs

Expect

Less

Competitors

D

MR

Q

Q

slide26

Short-Run Price and Output Determination

Expect New Competitors

MC

P

ATC

Price and Costs

Economic

Profits

D

MR

Q

Q

slide27

Short-Run Price and Output Determination

Long-run equilibrium

MC

P

ATC

P = MC

Price and Costs

D

MR

Q

Q

Q @ ATC Min ?

slide28

Monopolistic Competition

and Economic Efficiency

slide29

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
slide30

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
  • Not Allocatively Efficient
slide31

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
  • Not Allocatively Efficient
  • Excess Capacity
slide32

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
  • Not Allocatively Efficient
  • Excess Capacity

Nonprice Competition

slide33

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
  • Not Allocatively Efficient
  • Excess Capacity

Nonprice Competition

  • Product Differentiation
slide34

Monopolistic Competition

and Economic Efficiency

  • Not Productively Efficient
  • Not Allocatively Efficient
  • Excess Capacity

Nonprice Competition

  • Product Differentiation
  • Product Development
slide35

Features of a Monopolistic Competitive Markets:

1. Many sellers

2. Unique Products that have close or identical substitutes:

Big Mac v Whopper

3. Small barrier to entry or exit

4. Some market power exists

5. Price is greater than MR, Separate DARP and MR curves

6. Non price competition and advertising exist

7. Profits maximized at the Quantity and Price where MC = MR

8. Excess or Economic Profits in the Short Run only (P>ATC)

9. Profits must be Normal in the Long Run (P=ATC)

10. Firms should shut down when P < AVC

11. Excess capacity exists in terms of potential output

12. Demand is relatively elastic by comparison to monopoly

13. Example market - Minimarts, Fast food at local franchises

14. This market is much closer to perfect competition than

pure monopoly

slide36

Four Market Models

Oligopoly

Pure

Monopoly

Pure

Competition

Monopolistic

Competition

Market Structure Continuum

slide38

Oligopoly: Characteristics

  • Oligopoly Defined
slide39

Oligopoly: Characteristics

  • Oligopoly Defined
  • Homogeneous or Differentiated Products
slide40

Oligopoly: Characteristics

  • Oligopoly Defined
  • Homogeneous or Differentiated Products
  • Control over Price
slide41

Oligopoly: Characteristics

  • Oligopoly Defined
  • Homogeneous or Differentiated Products
  • Control over Price
  • Mutual Interdependence
slide42

Oligopoly: Characteristics

  • Oligopoly Defined
  • Homogeneous or Differentiated Products
  • Control over Price
  • Mutual Interdependence
  • Entry Barriers
slide43

Oligopoly: Characteristics

  • Oligopoly Defined
  • Homogeneous or Differentiated Products
  • Control over Price
  • Mutual Interdependence
  • Entry Barriers
  • Mergers
slide44

Oligopoly: Characteristics

  • Concentration Ratios

Ratios that look at what the concentration of firms are in the industry.

slide45

Oligopoly: Characteristics

  • Concentration Ratios
  • - Herfindahl Index – The larger
  • the index number the higher the
  • concentration of the industry.
slide46

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

High

Uptown’s Price Strategy

Low

slide47

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Greatest

Combined

Profit

High

Uptown’s Price Strategy

Low

slide48

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Independent

Actions

Stimulate

Response

High

Uptown’s Price Strategy

Low

slide49

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Independent

Actions

Stimulate

Response

Gravitating

to the

Worst Case

High

Uptown’s Price Strategy

Low

slide50

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Collusion

Invites a

Different

Solution

High

Uptown’s Price Strategy

Low

slide51

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Collusion

Invites a

Different

Solution

High

Uptown’s Price Strategy

Low

slide52

A

B

$12

$15

$12

$6

D

C

$6

$8

$15

$8

Oligopoly Behavior

A Game Theory Overview...

RareAir’s Price Strategy

High

Low

Collusion

Invites a

Different

Solution

But, the

incentive

to cheat

is very real

High

Uptown’s Price Strategy

Low

slide53

Pay Off Matrix Oligopoly – Reasons for Collusion

Ads Effect Sales (Q) and P x Q = TR so Ads effect Total Revenue!

Low Cost Ads: 120 :30 second Ads/week for$10,000

High Cost Ads: 240 :30 second Ads/week for$20,000

TR - TC = TP

TR - TC = TP

Company A High Ads $100,000 – 20,000 = $80,000 Low Ads $50,000 – 10,000 = $40,000

Company B Low Ads $50,000 – 10,000 = $40,000 High Ads $100,000 – 20,000 = $80,000

Company A Low Ads $75,000 – 10,000 = $65,000 High Ads $75,000 – 20,000 = $55,000

Company B Low Ads $75,000 – 10,000 = $65,000 High Ads $75,000 – 20,000 = $55,000

If either duopolist begins running High Ads, its competitor will

counter with High Ads!

Games Theory and Collusion’s answer is an agreement by

“both”to keep advertising low in order to maximize profits!

Would their be incentive to Cheat?

slide54

Three Oligopoly Models

No Standard Model due to...

slide55

Three Oligopoly Models

No Standard Model due to...

Diversity

slide56

Three Oligopoly Models

No Standard Model due to...

Diversity

Interdependence

slide57

Three Oligopoly Models

No Standard Model due to...

Diversity

Interdependence

1 - Kinked Demand Curve

slide58

Three Oligopoly Models

No Standard Model due to...

Diversity

Interdependence

1 - Kinked Demand Curve

2 - Collusive Pricing

slide59

Three Oligopoly Models

No Standard Model due to...

Diversity

Interdependence

1 - Kinked Demand Curve

2 - Collusive Pricing

3 - Price Leadership

slide60

D1

MR1

Kinked Demand: Noncollusive Oligopoly

P

The firm’s demand

and marginal

revenue curves

when rivals follow

pricing patterns.

Q

Quantity

slide61

D2

MR2

Kinked Demand: Noncollusive Oligopoly

P

The firms demand

and marginal

revenue curves when

rivals don’t follow

pricing patterns.

D1

Q

MR1

Quantity

slide62

Kinked Demand: Noncollusive Oligopoly

P

Rivals tend to

follow a price cut

D2

MR2

D1

Q

MR1

Quantity

slide63

Kinked Demand: Noncollusive Oligopoly

P

Rivals tend to

follow a price cut

or ignore a

price increase

D2

MR2

D1

Q

MR1

Quantity

slide64

Kinked Demand: Noncollusive Oligopoly

P

Effectively creating

a kinked demand curve

D2

MR2

D1

Q

MR1

Quantity

slide65

MC1

MC2

Kinked Demand: Noncollusive Oligopoly

P

Effectively creating

a kinked demand curve

D2

MR2

D1

Q

MR1

Quantity

slide67

Cartels and Collusion

Oligopoly is conducive to collusion

slide68

Cartels and Collusion

Oligopoly is conducive to collusion

If a few firms face identical or

highly similar demand and costs...

slide69

Cartels and Collusion

Oligopoly is conducive to collusion

If a few firms face identical or

highly similar demand and costs...

They will seek joint profit

maximization...

slide70

Colluding Oligopolists Will

Split the Monopoly Profits

MC

P

Price

ATC

D

MR = MC

Economic

Profit

MR

Q

Quantity

slide71

Cartels and Collusion

Overt Collusion

slide72

Cartels and Collusion

Overt Collusion

OPEC Cartel

slide73

Cartels and Collusion

Overt Collusion

OPEC Cartel

Covert Collusion

slide75

Obstacles to Collusion

Demand & Cost Differences

slide76

Obstacles to Collusion

Demand & Cost Differences

Number of Firms

slide77

Obstacles to Collusion

Demand & Cost Differences

Number of Firms

Cheating

slide78

Obstacles to Collusion

Demand & Cost Differences

Number of Firms

Cheating

Recession

slide79

Obstacles to Collusion

Demand & Cost Differences

Number of Firms

Cheating

Recession

Potential Entry

slide80

Obstacles to Collusion

Demand & Cost Differences

Number of Firms

Cheating

Recession

Potential Entry

Legal Obstacles: Antitrust

slide82

Price Leadership

Leadership Tactics

slide83

Price Leadership

Leadership Tactics

Infrequent Changes

slide84

Price Leadership

Leadership Tactics

Infrequent Changes

Communication

slide85

Price Leadership

Leadership Tactics

Infrequent Changes

Communication

Limit Pricing - sometimes

smaller companies will wage price

wars to knock the leader down.

slide87

Advertising Effects on Output & Average Costs

Unit Costs

ATC

without

advertising

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide88

Advertising Effects on Output & Average Costs

ATC

with

advertising

Unit Costs

ATC

without

advertising

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide89

Advertising Effects on Output & Average Costs

Advertising Costs

ATC

with

advertising

Unit Costs

ATC

without

advertising

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide90

Oligopoly and Economic Efficiency

Recall...

Allocative Efficiency

(Price = MC)

slide91

Oligopoly and Economic Efficiency

Recall...

Allocative Efficiency

(Price = MC)

Productive Efficiency

(Price = Minimum ATC)

slide92

Oligopoly and Economic Efficiency

Recall...

Allocative Efficiency

(Price = MC)

Productive Efficiency

(Price = Minimum ATC)

Neither is likely in an

oligopoly market structure

slide93

Features of an Oligopolistic Markets:

1. Few sellers (Less than seven),

Duopoly - two main sellers + the fringe firms

2. Unique Products but similar products Coke v Pepsi, Chevy v Ford

3. Large barrier to entry or exit

4. A large measure of market power exists

5. Price is greater than MR, Separate DARP and MR curves

6. Non price competition and advertising exist

Procter & Gamble: $3,277,000,000 in Ads 1999

7. Profits maximized at the Quantity and Price where MC = MR

8. Excess or Economic Profits possible in the Long Run (P>ATC)

9. Interdependence, Collusion, Spies, Pay off Matrix

Price and Innovative Leaders exist, Gamesmanship

“A Beautiful Mind”

10. Firms should shut down when P < AVC

11. Excess capacity exists in terms of potential output

12. Demand is relatively inelastic

13. Theory of the Kinked Demand Curve and Price Stickiness

results from collusion and gamesmanship

14. Example market - Automobiles, Soda, Beer, Steel, Tobacco

Products may be differentiated (Toyota v Ford) or homogeneous (Steel)

slide94

Questions

and

Discussion...

Advertising Effects on Output & Average Costs

Advertising Costs

ATC

with

advertising

Unit Costs

ATC

without

advertising

Q

Q

Copyright McGraw-Hill, Inc., 1999

slide95
monopolistic competition

product differentiation

nonprice competition

excess capacity

oligopoly

homogeneous oligopoly

differentiated oligopoly

mutual interdependence

concentration ratio

interindustry competition

import competition

Herfindahl index

game theory model

collusion

kinked demand curve

price war

cartel

tacit understandings

price leadership

slide96

Next...

Technology,

R&D,

and

Efficiency

Chapter 26