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Chapter 12: Oligopoly and Monopolistic Competition. Characteristics of a monopolistically competitive market. Many buyers and sellers Differentiated products Easy entry and exit. examples. running shoes fast food franchises clothing cleaning supplies beauty products.

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characteristics of a monopolistically competitive market
Characteristics of a monopolistically competitive market
  • Many buyers and sellers
  • Differentiated products
  • Easy entry and exit
examples
examples
  • running shoes
  • fast food franchises
  • clothing
  • cleaning supplies
  • beauty products
product differentiation
product differentiation
  • physical differences
    • color, size, taste ...
  • location
    • convenience, drug stores
  • services
    • delivery
  • image
    • high quality vs. value
relationship to perfect competition
Relationship to perfect competition
  • Monopolistic competition is similar to perfect competition in that:
    • There are many buyers and sellers
    • There are no barriers to entry or exit
  • But it is difference because:
    • Product is NOT identical
    • Downward sloping demand curve
relationship to monopoly
Relationship to monopoly
  • Monopolistic competition is similar to monopoly in that:
    • Each firm is the sole producer of a particular product (although close substitutes)
    • The firm faces a downward sloping demand curve for its product
  • But it is different from monopoly in that
    • No barriers to entry
    • Many firms
the firm s demand curve and entry and exit
The firm’s demand curve and entry and exit
  • Monopolistically competitive demand curve
    • More elastic than monopoly
    • Less elastic than perfect competition
the firm s demand curve and entry and exit9
The firm’s demand curve and entry and exit
  • As firms enter a monopolistically competitive market, the demand facing a typical firm
    • Declines
    • becomes more elastic.
slide10

P

D

D

after entry

Q

Before entry

short run equilibrium in a monopolistically competitive industry

P, cost

MC

P*

D

MR

Q

Q*

Short-run equilibrium in a monopolistically competitive industry
  • choose price & output like a monopolist
short run equilibrium in a monopolistically competitive industry12

economic profit

P, cost

MC

P*

ATC

D

MR

Q

Q*

Short-run equilibrium in a monopolistically competitive industry
  • Economic profits lead to entry and a reduction in the demand facing a typical firm.

ATC*

long run
Long Run
  • zero economic profit
  • why?
    • economic profit leads to entry
      • Falling FIRM demand
    • economic loss leads to exit
      • Rising FIRM demand
    • no entry/exit with zero economic profit
long run equilibrium in a monopolistically competitive industry

P, cost

MC

P*

ATC

D

MR

Q

Q*

Long-run equilibrium in a monopolistically competitive industry
  • Entry continues until economic profit equals zero
  • “tangency equilibrium.”

ATC*

excess capacity
Excess capacity
  • firms output is not at minimum of ATC
    • Cost is not minimized
    • output too small
    • loss of economic welfare
  • This is the tradeoff for product variety
monopolistic competition and efficiency
Monopolistic competition and efficiency
  • As the number of firms rises, a monopolistically competitive firm’s demand curve becomes more elastic.
  • As the number of firms in a market expands, the market approaches a perfectly competitive market.
  • Thus, economic inefficiency may be smaller when there is a large number of firms in a monopolistically competitive market.
product differentiation and advertising
Product differentiation and advertising
  • Monopolistically competitive firms may receive short-run economic profit from successful product differentiation and advertising.
  • These profits are, however, expected to disappear in the long run as other firms copy successful innovations.
location decisions
Location decisions
  • Why do gas stations locate across the street?
    • To eliminate customer choice based solely on location
  • Monopolistically competitive firms often locate near each other to appeal to the “median” customer in a geographical region.
    • Example: auto row (Genesee St.)
next time 11 8
Next time, 11/8
  • Dr. Spizman
  • Oligopoly (chapter 12)
oligopoly
Oligopoly
  • a small number of firms produce most output
  • a standardized or differentiated product
  • recognized mutual interdependence, and
  • difficult entry.
strategic behavior
Strategic behavior
  • Strategic behavior occurs when the best outcome for one party depends upon the actions and reactions of other parties.
kinked demand curve model
Kinked demand curve model
  • Other firms are assumed to match price decreases, but not price increases.
  • There is little evidence suggesting that this model describes the behavior of oligopoly firms.
  • Game theory models are more commonly used.
game theory
Game theory
  • Examines the payoffs associated with alternative choices of each participant in the “game.”
game theory examples
Game theory examples
  • Prisoners’ dilemma
  • Duopoly pricing game
dominant strategy
Dominant strategy
  • A dominant strategy is one that provides the highest payoff for an individual for each and every possible action by rivals.
  • Confession is the dominant strategy in the prisoners’ dilemma game. A low price is the dominant strategy in the duopoly pricing game
  • It is more difficult to predict the outcome when no dominant strategy exists or when the game is repeated with the same players.
shared monopoly
Shared monopoly
  • Joint profits are higher when firms behave as a shared monopoly
  • Such a cartel arrangement is illegal in the U.S.
  • Price leadership
  • Facilitating practices (e.g., cost-plus pricing, recommended retail prices, etc.)
cartels
Cartels
  • Cartels are legal in some countries
  • A cartel arrangement can maximize industry profits
  • Each firm can increase its profits by violating the agreement
  • Cartel agreements have generally been unstable.
imperfect information
Imperfect information
  • Brand name identification – serves as a signal of product quality. Customers are willing to pay a higher price for products produced by firms that they recognize.
  • Product guarantees also serve as a signal of product quality