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Understanding Monopolistic Competition and Oligopoly

Learn about monopolistic competition, oligopoly, price competition, and implications of collusion in different market structures. Explore the characteristics and equilibrium comparisons of monopolistically competitive and perfectly competitive markets. Understand oligopoly, price competition, and cartelization in various industries. Discover the factors affecting success in cartels and the dynamics of intercollegiate athletics as a case study.

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Understanding Monopolistic Competition and Oligopoly

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  1. Chapter 12 Monopolistic Competition and Oligopoly

  2. Topics to be Discussed • Monopolistic Competition • Oligopoly • Price Competition • Competition Versus Collusion: The Prisoners’ Dilemma • Implications of the Prisoners’ Dilemma for Oligopolistic Pricing • Cartels Chapter 12

  3. Monopolistic Competition • Characteristics 1) Many firms 2) Free entry and exit 3) Differentiated product • The amount of monopoly power depends on the degree of differentiation. • Examples of this very common market structure include: • Toothpaste • Soap • The Makings of Monopolistic Competition • Two important characteristics • Differentiated but highly substitutable products • Free entry and exit Chapter 12

  4. MC MC AC AC PSR PLR DSR DLR MRSR MRLR QSR QLR A Monopolistically CompetitiveFirm in the Short and Long Run $/Q $/Q Short Run Long Run Quantity Quantity

  5. A Monopolistically CompetitiveFirm in the Short and Long Run • Observations (short-run) • Downward sloping demand--differentiated product • Demand is relatively elastic--good substitutes • MR < P • Profits are maximized when MR = MC • This firm is making economic profits Chapter 12

  6. A Monopolistically CompetitiveFirm in the Short and Long Run • Observations (long-run) • Profits will attract new firms to the industry (no barriers to entry) • The old firm’s demand will decrease to DLR • Firm’s output and price will fall • Industry output will rise • No economic profit (P = AC) • P > MC -- some monopoly power Chapter 12

  7. Deadweight loss MC AC MC AC P PC D = MR DLR MRLR QC QMC Comparison of Monopolistically CompetitiveEquilibrium and Perfectly Competitive Equilibrium Monopolistic Competition Perfect Competition $/Q $/Q Quantity Quantity

  8. Monopolistic Competition • Monopolistic Competition and Economic Efficiency • The monopoly power (differentiation) yields a higher price than perfect competition. If price was lowered to the point where MC = D, consumer surplus would increase by the yellow triangle. • With no economic profits in the long run, the firm is still not producing at minimum AC and excess capacity exists. Chapter 12

  9. Oligopoly • Characteristics • Small number of firms • Product differentiation may or may not exist • Barriers to entry • Examples • Automobiles, Steel, Aluminum, Petrochemicals, Electrical equipment, Computers Chapter 12

  10. Oligopoly • The barriers to entry are: • Natural • Scale economies • Patents • Technology • Name recognition • Strategic action • Flooding the market • Controlling an essential input Chapter 12

  11. Price Competition • Price Competition with Differentiated Products • Market shares are now determined not just by prices, but by differences in the design, performance, and durability of each firm’s product. Chapter 12

  12. Oligopolistic Pricing • The Dominant Firm Model • In some oligopolistic markets, one large firm has a major share of total sales, and a group of smaller firms supplies the remainder of the market. • The large firm might then act as the dominant firm, setting a price that maximized its own profits. Chapter 12

  13. Cartels • Characteristics 1) Explicit agreements to set output and price 2) May not include all firms 3) Most often international • Examples of successful cartels : OPEC • Examples of unsuccessful cartels : Copper,Tin,Tea 4) Conditions for success • Competitive alternative sufficiently deters cheating • Potential of monopoly power--inelastic demand Chapter 12

  14. Cartels • Observations • To be successful: • Total demand must not be very price elastic • Either the cartel must control nearly all of the world’s supply or the supply of noncartel producers must not be price elastic Chapter 12

  15. The Cartelizationof Intercollegiate Athletics • Observations 1) Large number of firms (colleges) 2) Large number of consumers (fans) 3) Very high profits Chapter 12

  16. Summary • In a monopolistically competitive market, firms compete by selling differentiated products, which are highly substitutable. • In an oligopolistic market, only a few firms account for most or all of production. • Firms would earn higher profits by collusively agreeing to raise prices, but the antitrust laws usually prohibit this. • In a cartel, producers explicitly collude in setting prices and output levels. Chapter 12

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