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Chapter 7.1 Monopolistic Competition and Oligopoly. The Continuum of the Market Structure. Perfect Competition. Monopoly. n=infinity. No of firms, n. n=1. n small Oligopoly. n large Monopolistic Competition. MONOPOLISTIC COMPETITION. Assumptions of monopolistic competition

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slide1

Chapter 7.1

Monopolistic Competition and Oligopoly

the continuum of the market structure
The Continuum of the Market Structure

Perfect Competition

Monopoly

n=infinity

No of firms, n

n=1

n small

Oligopoly

n large

Monopolistic

Competition

monopolistic competition
MONOPOLISTIC COMPETITION
  • Assumptions of monopolistic competition
  • Each firm sells a different variety or brand (think of coke or restaurants)
  • There are many firms
    • Act independently – ignore others’ reactions
  • Freedom of Entry and Exit
  • There is Symmetry
    • New firms affect all old ones equally
monopolistic competition4
MONOPOLISTIC COMPETITION
  • Equilibrium:
    • short run
suppose we consider the case of demand for eating out
Suppose we consider the case of demand for eating out.

The ‘Industry’ Demand Curve looks like this

£

Ps

O

Qs

Q

suppose we consider the case of demand for eating out6
Suppose we consider the case of demand for eating out.

£

What about an individual restaurant?

It is further in

and flatter

Why?

Ps

O

Qs

Q

suppose we consider the case of demand for eating out7
Suppose we consider the case of demand for eating out.

Each restaurant type has a share of the industry

But knows that it can only vary its price a little

Ps

£

O

Qs

Q

suppose we consider the case of demand for eating out8
Suppose we consider the case of demand for eating out.

£

What if a new competitor appears?

Demand line shifts in more and flattens more

Getting closer and closer to Perfect Competition

Ps

O

Qs

Q

so now suppose we have a firm like the blue line and this restaurant is doing well in the short run
So now suppose we have a firm like the blue line … and this restaurant is doing well in the short-run

£

Ps

O

Qs

Q

let s make the picture bigger11
Let’s make the picture bigger

£

MC

AC

Ps

AR =D

MR

O

Qs

Q

short run equilibrium of the firm under monopolistic competition
Short-run equilibrium of the firm under monopolistic competition

£

MC

AC

Ps

ACs

AR =D

MR

O

Qs

Q

short run equilibrium
Short-run equilibrium

£

MC

AC

Ps

ACs

AR =D

MR

O

Qs

Q

what happens now
What happens now?

New Firms enter

What happens to D?

£

MC

So P and Q down

AC

P1

ACs

D

MR

O

Qs

Q

what happens now15
What happens now?

New Firms enter

What happens to D?

£

MC

So P and Q down

AC

And Super-normal Profits down

ACs

D

MR

O

Qs

Q

what happens now16
What happens now?

New Firms enter

What happens to D?

£

MC

So P and Q down

And Super-normal Profits down

AC

ACs

D

MR

O

Qs

Q

what happens next
What Happens Next?
  • Still Super-Normal Profits
  • So firms keep entering
  • P keeps falling and Super-normal profits keep falling until….
  • In the LR
  • AR = AC and there are no supernormal profits
long run equilibrium of the firm under monopolistic competition
Long-run equilibrium of the firm under monopolistic competition

£

LRMC

LRAC

PL

ARL=DL

MRL

O

QL

Q

notice
NOTICE:
  • AR (=D) curve still slopes down
  • So not in perfectly competitive case
  • Firms have market power (can choose price and quantity), but….
  • Competition is such that this power is illusory (in the long run)
monopolistic competition20
MONOPOLISTIC COMPETITION
  • Limitations of the model
    • imperfect information about profits and demand
    • difficulty in identifying industry demand curve
    • indivisibilities/local monopolies
    • importance of non-price competition
      • Variety
      • Advertising
monopolistic competition21
MONOPOLISTIC COMPETITION
  • The public interest
    • comparison with perfect competition;
    • PRODUCTION WILL NOT OCCUR WHERE LRAC IS AT ITS MINIMUM (unlike perfect competition which is efficient)
slide22
Long run equilibrium under perfect andmonopolistic competition (with decreasing or constant returns to scale)

£

LRAC

P1

DLunder perfect

competition

O

Q1

Q

slide23
Long run equilibrium under perfect andmonopolistic competition (with decreasing or constant returns to scale)

£

LRAC

P2

P1

DLunder perfect

competition

DLunder monopolistic

competition

O

Q2

Q1

Q

the continuum of the market structure24
The Continuum of the Market Structure

Perfect Competition

Monopoly

n=infinity

No of firms, n

n=1

n small

Oligopoly

n large

Monopolistic

Competition

oligopoly
OLIGOPOLY
  • Key features of oligopoly
    • barriers to entry
    • interdependence of firms
    • ~What’s he up to?
    • incentives to compete versus incentives to collude
day 1 suppose initially monopoly firm in the industry
Day 1: Suppose initially Monopoly firm in the Industry

£

To make life simple suppose P=200-Q is the demand curve

D

O

Q

suppose initially monopoly firm in the industry
Suppose initially Monopoly firm in the Industry

£

To make life simple suppose P=200-Q is the demand curve,

And MC are zero

200

What is the MR curve?

D

O

200

Q

suppose initially monopoly firm in the industry28
Suppose initially Monopoly firm in the Industry

£

P=200-Q

TR= P*Q

TR=[200-Q]*Q

TR=200Q-Q2

MR=200-2Q

200

D

O

200

Q

suppose initially monopoly firm in the industry29
Suppose initially Monopoly firm in the Industry

£

P=200-Q

TR= P*Q

TR=[200-Q]*Q

TR=200Q-Q2

MR=200-2Q

200

If MR = 0,

200=2Q

D

MR

MC

O

200

100

Q

suppose initially monopoly firm in the industry30
Suppose initially Monopoly firm in the Industry

What quantity will this firm supply to the market

MR=MC at 100

Q=100

P=200-Q

P=200-100

=100

£

200

P=100

MR

D

MC

O

200

100

Q

suppose initially monopoly firm in the industry31
Suppose initially Monopoly firm in the Industry

So monopolist supplies half the market in this case

(Linear demand, MC=0)

£

200

P=100

MR

D

MC

O

200

100

Q

day 2 harmony is broken suppose now a new firm notices there are unfulfilled customers
Day 2: Harmony is broken! Suppose now a new firm notices there are unfulfilled customers

£

200

What will new firm do?

P=100

MR

D

MC

O

200

100

Q

suppose now a new firm notices there are unfulfilled customers
Suppose now a new firm notices there are unfulfilled customers

£

200

What will new firm do?

It thinks it has demand

P=100-Q

MR=100-2Q

P=100

MR

D

MC

O

MC2

200

100

Q

suppose now a new firm notices there are unfulfilled customers34
Suppose now a new firm notices there are unfulfilled customers

It is just looking at this bit of the market

Setting MC = MR =0

100=2Q

Q=50

What will new firm do?

200

It thinks it has demand

P=100-Q

MR=100-2Q

P=100

MR

D

MC

MC2

100

0

Q

slide35
So now firm 1 is supplying 100 units
  • And firm 2 is supplying 50 Units
  • Will firm 1 accept that?
  • How will it react?
day 3 the reckoning
Day 3: The reckoning

£

200

Firm 1 sees that 50 people are already being supplied. So its market is

P=200-Q –50

P=150-Q

P=100

MR

D

MC

O

MC2

200

100

Q

day 3 the reckoning37
Day 3: The reckoning

£

200

Firm 1 sees that 50 people are already being supplied. So its market is

P=200-Q –50

P=150-Q

150

P=100

MR

D

MC

O

150

200

100

Q

day 3 the reckoning38
Day 3: The reckoning

£

200

And MR is now

MR=150-2Q

So when MR=MC=0

Q=75

150

P=100

D

MR

MC

O

200

100

Q

75

slide39
Firm 1 was supplying 100 units
  • Is Now Supply 75 units
  • Firm 2 is still producing 50 units
  • How will firm 2 react to the cut in firm 1’s production?
this is essentially the story now
This is essentially the story now

£

200

Firm 1 Supplies 75

Firm 2 Supplies 50

But now Firm 2 sees that there are 125 unsatisfied consumers

P=100

MR1

Market D

D1

D1

D2

MR2

MC

O

MC2

200

100

Q

day 4 the mob strikes back
Day 4: The Mob Strikes BACK

£

200

Firm 2 sees that 75 people are already being supplied. So its market now is

P=200-Q –75

P=125-Q

125

P=100

MR

D

MC

O

200

125

100

Q

day 4 the mob strikes back42
Day 4: The Mob Strikes BACK

£

200

And MR is now

MR=125-2Q

So when MR=MC=0

Q=62.5

125

P=100

D

MR2

MC

O

62.5

200

100

125

Q

slide43
Firm 1 was supplying 100 units
  • Firm 1 Is Now producing 75 units
  • Firm 2 was producing 50 units
  • Firm 2 is now Producing 62.5 units
  • Firm 1’s Q is going down as Firm 2 goes Up
  • Firm 2’s Q is going Up as Firm 1 goes down
  • When will equilibrium occur?
armageddon
Armageddon

£

If each firm sees that 66.66 people are already being supplied, then it sees its market as

P=200-Q –66.66

P=133.33-Q

200

133.3

P=100

D

MC

O

200

100

133.33

Q

armageddon45
Armageddon

£

If each firm sees that 66.66 people are already being supplied, then P=133.33-Q

200

133.3

And MR is now

MR=133.33-2Q

So when MR=MC=0

Q=66.66

P=100

D1=D2

D

MR1= MR2

MC

O

66.66

200

100

133.33

Q

slide46
Firm 1 fall from supplying 100 units to 66.66 units
  • Firm 2 rises from supplying 0 units to 66.66 units
  • Given that firm 1 is supplying 66.66 units firm 2’s best response is 66.66 units
  • Given that firm 2 is supplying 66.66 units firm 1’s best response is 66.66 units
  • EQUILIBRIUM (Cournot equilibrium)
slide47
What do we learn from this story?
  • With a small number of firms, one firm’s actions directly affects the other.
  • Where the number of firms are small, the firms will think strategically!!
  • What is the other guy (male or female) up to ?
  • How will they react to my actions
slide48
Indeed:
  • Firms wouldn’t go through this tortuous process, they would figure out the situation pretty quickly and if firm 1 couldn’t stop 2 entering they would go to final equilibrium.
  • Called Cournot Competition (competing over market share - Quantities)
  • Can also model price competition- Bertrand
comparison of cournot with perfect compt and monopoly
Comparison of Cournot with Perfect Compt. and Monopoly
  • Under Monopoly Firm 1 with a linear demand curve Zero MC supplied half the market, that is Q1 =1/2 of 200=100
  • Here with 2 firms each supply 1/3 of 200, that is, 66.66 and total output = 133.33
  • Under perfect competition MC = 0 would produce at Q = 200
  • So oligopoly moves the economy closer to perfect competition as compared with monopoly
cournot
Cournot:
  • 1 firm supplies ½ of market
  • 2 firms supply 1/3 market each, 2/3 overall.
  • What about 3 firms?
  • 3 firms supply 1/4 market each, 3/4 overall.
  • ..and 4 firms?
  • 4 firms supply 1/5 market each, 4/5 overall.
  • n firms, supply 1/(n+1) of market each, n/(n+1) overall
  • So more firms getting closer and closer to perfect competition
slide51

Profits Under Cournot

P= 200-2(66.66)=

= 200-133.33= 66.66

Industry Profits=2(TR-TC)

=2{66.66(66.66)}=8887.7

But under Monopoly p=100; Q=100 and

Profits = 100*100

=10,000

£

200

133.3

P=100

D1=D2

D

MR1= MR2

MC

O

66.66

200

100

133.33

Q

slide52

So two firms would be better off if they could get together and agree to limit market:

Collusion

£

200

Profits Under Cournot: 8,888

Profits under monopoly: 10,000

133.3

P=100

D1=D2

D

MR1= MR2

MC

O

66.66

200

100

133.33

Q

oligopoly53
OLIGOPOLY
  • Key features of oligopoly
    • barriers to entry
    • interdependence of firms~What’s s/he up to?
    • incentives to compete versus incentives to collude
  • Factors favouring collusion
  • Collusive oligopoly: cartels
    • equilibrium of the industry
oligopoly54
OLIGOPOLY
  • Key features of oligopoly
    • barriers to entry
    • interdependence of firms
    • incentives to compete versus incentives to collude
  • Factors favouring collusion
  • Collusive oligopoly: cartels
    • Join forces and act collectively as a monopoly
    • allocating and enforcing quotas