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Monopolistic Competition. Many firms with relative ease of entry producing differentiated products. Characteristics: 1. Large # of firms. 2. Each producer has a small % of the market and can  ignore rivals action when setting price. 3. Product differentiation.

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Monopolistic competition l.jpg
Monopolistic Competition

  • Many firms with relative ease of entry producing differentiated products.

  • Characteristics:

    1. Large # of firms.

    2. Each producer has a small % of the market and can  ignore rivals action when setting price.

    3. Product differentiation.

    4. Each seller has some degree of market power since each seller faces an elastic demand curve.

    5. Non-price competition.

    6. Ease of entry 0 long run profits


Product differentiation l.jpg
Product Differentiation

  • The distinguishing between products through real or imagined properties

    • Quality

    • Services

    • Location

    • Advertising

    • Packaging

      More product differentiation

      =

      less elasticity of demand


Short run equilibrium monopolistic competition l.jpg

-Price (Pe) < ATC

-Economic loss

-Price (Pe) > ATC

-Economic profit

MC

MC

ATC

ATC

ATC

Pe

Dollars per Unit

Pe

Dollars per Unit

d

d

ATC

Losses

E

E

Profits

MR

MR

qe

qe

Quantity

Quantity

Short-Run Equilibrium: Monopolistic Competition


Long run zero economic profit l.jpg
Long Run: Zero Economic Profit

  • The key difference between monopoly and monopolistic competition lies in the long run.

    • In Monopolistic Competition economic profit attracts new entrants.

      • the firm’s demand and marginal revenue start to shift leftward.

      • firm’s demand becomes more elastic

      • the profit-maximizing quantity and price fall until P=ATC in the LR


Long run equilibrium l.jpg

MC

ATC

Pe =

ATC

Dollars per Unit

d

E

-Price (Pe) = ATC

-Zero econ. profits

-Normal rate of return

MR

qe

Quantity

Long-Run Equilibrium

  • The greater the # of rivals and the more similar the product,

  • the more elastic will be the demand and the closer the monopolistically competitive market will be to perfect competition.


Comparison of the perfect competitor with the monopolistic competitor efficiency l.jpg

Minimum ATC

d

MR = P

Comparison of the Perfect Competitorwith the Monopolistic Competitor: Efficiency

Perfect Competition

Monopolistic Competition

MC

ATC

Minimum ATC

ATC

MC

P2

P1

Dollars per Unit

Dollars per Unit

d'

In Mon Comp:

PMC

Pmin ATC

MR

q2

q1

Quantity per Time Period

Quantity per Time Period


Efficiency excess capacity l.jpg

MC

Excess

capacity

Capacity

output

Profit-

maximizing

output

Efficiency - Excess Capacity

  • Excess Capacity Theorem of Monopolistic Competition:

  • each firm is producing an output less than the one for which its ATC reaches its minimum point; i.e., it has excess capacity.

Price (dollars/unit)

ATC

P1

120

MR

D

Quantity

0

Q1


Efficiency monopolistic competition l.jpg
Efficiency: Monopolistic Competition

 Monopolistically Competitive Markets tend to be

  • overcrowded with firms,

  • each of which tends to be underutilized

     “wastes” of monopolistic competition.

Qualifications to “wastes”/ inefficiency.

Consumers gain from

  • variety and choice.

  • advertising

    •pros….•cons…

  • product development…..


Oligopoly l.jpg
Oligopoly

  • Competition among the few.

    • A market structure in which a small number of producers compete with each other.

    • 2 producers = Duopoly

  • Numbers must be small enough that

    • each firm has a significant share of the market

    • each firm must consider the reactions of rivals in formulating its best price and output decision.


Which model applies l.jpg
Which model applies?

  • 1. Definition, table

  • 2. 4 (8) firm concentration ratio;

    • i.e., % of the value of sales accounted for by the largest 4 (8) firms in the industry.

    • helps to determine the degree of competition

  • Concentration ratio must be applied with other information such as:

    • a) geographical scope

    • b) barriers to entry & turnover

    • c) correspondence between a market and an industry.


Characteristics of oligopoly l.jpg
Characteristics of Oligopoly

1. Few dominant producers.

2. Homogeneous or differentiated product.

3. Advertising/Promotion.

4. Barriers to entry.

And


Characteristics of oligopoly12 l.jpg
Characteristics of Oligopoly

  • 5. Mutual interdependence among firms.

    • No firm in oligopoly will alter its price without trying to calculate the most likely reactions of rivals

      • Strategic Behaviour

        “ Oligopolies are price searchers engaged in a game of strategy.”


Creating barriers to entry l.jpg
Creating Barriers to Entry

  • Increasing Entry Costs (largely illegal)

  • Limit-Pricing

    -setting a price that will cause losses to new entrants (illegal in Canada)

    3) Raising switching costs

    -ie: incompatible components

    -varying legality

    4) Predatory Reputation

    -illegal


Models of oligopoly l.jpg

Characteristics of Oligopoly

Models of Oligopoly

  • Notice

    •  there is no single model of oligopoly.

       there is tension between co-operation and self interest.

  • 1.)Cartel

    • cartel: a group of firms acting together to minimize strategic behaviour behave like monopoly

    • collusion: agreement among firms in a market about quantities to produce &/or prices to charge.


Collusion will be most successful when l.jpg
Collusion will be most successful when

1. Demand is inelastic few substitutes outside the cartel.

2. Members of the cartel play by the rules; e.g., no price cutting: obey quota

3. Number of members is low.

4. Market conditions are good.

5. Barriers to entry are strong.


Colluding to maximize profits l.jpg
Colluding to Maximize Profits

  • Maximize industry profits:

    • agree to set the industry output level equal to the monopoly output level.

    • agree on how much of the monopoly output each firm will produce.

    • for each firm, price is greater than MC; for the industry, MR = MC.


Colluding to maximize profits17 l.jpg

Collusion achieves

monopoly outcome

Economic

Profit

Quota Output for the firm

Colluding to Maximize Profits

Individual Firm

Industry

MC

ATC

10

10

9

9

MC1

8

Price and cost (thous. of $/ unit)

Price and cost (thous. of $/ unit)

6

6

D

MR

0

1

2

3

4

5

0

1

2

3

4

5

6

7

Quantity (thous.

/week)

Quantity (thous.

/week)


Colluding to maximize profits18 l.jpg

Economic

profit

Collusion achieves

monopoly outcome

Preferred firm

output, P=MC

9.00

8.00

6.00

Additional

profit from

cheating

2

3

4

6

Colluding to Maximize Profits

P$

P$

MC

ATC

MC1

D

MR

0

Q

Q

(a) Individual firm

(b) Industry


Incentive to cheat l.jpg
Incentive to cheat

  • Since P > MC at quota,

    • firms have an incentive to cheat, to produce more until P(MR)=MC

  • additional profit is available to a single cheating firm provided pricedoesn’t fall.

  • If all firms cheat, an excess quantity supplied in the market will cause the price to fall.


  • Models of oligopoly20 l.jpg
    Models of Oligopoly

    • 2.)Game Theory

      • The analysis of strategic oligopoly behaviour

        • Behaviour that recognizes mutual interdependence and takes account of the expected behaviour of others


    2 game theory l.jpg
    2. Game Theory

    • In all conflict situations - games - there are:

      decision makers,

      strategies and payoffs.

    • Players choose strategies without knowing with certainty what the opposing player will do.

    • Players construct BEST RESPONSES

      -optimal actions given all possible actions of other players


    Game theory l.jpg
    Game Theory

    • A special kind of Best Response.

    DOMINANT STRATEGY

    • Strategy that is best no matter what the other player does.

    • Eg. advertise


    Game theory23 l.jpg
    Game Theory

    • Payoff Matrix

      • table that shows the payoffs/

      • outcomes for every possible

      • action by each player for every

      • possible action by the other player.

    Eg: Advertising where firms are assumed to anticipate how rival firms might react


    Game theory24 l.jpg
    Game Theory

    B’sSTRATEGY

    Don’t advertise

    Advertise

    A’s STRATEGY

    A’s profit= $50 000

    A’s loss =

    $25 000

    Don’t advertise

    B’s profit = $50 000

    B’s profit = $75 000

    A’s profit= $75 000

    A’s profit = $10 000

    Advertise

    B’s loss = $25 000

    B’s profit = $10 000


    Game theory25 l.jpg
    Game Theory

    • The best strategy, resulting in the best outcome for both players, would be to collude and not advertise.

    • “Nash” Equilibrium:

      • when player A takes the best possible action given the action of player B and player B takes the best possible action given the action of player A

    • eg. In equilibrium both firms will advertise


    Game theory26 l.jpg
    Game Theory

    • This is an example of a prisoner’s dilemma type of game.

      • There is dominant strategy.

      • The dominant strategy does not result in the best outcome for either player.

      • It is hard to cooperate even when it would be beneficial for both players to do so

    • eg., The dominant strategy: advertise


    Prisoners dilemma payoff matrix l.jpg

    1 year

    Go free

    1 year

    7 years

    7 years

    5 years

    Go free

    5 years

    Prisoners’ Dilemma Payoff Matrix

    Rocky’s strategies

    Deny

    Confess

    Dominant strategy: confess, even though they would both be better off if they both kept their mouths shut.

    Deny

    Ginger’s

    strategies

    Confess


    Game theory28 l.jpg
    Game Theory

    • Cooperation between players is difficult to maintain because cooperation is individually irrational.

    • Dominant Strategy Equilibrium

      • prisoners will confess, firms will advertise, countries arm:

        • eg, ban on cigarette advertising


    Solving the dilemma l.jpg
    Solving the “dilemma”

    • 1. Enforceable contract

    • without an enforceable contract, is cooperation possible?

      • A solution to the “prisoner’s dilemma” can emerge if the game is played more than once; i.e., many times.


    Solving the dilemma30 l.jpg
    Solving the “dilemma”

    • 2. Repeated Games

      • Most real-world games get played repeatedly

      • Repeated games have a larger number of strategies because a player can be punished for not cooperating

      • This suggests that real-world duopolists might find a way of cooperating in order to increase profits


    Solving the dilemma31 l.jpg
    Solving the “dilemma”

    • 2. Tit-for-Tat Strategy

      • a player should start by cooperating and then do whatever the other player did last time.

        • e.g., player cooperates until the other player cheats, the first player then cheats until the other player co-operates again.

      • What is the Nash Equilibrium when facing a tit-for-tat strategy?