Monopolistic Monopolistic Competition & Competition & OligopolyOligopoly

OutlineOutline

I. Introduction

A. Where Does Monopolistic Competition “fit in”?

B. Assumptions of Monopolistic Competition

II. Monopolistic Competition

A. Short Run

B. Long Run

Outline (Cont.)Outline (Cont.)

III. Long Run Conditions

A. Excess Capacity

B. Product Differentiation

C. Allocative and Productive Efficiency

IV. Oligopoly

A. Where Oligopoly “fits in”

B. Assumptions

C. Concentration Ratios

Outline (Cont.)Outline (Cont.)

V. Models of Oligopoly

A. Cartel Theory

B. Game Theory

Where Does Monopolistic Where Does Monopolistic Competition “fit in?”Competition “fit in?”

Perfect Competition Monopoly

Where Does Monopolistic Where Does Monopolistic Competition “fit in?”Competition “fit in?”

Perfect Competition Monopoly

MonopolisticCompetition

Assumptions of Monopolistic Assumptions of Monopolistic CompetitionCompetition

• Many buyers and sellers (as opposed to monopoly)

• Firms produces a similar, yet unique product (gives us downward sloping demand)

• Ease of entry and exit

Examples of Monopolistically Examples of Monopolistically Competitive MarketsCompetitive Markets

• Pizza Places (Pizza Hut, Dominos)

• Hairdressers

• Grocery Stores (IGA, Kroger, Meijer)

Monopolistic Competition in the Monopolistic Competition in the Short RunShort Run

• Looks and Acts Like Monopoly• Faces Downward Sloping Demand and MR• Produces where MR=MC and may make a

profit.

Monopolistic Competition in the Monopolistic Competition in the Short RunShort Run

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVCatc*

p*

Monopolistic Competition in the Monopolistic Competition in the Long RunLong Run

• Firm Demand Shifts Back and Gets More Elastic.• Demand Shifts Back Because More Firms Enter

the Industry, So There is Less Demand Per Firm.

• Demand Gets More Elastic Because More Firms Means More Substitutes and More Substitutes Means More Elastic

Monopolistic Competition in the Monopolistic Competition in the Long RunLong Run

• Like Perfect Competition, Firms Will Continue to Enter Until There are No More Profits to Attract Them.

Monopolistic Competition in the Monopolistic Competition in the Long RunLong Run

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVCatc*p*=

Long Run Conditions of Long Run Conditions of Monopolistic CompetitionMonopolistic Competition

• Excess Capacity

• Product Differentiation

• Efficiency

Excess CapacityExcess Capacity

• Excess Capacity is the Difference Between The Long Run Perfectly Competitive Quantity Produced and the Long Run Monopolistically Competitive Quantity Produced.

• Generally Speaking, There Will be Excess Capacity in the Long Run of Monop. Competition.

Excess CapacityExcess Capacity

P

Q

D

0MR

MC

P*

ATCAVC

Q

Excess Capacity

Q

Product DifferentiationProduct Differentiation

• The More That a Firm Can Differentiate Their Product, The More Inelastic The Demand Becomes.

• Thus, Profits Can Be Sustained.

• This is the Role of Advertising.

EfficiencyEfficiency

• Productive Efficiency– Generally, A Monopolistically Competitive

Firm is not Productively Efficient, since it is not producing at the bottom of it’s ATC curve

• Allocative Efficiency– Generally, A Monopolistically Competitive

Firm is not Allocatively Efficient, since there is excess capacity.

OligopolyOligopoly

• For a Market to be Described as Oligopolistic, it must satisfy the following conditions:– Few Sellers, Many Buyers (more like

Monopoly).– The Firm’s products may be identical or unique– The are Barriers to Entry (like monopoly)

Where Does Oligopoly “fit in?”Where Does Oligopoly “fit in?”

Perfect Competition Monopoly

MonopolisticCompetition

Oligopoly

Concentration RatiosConcentration Ratios

• One Way to Determine Whether a Market is Oligopolistic is to look at a Concentration Ratio

• A Concentration Ratio Let’s Us Know if the Whole Industry’s Sales are Dominated by the Sales of a Few Firms.

• The X-Firm Concentration Ratio is the Percentage of Industry Sales Accounted for by the Sales of the Top X Firms in the Industry:

• Sales of the Top X Firms

Total Industry Sales

The X-Firm Concentration RatioThe X-Firm Concentration Ratio

Models of OligopolyModels of Oligopoly

• Cartel Theory: The Oligopolists Get Together (Since There are So Few of Them) and Act As If They Were One Monopolist and Collectively Produce the Monopolistic Quantity - Thus Maximizing Profit

• Example: OPEC

Problems With CartelsProblems With Cartels

• Generally, They Are Not Legal (Price Fixing)

• They Are Difficult to Organize and Monitor

• Can’t Force New Firms to Join

• Cheating

The Incentive to Cheat On A The Incentive to Cheat On A CartelCartel

• If the Cartel Maintains the Monopoly Price, The Individual Member of the Cartel Can Act Like a Price Taker (They Can Sell All They Want at the Market Price)

• As a Price Taker, They Maximize Profit Where MC=MR.

The Incentive to Cheat On A The Incentive to Cheat On A Cartel (Cont.)Cartel (Cont.)

• This Quantity is Greater Than the Cartel Wants the Individual Firm to Produce.

• All Firms in the Cartel Do This and the Cartel Falls Apart

Qcheater

The Incentive to Cheat On A The Incentive to Cheat On A CartelCartel

Firm

$ $

Q

DMR

MC

P

Q Q

MC ATC

MR

Market

Game TheoryGame Theory

• Game Theory is a Technique That Allows Us to Examine The Strategies of Oligopolists

• This Technique Allows Us to Determine the Best Strategy for a Oligopolist if the Other Oligopolists are Aware of the All of Avaliable Strategies

Example - The Prisoner’s Example - The Prisoner’s DilemmaDilemma

Consider the Following Story:

• Bill and Jill Have Cheated on an Exam

• They are Both Caught

• Bill in Prof. Platt’s Office and Jill is Prof. Lage’s Office

• Each Are Told That Their Punishment Will Be Somewhat Lighter if They Confess

Example - The Prisoner’s Example - The Prisoner’s Dilemma (Cont.)Dilemma (Cont.)

• They Both Know That if They BOTH Admit Nothing, it Will Be Tough to Prove That They Cheated

• They Can’t Communicate With Each Other

• What Do They Do?

Example - The Prisoner’s Example - The Prisoner’s DilemmaDilemma

Bill Confesses

Bill is Silent

Jill ConfessesJill is Silent

They Are Both Suspended For a Year, Fail the Class andTranscipts are Noted.

They Fail The Classand Their Transcriptis Noted

Jill Fails,Bill is Expelled

Bill Fails,Jill is Expelled

How Does The Prisoner’s How Does The Prisoner’s Dilemma Apply to Oligopoly?Dilemma Apply to Oligopoly?

• A Cartel Can only Hold Together if Everyone Sticks to Producing the Monopoly Quantity

• But a Cheater Benefits More Than the Others - Much Like Confession By Bill or Jill Alone, Benefits One More Than the Other.

• But if They All Know This -- They All Cheat and the Cartel Falls Apart.