Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill...
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Transcript of Monopolistic Competition and Oligopoly 11 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill...
Monopolistic Competition and Oligopoly
11
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopolistic Competition
• Relatively large number of sellers
• Differentiated products
• Easy entry and exit
• Advertising
LO1 11-2
Monopolistically Competitive
• Industry concentration
• Measured by:
• Four-firm concentration ratios
•Percentage of 4 largest firms
• Herfindahl index
• Sum of squared market shares
LO1
4-Firm CR = Output of four largest firmsTotal output in the industry
HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2
11-3
Low Concentration Industries(1)
Industry(2)
4-Firm Concentration
Ratio
(3)Herfindahl
Index
(1)Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
Index
Asphalt paving 25 207Metal windows and doors 14 114
Plastic pipe 24 262 Women’s dresses 13 84
Textile bags 24 263 Ready mix concrete 11 63
Bolts, nuts, and rivets 24 205 Wood trusses 10 50
Plastic bags 23 240 Stone products 10 59
Quick printing 22 319 Metal stamping 8 31
Textile machinery 20 206 Wood pallets 7 24
Sawmills 18 117 Sheet metal work 6 25
Jewelry 16 117 Signs 5 19
Curtains and draperies 16 111 Retail bakeries 4 7
LO1 11-4
Price and Output in Monopolistic Comp
• Demand is highly elastic
• Short run profit or loss
• Produce where MR=MC
• Long run normal profit
• Entry and exit
• Inefficient
• Product variety
LO2 11-5
The Short Run: Profit or Loss
LO2
Quantity
Pri
ce
an
d C
os
ts
MR = MC
MC
MR
D1
ATC
EconomicProfit
Q1
A1
P1
0
11-6
The Short Run: Profit or Loss
LO2
Quantity
Pri
ce
an
d C
os
ts
MC
MR
D2
ATC
Loss
Q2
A2
P2
0
MR = MC
11-7
The Long Run: Only a Normal Profit
LO2
Quantity
Pri
ce
an
d C
os
ts
MC
MR
D3
ATC
Q3
P3= A3
0
MR = MC
11-8
Monopolistic Competition: Efficiency
• Inefficient
• Productive inefficiency
•P > ATC
• Allocative inefficiency
•P > MC
LO2 11-9
Monopolistic Competition: Efficiency
LO2
P=MC=Min ATC for pure competition (recall)
P4
Q4
Price is Lower
Excess Capacity atMinimum ATC
Monopolistic competition is not efficient11-10
Product Variety
• The firm constantly manages price, product, and advertising.
• Better product differentiation
• Better advertising
• The consumer benefits by greater array of choices and better products.
• Types and Styles
• Brands and Quality
LO2 11-11
Oligopoly
• A few large producers
• Homogeneous or differentiated products
• Limited control over price
• Mutual interdependence
• Strategic behavior
• Entry barriers
• Mergers
LO3 11-12
Oligopolistic Industries
• Four-firm concentration ratio
• 40% or more to be oligopoly
• Shortcomings
• Localized markets
• Inter-industry competition
• World price
• Dominant firms
LO3 11-13
High Concentration Industries(1)
Industry(2)
4-Firm Concentration
Ratio
(3)Herfindahl
Index
(1)Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
Index
Primary copper 99 ND Petrochemicals 85 2662
Cane sugar refining 99 NDSmall arms ammunition 83 1901
Cigarettes 95 ND Motor vehicles 81 2321
Household laundry equipment 93 ND
Men’s slacks and jeans 80 2515
Beer 91 ND Aircraft 81 ND
Electric light bulbs 89 2582 Breakfast cereals 78 2521
Glass containers 88 2582Household vacuum cleaners 78 2096
Turbines and generators 88 ND Phosphate fertilizers 78 1853
Household refrigerators and freezers 85 1986
Tires 77 1807
Electronic computers 76
2662
Primary aluminum 85 ND Alcohol distilleries 71 1609
LO1 11-14
Game Theory Overview
• Oligopolies display strategic pricing behavior
• Mutual interdependence
• Collusion
• Incentive to cheat
• Prisoner’s dilemma
LO4 11-15
Game Theory Overview
LO4
RareAir’s Price Strategy
Up
tow
n’s
Pri
ce
Str
ate
gy A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low•2 competitors•2 price strategies
•Each strategy has a payoff matrix
•Greatest combinedprofit
• Independent actionsstimulate a response
11-16
Game Theory Overview
LO4
RareAir’s Price Strategy
Up
tow
n’s
Pri
ce
Str
ate
gy A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low• Independently lowered prices in expectation of greater profit leads to worst combined outcome
•Eventually low outcomes make firms return to higher prices.
11-17
3 Oligopoly Models
• Kinked Demand Curve
• Collusive Pricing
• Price Leadership
• Reasons for 3 models
• Diversity of oligopolies
• Complications of interdependence
LO5 11-18
Kinked-Demand Theory
• Noncollusive oligopoly
• Uncertainty about rivals reactions
• Rivals match any price change
• Rivals ignore any price change
• Assume combined strategy
• Match price reductions
• Ignore price increases
LO5 11-19
Kinked Demand Curve
LO5
P0
MR2
D2
D1
MR1
e
f
g
Rivals IgnorePrice Increase
Rivals MatchPrice Decrease
Q0
MR2
D2
D1
MR1Q0
MC1
MC2
P0
e
f
g
11-20
Kinked Demand Curve
• Criticisms
• Explains inflexibility, not price
• Prices are not that rigid
• Price wars
LO6 11-21
Cartels and Other Collusion
LO6
D
MR=MC
ATC
MC
MR
P0
A0
Q0
EconomicProfit
11-22
Global Perspective
LO6 11-23
Overt Collusion
• Cartels - a group of firms or nations that collude
• Formally agreeing to the price
• Sets output levels for members
• Collusion is illegal in the United States
• OPEC
LO6 11-24
Obstacles to Collusion
• Demand and cost differences
• Number of firms
• Cheating
• Recession
• New entrants
• Legal obstacles
LO6 11-25
Price Leadership Model
• Price Leadership
• Dominant firm initiates price changes
• Other firms follow the leader
• Use limit pricing to block entry of new firms
• Possible price war
LO6 11-26
Oligopoly and Advertising
• Prevalent to compete with product development and advertising
• Less easily duplicated than a price change
• Financially able to advertise
LO7 11-27
Positive Effects of Advertising
• Low-cost way of providing information to consumers
• Enhances competition
• Speeds up technological progress
• Can help firms obtain economies of scale
LO7 11-28
Oligopoly and Advertising
LO7
The Largest U.S. Advertisers, 2008
CompanyAdvertising Spending Millions of $
Procter & Gamble $4831
Verizon $3700
AT&T $3073
General Motors $2901
Johnson & Johnson $2529
Unilever $2423
Walt Disney $2218
Time Warner $2208
General Electric $2019
Sears $1865
Source: Advertising Age http://www.adage.com
11-29
Negative Effects of Advertising
• Can be manipulative
• Contains misleading claims that confuse consumers
• Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product.
LO7 11-30
Global Perspective
LO7 11-31
Oligopoly and Efficiency
• Oligopolies are inefficient
• Productively inefficient P > minATC
• Allocatively inefficient P > MC
• Qualifications
• Increased foreign competition
• Limit pricing
• Technological advance
LO7 11-32
Oligopoly in the Beer Industry
• The beer industry is now an oligopoly.
• Changes in demand
• Change in tastes
• Consumed at home and mass produced
• Changes in supply
• Technological advance
• Economies of scale
11-33