Monopolistic Competition and Oligopoly

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Monopolistic Competition and Oligopoly
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Monopolistic Competition

• Large of firms selling products that are close
  substitutes
• Different enough so that the firms demand curve
  slopes downward
• Differences may be real or perceptual
• Few barriers to entry
• Sellers act independently

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Types of Differences

• Physical Differences- called product
  differentiation
• Location- number and variety of locations a
  product can be purchases at
• Services that accompany product
• Product Image- real or perceptual differences in
  how consumers perceive product

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Exhibit 1a The Firm in Monopolistic Competition
in the Short Run

• Produce at MC-MR
• At that point, find Demand.
• If ATC is below that point, you have profit, if
  not, you have a loss

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Exhibit 2 Long-run Equilibrium in Monopolistic
Competition
If there are economic profits, new firms will
enter the industry. The firms demand curve
declines until MCMRATC. At that point,
economic profit is zero.
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Exhibit 3a Monopolistic Competition Versus
Perfect Competition (Perfect Competition)
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Exhibit 3b Monopolistic Competition Versus
Perfect Competition (Monopolistic Competition)
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Economic Efficiency

• Perfect Competition Price intersects average
  total cost at its minimum point lowest price and
  highest quantity
• Monopolistic Competition- Price intersects
  average total cost above its minimum point
  therefore a higher resultant price and lower
  quantity

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Oligopoly

• Market structure characterized by a small number
  of interdependent firms.
• Some can have a homogeneous product, some are
  differentiated.
• In general, the more differentiated, the more
  price sensitive
• Usually cause by some barrier to entry

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Exhibit 4 Economies of Scale as a Barrier to
Entry
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Barriers to Entry

• Economies of Scale
• High Cost of Entry into the firm or industry
• Oligopolic behavior can occur at the local or
  regional level, not just the national and
  international level.

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Models of Oligopoly

• Collusion
• Price Leadership
• Game Theory
• Kinked Demand

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Collusion

• An agreement among firms to divide the market or
  to fix the market price to maximize the economic
  benefit..
• Cartel- a group of firms that agree to coordinate
  production and pricing decisions

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Exhibit 5 Cartel Model Where Firms Act as a
Monopolist
Cartel creates a multi- Firm monopoly. Produce
at MCMR, sell quantity q at price p.
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Problems with Cartels

• Firms have different costs so at the
  monopolistic behavior point they have different
  profits from different production costs
• If the cartel cannot block entry into the
  industry, new entrants will force the price down
• Members Cheat
• The more cartel members, the harder to keep
  agreement and coordination.

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Price Leadership

• A firm whose price is adopted by the industry.
• Still have different cost structures
• Greater the differentiation, the harder to follow
  the lead
• Profitable price will attract new entrants

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Game Theory

• A model that looks at Oligopoly as a series of
  strategic moves and counter moves by rival firms.
• Cooperate or Compete
• What strategy should the firm follow?

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Exhibit 6 A Payoff Matrix
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Kinked Demand

• A demand curve that illustrates price stickiness
  
• If one firms cuts its prices, others in the
  industry will cut as well
• If the firm raises its prices, other firms will
  not change theirs

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Exhibit 7 The Kinked Demand Model of Oligopoly
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Marginal Revenue Effects

• Look at the resultant MR on the next slide,
• It kinks to with a gap.
• Within the gap marginal cost has a range where
  costs can change and P and Q do not.

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Exhibit 8 Demand and Marginal Revenue Curves for
the Kinked Demand Model
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Summary

• Price is usually higher under oligopoly (than
  perfect competition)
• Profits are usually higher under oligopoly (than
  perfect competition)