Monopolistic Competition

1
Monopolistic Competition

• A large number of firms compete.
• Small market share
• Ignore other firms
• Collusion Impossible
• Each firm produces a differentiated product.
• A product slightly different from the products of
  competing firms.

2

• Firms compete on product quality, price, and
  marketing.
• Quality - design, reliability, service, ease of
  access to the product.
• Price - downward sloping demand curve.
• Marketing - advertising and packaging.
• Firms are free to enter and exit.
• Consequently, a firm in monopolistic competition
  cannot make an economic profit in the long-run.

3
Output and Price inMonopolistic Competition

• Short-Run Economic Profit
• The firm in monopolistic competition looks just
  like a single price monopoly.
• The key difference between monopoly and
  monopolistic competition lies in the long-run.

4
Monopolistic Competition
Short-run
220
Price (dollars per jacket)
ATC
190
160
D
140
120
MR
150
50
100
200
250
300
0
Quantity (jackets per day)
5
Output and Price inMonopolistic Competition

• Long-Run Zero Economic Profit
• Economic profit attracts new entrants.
• As new firms enter the industry, the firms
  demand curve and marginal revenue start to shift
  leftward.
• The profit-maximizing quantity and price fall.

6
Monopolistic Competition
Long-run
220
Price (dollars per jacket)
180
ATC
160
145
120
MR'
D'
0
150
50
100
200
250
300
Quantity (jackets per day)
7
Monopolistic Competition and Efficiency P gt
MC Willingness to pay exceeds marginal
cost Some deadweight loss Also, ATC not at a
minimum (excess capacity) BUT, There is more
product variety, which consumers value Thus,
efficiency implications are unclear
8
Advertising in Monopolistic Competition -
Advertising expenditures increase the costs of a
monopolistically competitive firm above those of
a competitive firm or monopoly. - Advertising
increases demand for the product of the
advertiser, and reduces demand for competing
products. Distinguish demand creation and demand
diversion Demand diversion is main effect
9
What effect would restrictions on advertising (or
other marketing efforts) have in monopolistically
competitive markets? Examples Restrictions on
cigarette advertising Blue laws Financial aid
coordination Such restrictions reduce
competition, which increases price and reduces
variety
10
Oligopoly

• Price and quantity of a producer depends upon
  that of the other producers.
• Models developed to explain the prices and
  quantities in oligopoly markets
• Traditional
• Kinked Demand Curve Model
• Dominant Firm Model
• Game Theory

11
The Kinked Demand Curve Model

• Assumption
• If a firm raises its price, others not follow
• more elastic response
• If a firm cuts its price, others will follow
• less elastic response
• This assumption results in the kinked demand
  curve.

12
The Kinked DemandCurve Model
Price and cost (dollars)
P
D
0
Q
Quantity
13
The Kinked Demand Curve Model

• Problems with this model
• Beliefs about the demand curve are not always
  correct.
• Other firms may, in fact, follow a price
  increase.
• This may result in the firm incurring an economic
  loss.

14
Dominant Firm Oligopoly

• A dominant firm oligopoly may exist if one
  firm
• Has a big cost advantage over the other firms.
• Sells a large part of the industry output.
• Sets the market price.
• Other firms are price takers.

15
Dominant Firm Oligopoly
Ten small firms and market demand
Big-Gs price and output decision
1.50
1.50
Price (dollars per gallon)
1.00
1.00
D
0.50
0.50
XD
10
0
0
20
10
20
Quantity (thous. of gal./week)
Quantity (thous. of gal./week)
16
Game Theory

• What is a game?
• Games have 3 features
• Rules
• Strategies
• Payoffs
• The Prisoners Dilemma is a game that is used
  to generate predictions.
• Use game theory to help understand Oligopoly

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Prisoners Dilemma Payoff Matrix
Arts strategies
Confess
Deny
Confess
Bobs strategies
Deny
18
Duopoly Payoff Matrix
Gears strategies
Cheat
Comply
Cheat
Tricks strategies
Comply
19
Pampers Versus Huggies An RD Game
Procter Gambles strategies
RD
No RD
RD
Kimberly- Clarks strategies
No RD