1、Chapter 13 Monopolistic Competition and Oligopoly,Monopolistic competition. Output and price determination in SR and LR. Role of advertising Oligopoly Definition. Price and output determination game theoryCartelsAnti-trust laws and regulation of markets,Monopolistic Competition,Characteristics of Mo
2、nopolistic competition Large number of firms.limited market power (demand relatively elastic).Independent decision makingCollusion impossible Each firm produces a differentiated pete on product quality, price, and marketing.Firms are free to enter and exit the industry.Economic profits driven to zer
3、o in long run,Monopolistic Competition,Red=4 largest. Green=5-8 Blue=9-20,Market Share in Monopolistic Competition,Output and Price in Monopolistic Competition,The Firms Short-Run Output and Price Decision Holding quality and marketing constant, profit maximization is achieved by choosing the price/
4、quantity where MR = MC Identical to profit maximizing rule for perfect competition and single price monopoly,SR Output and Price in Monopolistic Competition,Identify: profit maximizing P & Q Profit Socially efficient Q Deadweight loss,Output and Price in Monopolistic Competition,Long Run: Zero Econo
5、mic Profit In the long run, economic profit (loss) induces entry (exit). Entry (exit) causes demand curve for existing firms to shift downward (upward). Entry continues as long as firms in the industry earn an economic profitas long as (P ATC).,To maximize profits, this firm should produce,Less than
6、 40 40 60 Between 40 and 60,To maximize profits, this firm should charge a price of,$1 $2 $3 Above $3,If the firm maximizes profits, its profits will be,$20 $40 $80 Above $80,SR Output and Price in Monopolistic Competition,Given the short run equilibrium described, why does entry occur? As entry occ
7、urs, demand shifts leftward until profit equals zero.,Output and Price in Monopolistic Competition,LR equilibrium for monopolistically competitive firm. Economic profits Excess capacity socially efficient output deadweight loss Effect of elasticity on price mark-up (P vs MC) excess capacity,Output a
8、nd Price in Monopolistic Competition,Contrast to LR equilibrium for firms in perfect competition: Economic profits? Excess capacity? Socially efficient? Deadweight loss? Source of difference: product differentiation leading to downward sloping demand.,Product Development and Marketing,Innovation and
9、 Product Development To keep earning an economic profit, a firm in monopolistic competition must be in a state of continuous product development. New product development allows a firm to gain a competitive edge, if only temporarily, before competitors imitate the innovation. Examples of recent innov
10、ations in design of Banking Fast food Household cleaners,Give an example of a good or service which has incorporated a new innovation over the past year or two.,Product Development and Marketing,Advertising Firms in monopolistic competition incur heavy advertising expenditures. Why? How can advertis
11、ing be “profitable”?Changes in product demand versus changes in ATC.,Product Development and Marketing,Advertising expenditure an increase in fixed costs (not MC) shifts ATC upward and to the right may increase profit maximizing sales allowing firm to take advantage of scale economies.,Product Devel
12、opment and Marketing,Advertising increases product demand and could make it more elastic. Profits could rise or fall (should rise, or firm wouldnt advertise) If product demand becomes more elastic, (P-MC) markup could fall. Price could rise or fall.,What is Oligopoly?,The distinguishing features of
13、oligopoly are:Natural or legal barriers that prevent entry of new firmsA “small” number of firms compete causing “interdependent” decision making.,What is Oligopoly?,Barriers to Entry Either natural or legal barriers to entry can create oligopoly. With demand as drawn, there is a natural duopolya ma
14、rket with two firms. How would answer change if demand increases?,What is Oligopoly?,Small Number of Firms With a small number of firms, each firms profit depends on every firms actions. Firms are interdependent and face a temptation to collude. Cartel: group of firms acting together to limit output
15、, raise price, and increase profit. Can be illegal. Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often “break down”.,What is Oligopoly?,Examples of Oligopoly An HHI that exceeds 1800 is generally regarded as an oligopoly by DOJ. An HHI below 1800 is
16、generally regarded as monopolistic competition. Recall earlier caveats on HHI (e.g. geographic boundaries, entry barriers),Red=4 largest; green=next 4; blue =next 12,Two Traditional Oligopoly Models,The Kinked Demand Curve Model. SKIP IT.Dominant Firm Oligopoly SKIP IT.,Oligopoly Games,Game theory a
17、 tool for studying strategic behavior, which is behavior that takes into account the expected behavior of others and the mutual recognition of interdependence.,British game show illustrates a common type of “game” that arises in economics,Golden Balls (compliments of youtube),Whats your prediction?
18、She will _ and he will _.,Split; SplitSplit; StealSteal; SplitSteal; Steal,Oligopoly Games,The Prisoners Dilemma Each prisoner is told that both are suspected of committing a more serious crime. If one of them confesses, he gets a 1-year sentence for cooperating while his accomplice gets a 10-year s
19、entence for both crimes. If both confess to the more serious crime, each receives 3 years in jail for both crimes. If neither confesses, each receives a 2-year sentence for the minor crime only.,Oligopoly Games,Nash equilibrium first proposed by John Nash if a player makes a rational choice in pursu
20、it of his own best interest, he chooses the action that is best for him, given any action taken by the other player.,Whats the Nash Equilibrium? Whats the “cooperative” equilibrium?,Oligopoly Games,An Oligopoly Price-Fixing Game: Cartels.,Oligopoly Games,Based on above diagram:What is competitive pr
21、ice, firm output, industry output, profit?What is cartel (“collusive agreement”) price, output, profit?What is deadweight loss? Effect on consumer? Effect on producers?What is “incentive to cheat”?How is this like “prisoners dilemma”?How do each of following affect ability to enforce cartel?Entry re
22、strictions.Ability to monitor each other.,Oligopoly Games,Other Oligopoly Games Advertising and R & D games are prisoners dilemmas. An R & D Game Procter & Gamble and Kimberley Clark play an R & D game in the market for disposable diapers.,What is the cooperative equilibrium?,Neither advertises P P&
23、G does not Both advertise,What is the Nash equilibrium?,Neither advertises P P&G does not Both advertise,Anti-trust policy,Measuring concentration. DOJ formed merger guidelines in early 1980s. if post-merger HHIindustry competitive. if 1000merger scrutinized (gray area). if HHI1800= merger likely to
24、 be challenged (red zone). Difficulties in using concentration measures as indicators of competition for mergers. geographic scope of market product boundaries firms produce multiple products.,Anti-trust policy,Likelihood of collusion and DOJ anti-trust policy. When HHI is in a questionable area, ot
25、her factors are considered.Barriers to entryAbility to monitor each others behavior.Is the game “repeated”?,Anti-trust policy,Theories of regulation. Public interest theory political process generates regulations designed to achieve “socially efficient” outcome.Capture theory regulations are designe
26、d to satisfy the demand of producers to maximize producer surplus.benefit producers (concentrated group) at expense of consumers (disperse group).,Anti-trust policy,Evidence on Deregulation of 1980s. AIRLINESprices fell and volume increased. consumer surplus increased $11.8 billion producer surplus
27、increased $4.9 billion. rapid change in structure of airline industry (hubs, excess capacity reduced, pricing changes, etc.) TRUCKING consumer surplus increased $15.4 billion producer surplus decreased $4.8 billion. truck drivers wages fell.,Anti-trust policy,Anti-trust policy. The Standard Oil Stor
28、y:John D. Rockefeller owned standard oil. Able to extract discounts from the railroads for shipping During the 1870s, Standard Oil increased its capacity from 10 to 90 percent of the U.S. total. In 1882, the independent members of standard oil contributed shares to a central trustAllowed a central b
29、ody to manage all firms. The central body shut down some refineries, restricted production, and drove up oil prices.,Anti-trust policy,1890: Sherman Act passed partly in response to the monopolization of the oil industry. Law prohibited “combination, trust, or conspiracy to restrict interstate or in
30、ternational trade”.Sherman Act used in 1911 to break up Standard Oil (created Exxon, Sohio, Chevron, etc.),Anti-trust policy,1914: Clayton Act. prohibited interlocking directorates & tying contracts1914: Federal Trade Commission Actcreated FTC to prosecute “unfair competition” outlawed misleading ad
31、vertising.,Anti-trust policy,1936: Robinson-Patman Act (Chain store law)made “quantity discounts” illegalprevented stores from selling to public at “unreasonably low” prices. 1937: Miller-Tydings Actallowed Resale Price Maintenace if state approved.arguments against RPM (cartel enforcement)argument for RPM (high quality service) McTravel Apple computer,
