Ch13
- 1. Monopolistic Competition and Oligopoly
- 2. Monopolistic Competition A monopolistically competitive industry has the following characteristics: A large number of firms No barriers to entry Product differentiation
- 3. Monopolistic Competition Monopolistic competition is a common form of industry (market) structure in the United States, characterized by a large number of firms, none of which can influence market price by virtue of size alone. Some degree of market power is achieved by firms producing differentiated products. New firms can enter and established firms can exit such an industry with ease.
- 4. Nine Industries with Characteristics of Monopolistic Competition 7605 13 8 5 Miscellaneous plastic products 3089 Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. 3943 30 17 11 Women’s dresses 2335 518 41 22 14 Blowers and fans 3564 600 47 28 19 Fresh or frozen seafood 2092 1004 48 32 22 Curtains and draperies 2391 2504 62 38 23 Book publishing 2731 611 51 34 26 Wood office furniture 2521 204 67 47 34 Dolls 3942 270 72 57 41 Travel trailers and campers 3792 NUMBER OF FIRMS TWENTY LARGEST FIRMS EIGHT LARGEST FIRMS FOUR LARGEST FIRMS INDUSTRY DESIGNATION SIC NO. Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992
- 5. Product Differentiation, Advertising, and Social Welfare Source: McCann Erickson, Inc., Reported in U.S. Bureau of the Census, Statistical Abstract of the United States , 1999, Table 947. 200.3 Total 10.4 Magazines 14.5 Radio 12.0 Yellow pages 31.7 Other 39.5 Direct mail 48.0 Television 44.2 Newspapers DOLLARS (BILLIONS) Total Advertising Expenditures in 1998
- 6. The Case for Product Differentiation and Advertising The advocates of free and open competition believe that differentiated products and advertising give the market system its vitality and are the basis of its power. Product differentiation helps to ensure high quality and efficient production.
- 7. The Case for Product Differentiation and Advertising Advertising provides consumers with the valuable information on product availability, quality, and price that they need to make efficient choices in the market place.
- 8. The Case Against Product Differentiation and Advertising Critics of product differentiation and advertising argue that they amount to nothing more than waste and inefficiency. Enormous sums are spent to create minute, meaningless, and possibly nonexistent differences among products.
- 9. The Case Against Product Differentiation and Advertising Advertising raises the cost of products and frequently contains very little information. Often, it is merely an annoyance. People exist to satisfy the needs of the economy, not vice versa. Advertising can lead to unproductive warfare and may serve as a barrier to entry, thus reducing real competition.
- 10. Product Differentiation Reduces the Elasticity of Demand Facing a Firm Based on the availability of substitutes, the demand curve faced by a monopolistic competitor is likely to be less elastic than the demand curve faced by a perfectly competitive firm, and likely to be more elastic than the demand curve faced by a monopoly.
- 11. Monopolistic Competition in the Short Run In the short-run, a monopolistically competitive firm will produce up to the point where MR = MC . This firm is earning positive profits in the short-run.
- 12. Monopolistic Competition in the Short-Run Profits are not guaranteed. Here, a firm with a similar cost structure is shown facing a weaker demand and suffering short-run losses.
- 13. Monopolistic Competition in the Long-Run The firm’s demand curve must end up tangent to its average total cost curve for profits to equal zero. This is the condition for long-run equilibrium in a monopolistically competitive industry.
- 14. Economic Efficiency and Resource Allocation In the long-run, economic profits are eliminated; thus, we might conclude that monopolistic competition is efficient, however: Price is above marginal cost. More output could be produced at a resource cost below the value that consumers place on the product.
- 15. Economic Efficiency and Resource Allocation In the long-run, economic profits are eliminated; thus, we might conclude that monopolistic competition is efficient, however: Average total cost is not minimized. The typical firm will not realize all the economies of scale available. Smaller and smaller market share results in excess capacity.
- 16. Oligopoly An oligopoly is a form of industry (market) structure characterized by a few dominant firms. Products may be homogeneous or differentiated. The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others.
- 17. Ten Highly Concentrated Industries 55 95 84 Small arms ammunition 3482 52 98 82 Household refrigerators and freezers 3632 Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. 398 91 84 Motor vehicles 3711 42 98 85 Cereal breakfast foods 2043 76 94 86 Electric lamp bulbs 3641 160 98 90 Malt beverages (beer) 2082 8 100 93 Cigarettes 2111 10 99 94 Household laundry equipment 3633 11 99 98 Primary copper 3331 5 100 98 Cellulosic man-made fiber 2823 NUMBER OF FIRMS EIGHT LARGEST FIRMS FOUR LARGEST FIRMS INDUSTRY DESIGNATION SIC NO. Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1992
- 18. Oligopoly Models All kinds of oligopoly have one thing in common: The behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry comprising the oligopoly.
- 19. The Collusion Model A group of firms that gets together and makes price and output decisions jointly is called a cartel . Collusion occurs when price- and quantity-fixing agreements are explicit. Tacit collusion occurs when firms end up fixing price without a specific agreement, or when agreements are implicit.
- 20. The Cournot Model The Cournot model is a model of a two-firm industry (duopoly) in which a series of output-adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly.
- 21. The Kinked Demand Curve Model The kinked demand model is a model of oligopoly in which the demand curve facing each individual firm has a “kink” in it. The kink follows from the assumption that competitive firms will follow if a single firm cuts price but will not follow if a single firm raises price.
- 22. The Kinked Demand Curve Model Above P*, an increase in price, which is not followed by competitors, results in a large decrease in the firm’s quantity demanded (demand is elastic). Below P*, price decreases are followed by competitors so the firm does not gain as much quantity demanded (demand is inelastic).
- 23. The Price-Leadership Model Price-leadership is a form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.
- 24. The Price-Leadership Model Assumptions of the price-leadership model: The industry is made up of one large firm and a number of smaller, competitive firms; The dominant firm maximizes profit subject to the constraint of market demand and subject to the behavior of the smaller firms; The dominant firm allows the smaller firms to sell all they want at the price the leader has set.
- 25. The Price-Leadership Model Outcome of the price-leadership model: The quantity demanded in the industry is split between the dominant firm and the group of smaller firms. This division of output is determined by the amount of market power that the dominant firm has. The dominant firm has an incentive to push smaller firms out of the industry in order to establish a monopoly.
- 26. Predatory Pricing The practice of a large, powerful firm driving smaller firms out of the market by temporarily selling at an artificially low price is called predatory pricing . Such behavior became illegal in the United States with the passage of antimonopoly legislation around the turn of the century.
- 27. Game Theory Game theory analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. In game theory, firms are assumed to anticipate rival reactions.
- 28. Payoff Matrix for Advertising Game The strategy that firm A will actually choose depends on the information available concerning B’s likely strategy. A’s profit = $10,000 B’s profit = $10,000 A’s profit = $75,000 B’s loss = $25,000 Advertise A’s loss = $25,000 B’s profit = $75,000 A’s profit = $50,000 B’s profit = $50,000 Do not advertise Advertise Do not advertise A’s STRATEGY B’s STRATEGY
- 29. Payoff Matrix for Advertising Game Regardless of what B does, it pays A to advertise. This is the dominant strategy , or the strategy that is best no matter what the opposition does. A’s profit = $10,000 B’s profit = $10,000 A’s profit = $75,000 B’s loss = $25,000 Advertise A’s loss = $25,000 B’s profit = $75,000 A’s profit = $50,000 B’s profit = $50,000 Do not advertise Advertise Do not advertise A’s STRATEGY B’s STRATEGY
- 30. The Prisoners’ Dilemma Both Ginger and Rocky have dominant strategies: to confess. Both will confess, even though they would be better off if they both kept their mouths shut. Ginger: 5 years Rocky: 5 years Ginger: 7 years Rocky: free Ginger: free Rocky: 7 years Ginger: 1 year Rocky: 1 year Do not confess Confess Do not confess Confess GINGER ROCKY
- 31. Payoff Matrix for Left/Right-Top/Bottom Strategies Because D’s behavior is predictable (he will play the right-hand strategy), C will play bottom. When all players are playing their best strategy given what their competitors are doing, the result is called Nash equilibrium. Original Game C wins $200 D wins $100 C loses $100 D wins no $ Bottom C wins $100 D wins $100 C wins $100 D wins no $ Top Right Left C’s STRATEGY D’s STRATEGY
- 32. Payoff Matrix for Left/Right-Top/Bottom Strategies C is likely to play top and guarantee herself a $100 profit instead of losing $10,000 to win $200, even if there is just a small chance of D’s choosing left. When uncertainty and risk are introduced, the game changes. A maximin strategy is a strategy chosen to maximize the minimum gain that can be earned. New Game C wins $200 D wins $100 C loses $10,000 D wins no $ Bottom C wins $100 D wins $100 C wins $100 D wins no $ Top Right Left C’s STRATEGY D’s STRATEGY
- 33. Contestable Markets A market is perfectly contestable if entry to it and exit from it are costless. In contestable markets, even large oligopolistic firms end up behaving like perfectly competitive firms. Prices are pushed to long-run average cost by competition, and positive profits do not persist.
- 34. Oligopoly is Consistent with a Variety of Behaviors The only necessary condition of oligopoly is that firms are large enough to have some control over price. Oligopolies are concentrated industries. At one extreme is the cartel, in essence, acting as a monopolist. At the other extreme, firms compete for small contestable markets in response to observed profits. In between are a number of alternative models, all of which stress the interdependence of oligopolistic firms.
- 35. Oligopoly and Economic Performance Oligopolies, or concentrated industries, are likely to be inefficient for the following reasons: They are likely to price above marginal cost. This means that there would be underproduction from society’s point of view. Strategic behavior can force firms into deadlocks that waste resources. Product differentiation and advertising may pose a real danger of waste and inefficiency.
- 36. The Role of Government The Celler-Kefauver Act of 1950 extended the government’s authority to ban vertical and conglomerate mergers. The Herfindahl-Hirschman Index (HHI) is a mathematical calculation that uses market share figures to determine whether or not a proposed merger will be challenged by the government.
- 37. Regulation of Mergers HERFINDAHL- HIRSCHMAN INDEX PERCENTAGE SHARE OF: 40 2 + 20 2 + 20 2 + 20 2 = 2,800 20 20 20 40 Industry D 25 2 + 25 2 + 25 2 + 25 2 = 2,500 25 25 25 25 Industry C 80 2 + 10 2 + 10 2 = 6,600 10 10 80 Industry B 50 2 + 50 2 = 5,000 50 50 Industry A FIRM 4 FIRM 3 FIRM 2 FIRM 1 Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms
- 38. Department of Justice Merger Guidelines (revised 1984) ANTITRUST DIVISION ACTION Unconcentrated No challenge Moderate Concentration Challenge if Index is raised by more than 100 points by the merger HHI 1,800 1,000 0 Concentrated Challenge if Index is raised by more than 50 points by the merger
Editor's Notes
- #14: As new firms enter a monopolistically competitive industry in search of profits, the demand curves of profit-making existing firms begin to shift to the left, pushing marginal revenue with them as consumers switch to the new close substitutes. This process continues until profits are eliminated, which occurs for a firm when its demand curve is just tangent to its average cost curve.