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CHAPTER 9
Monopolistic Competition and Oligopoly
1
Part Two: Microeconomics of Product Markets
Slides prepared by Bruno Fullone, George Brown College. Edited by
Laura Lamb©2010 McGraw-Hill Ryerson Ltd.
2Slides prepared by Bruno Fullone, George Brown College
9.1 Characteristics of Monopolistic Competition
• Relatively Large Number of Sellers– Small Market Shares– No Collusion– Independent Action
©2010 McGraw-Hill Ryerson Ltd.
3Slides prepared by Bruno Fullone,
George Brown College
Characteristics of Monopolistic Competition
Differentiated ProductsProduct Attributes
Service
Location
Brand Names and Packaging
Some Control Over Price
©2010 McGraw-Hill Ryerson Ltd.
Short-Run Profits
Quantity
Pri
ce a
nd
Cos
ts
MR = MC
MC
MR
D1
ATC
EconomicProfit
Q1
A1
P1
0
Figure 9-2 Monopolistic Competition
4Slides prepared by Bruno Fullone, George Brown College
©2010 McGraw-Hill Ryerson Ltd.
Short-Run Losses
Quantity
Pri
ce a
nd
Cos
ts
MR = MC
MC
MR
D2
ATC
Loss
Q2
A2
P2
0
Monopolistic Competition
5Slides prepared by Bruno Fullone, George Brown College
©2010 McGraw-Hill Ryerson Ltd.
Long-Run Equilibrium
Quantity
Pri
ce a
nd
Cos
ts
MR = MC
MC
MR
D3
ATC
Q3
P3= A3
0
Monopolistic Competition
6Slides prepared by Bruno Fullone, George Brown College
©2010 McGraw-Hill Ryerson Ltd.
Complicating factors
• Some firms may earn economic profits greater than zero in the long run.
– Why?
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
8Slides prepared by Bruno Fullone,
George Brown College
Monopolistic Competition and Efficiency
1. Allocative Efficiency
P > MC
Too little is produced
2. Productive Efficiency
Costs high
Excess capacity
©2010 McGraw-Hill Ryerson Ltd.
9Slides prepared by Bruno Fullone,
George Brown College
Product VarietyBenefits
Better match to consumer tastes
Better products
Tradeoff between variety and efficiency
Further ComplexityPrice, product, and advertising must be juggled to achieve maximum profit
©2010 McGraw-Hill Ryerson Ltd.
10Slides prepared by Bruno Fullone, George Brown College
9.3 Oligopoly: Characteristics
A Few Large ProducersHomogeneous or Differentiated Products Control Over Price, but Mutual InterdependenceEntry Barriers
Economies of scaleHigh capital costsOwnership of raw materials
Mergers©2010 McGraw-Hill Ryerson Ltd.
Two ways to measure industry concentration
1. Concentration ratio
• The four-firm concentration ratio gives the percentage of total industry sales accounted for by the four largest firms.
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
Slides prepared by Bruno Fullone, George Brown College
0 20 40 60 80 100
steel pipe & tube
frozen f ruit & vegetables
biscuit industry
tea & cof fee
motor vehicles
potato chip, pretzel & popcorn
brewery products
tobacco products
% of industry output
Figure 9-4% of Output Produced by the Four Largest Firms in
Selected High-Concentration Industries
4775
4365
3481
2453
2273
2069
1965
1038
Herfindahl Index
©2010 McGraw-Hill Ryerson Ltd.
13Slides prepared by Bruno Fullone,
George Brown College
9.4 Game Theory OverviewOligopolists must make plans in light of the actions and expected reactions of their rivals
Basic concepts:Players
Rules
Strategies
Payoffs
Equilibrium©2010 McGraw-Hill Ryerson Ltd.
14Slides prepared by Bruno Fullone,
George Brown College
Prisoner’s Dilemma
Two prisoners cannot communicate
Difficult to cooperate, even when mutually beneficial
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
Prisoner’s Dilemma Payoff Matrix
ConfessConfess Not confessNot confess
ConfessConfess
NotNot confessconfess
Al’s strategiesAl’s strategiesB
run
o’s
B
run
o’s
st
rate
gie
sst
rate
gie
s
AA BB
CC DD
44 1212
11 22
44 11
1212 22
Figure 9-5
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
Profit Payoff for a Two-Firm Oligopoly
HighHigh LowLow
HighHigh
LowLow
RareAir’s price strategyRareAir’s price strategy
Up
tow
n’s
pri
ce
Up
tow
n’s
pri
ce
stra
teg
yst
rate
gy
AA BB
CC DD
$12$12 $15$15
$6$6 $8$8
$12$12 $6$6
$15$15 $8$8
If both If both firmsfirms
choose a choose a high-price high-price strategy, strategy,
each each earns $12 earns $12 million in million in
profitprofit
If both If both firmsfirms
choose a choose a high-price high-price strategy, strategy,
each each earns $12 earns $12 million in million in
profitprofit
Collusive
Collusive
tendencies
tendencies
Collusive
Collusive
tendencies
tendencies
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
9.5 The Incentives and Obstacles to Collusion: Two Oligopoly Strategies
• Two distinct pricing strategies:1. Collusive pricing
2. Price leadership
• There is no one simple model to predict outcomes due to:
– Diversity of oligopolies– Complications of interdependence
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
Cartels and Other Collusion: Cooperative Strategies
• Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition
• Each firm acts as if it were a pure monopolist
Illustrated…©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
DD
MCMC
ATCATC
MRMR
PP
MR=MCMR=MCPri
ce a
nd
Co
sts
Pri
ce a
nd
Co
sts
QQ00
AA00
PP00Economic profitEconomic profit
Collusion and Joint-Profit Maximization
Figure 9-7
©2010 McGraw-Hill Ryerson Ltd.
Slides prepared by Bruno Fullone, George Brown College
Cartels and Other Collusion: Cooperative Strategies
• Three identical firms
• Each firm finds it most profitable to charge P0, but only if its rivals do
• The answer: collude and agree on price P0
©2010 McGraw-Hill Ryerson Ltd.
21Slides prepared by Bruno Fullone,
George Brown College
Overt Collusion – The OPEC Cartel
©2010 McGraw-Hill Ryerson Ltd.
22Slides prepared by Bruno Fullone,
George Brown College
Obstacles to Collusion
Demand and Cost Differences
Number of Firms
Cheating
Recession
Potential Entry
Legal Obstacles: Competition Policy
©2010 McGraw-Hill Ryerson Ltd.
23Slides prepared by Bruno Fullone,
George Brown College
Price Leadership Model
Dominant firm leads the way
Leadership strategy:Infrequent Price Changes
Communications
Limit Pricing
Breakdowns in price leadership: price wars
©2010 McGraw-Hill Ryerson Ltd.
24Slides prepared by Bruno Fullone,
George Brown College
9.6 Oligopoly and Advertising
Oligopolists prefer not to compete on price
Product development and advertising preferred:
Less easily duplicated
Oligopolists have sufficient financial resources
©2010 McGraw-Hill Ryerson Ltd.
25Slides prepared by Bruno Fullone,
George Brown College
Positive Effects of Advertising
1. Low cost source of information
2. Can diminish monopoly power
3. Can speed up technological progress
©2010 McGraw-Hill Ryerson Ltd.
26Slides prepared by Bruno Fullone,
George Brown College
Potential Negative Effects of Advertising
1. Only persuasion
2. Misleading claims
3. Barrier to entry
4. Self-cancelling advertising
©2010 McGraw-Hill Ryerson Ltd.
27Slides prepared by Bruno Fullone,
George Brown College
Global Perspective 9.2
©2010 McGraw-Hill Ryerson Ltd.
28Slides prepared by Bruno Fullone,
George Brown College
Oligopoly and Efficiency
Impossible to say anything definitive
Outcomes could be identical to monopoly
Unlikely because of:
1. Increased foreign competition
2. Limit pricing
3. Technological advance©2010 McGraw-Hill Ryerson Ltd.
29Slides prepared by Bruno Fullone,
George Brown College
The Last Word: Oligopoly in the Beer Industry
Since WW II degree of concentration has been increasing, mostly due to mergers
Today 80% of production controlled by 2 major companies
However, imports and microbreweries are starting to eat away at market share of majors
©2010 McGraw-Hill Ryerson Ltd.