Monopolistic n Oligoploy

8/3/2019 Monopolistic n Oligoploy

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Monopolistic Competition andOligopoly


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Monopolistic Competition

FIGURE 13.2 Characteristics of Different Market Organizations


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Monopolistic Competition

Monopolistic competition is a marketstructure in which many firms sell adifferentiated product and entry into and

exit from the market are relatively easy.Examples: furniture, jewelry, leather goods,

grocery stores, gas stations, restaurants,clothing stores and medical care.


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Characteristics ofMonopolistic Competition

Relatively large number of sellers firmshave small market shares, collusion isunlikely and each firm can act independently

Differentiated products the product isslightly different and is often promoted byheavy advertising

Easy entry to, and exit from, the industry

economies of scale are few, capitalrequirements are low but financial barriersexist


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Differentiated Products

Product differentiation is a form ofnonprice competition in which a firmtries to distinguish its product or service

from all competing ones on the basis ofattributes such as design and quality.

Production differentiation entails productattributes, service, location, brand name

and packaging, and some control overprice.


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Advertising

The goal of product differentiation andadvertising is to make price less of afactor in consumer purchases and make

product differences a greater factor. The intent is to increase the demand for

a product and to make demand less

elastic.


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Pricing and Output inMonopolistic Competition

The demand curve of a monopolisticallycompetitive firm is highly, but notperfectly, elastic.The price elasticity of demand for a

monopolistic competitor depends on thenumber of rivals and the degree of productdifferentiation.

The larger the number of rival firms and theweaker the product differentiation, thegreater the price elasticity of each firmsdemand.


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The Short Run: Profit or Loss

The monopolistically competitive firmmaximizes profit or minimizes loss in theshort run. It produces a quantity Qat

which MR = MC and charges a price Pbased on its demand curve.When P > ATC, the firm earns an economic

profit.When P < ATC, the firm incurs a loss.


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COMPETITION WITHDIFFERENTIATED PRODUCTS The Monopolistically Competitive Firm in the

Short Run

Short-run economic profits encourage new firms toenter the market. This: Increases the number of products offered. Reduces demand faced by firms already in the market.

Incumbent firms demand curves shift to the left.

Demand for the incumbent firms products fall, and their

profits decline.


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Figure 1 Monopolistic Competition in the Short Run

Copyright2003 Southwestern/Thomson Learning

Quantity0

Price

Profit-maximizing

quantity

Price

Demand

MR

ATC

(a) Firm Makes Profit

Averagetotal cost

Profit

MC


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COMPETITION WITHDIFFERENTIATED PRODUCTS The Monopolistically Competitive Firm in the

Short Run

Short-run economic losses encourage firms to exitthe market. This: Decreases the number of products offered. Increases demand faced by the remaining firms.

Shifts the remaining firms demand curves to the right.

Increases the remaining firms profits.


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Figure 1 Monopolistic Competitors in the Short Run


Demand

Quantity0

Price

Price

Loss-minimizing

quantity

Average

total cost

(b) Firm Makes Losses

MR

LossesATC

MC


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The Long-Run Equilibrium Firms will enter and exit until the firms are making

exactly zero economic profits.


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Figure 2 A Monopolistic Competitor in the Long Run


Quantity

Price

0

DemandMR

ATC

MC

Profit-maximizing

quantity

P= ATC


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Monopolistic or Imperfect

CompetitionImplications for the diagram:

Cost/Revenue

Output / Sales

MC

AC

D (AR)MR

Q1

Because there is relativefreedom of entry and exitinto the market, newfirms will enterencouraged by the

existence of abnormalprofits. New entrants willincrease supply causingprice to fall. As price falls,the AR and MR curvesshift inwards as revenuefrom each sale is nowless.

AR1MR1


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Long-Run Equilibrium Two Characteristics

As in a monopoly, price exceeds marginal cost. Profit maximization requires marginal revenue to equal

marginal cost.

The downward-sloping demand curve makes marginalrevenue less than price.

As in a competitive market, price equals averagetotal cost. Free entry and exit drive economic profit to zero.


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Monopolistic versus Perfect Competition There are two noteworthy differences between

monopolistic and perfect competitionexcesscapacity and markup.


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Monopolistic versus Perfect Competition Excess Capacity

There is no excess capacity in perfect competitionin the long run.

Free entry results in competitive firms producing at

the point where average total cost is minimized,which is the efficient scale of the firm.

There is excess capacity in monopolisticcompetition in the long run.

In monopolistic competition, output is less than theefficient scale of perfect competition.


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Figure 3 Monopolistic versus Perfect Competition


Quantity0

Price

Demand

(a) Monopolistically Competitive Firm

Quantity0

Price

P= MC P= MR(demand

curve)

(b) Perfectly Competitive Firm

MCATC

MCATC

MR

Efficientscale

P

Quantityproduced

Quantity produced =Efficient scale


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Why Monopolistic Competition Is Less Efficientthan Perfect Competition

Excess capacityThe monopolistic competitor operates on the

downward-sloping part of its ATC curve, producesless than the cost-minimizing output.

Under perfect competition, firms produce thequantity that minimizes ATC.

Markup over marginal cost

Under monopolistic competition, P> MC.Under perfect competition, P= MC.


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Monopolistic versus Perfect Competition Markup Over Marginal Cost

For a competitive firm, price equals marginal cost.

For a monopolistically competitive firm, priceexceeds marginal cost.

Because price exceeds marginal cost, an extra unitsold at the posted price means more profit for themonopolistically competitive firm.


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Quantity0

Price

Demand


Quantity0

Price

P= MC P= MR(demand

curve)


Markup

MCATC

MCATC

MR

Marginalcost

P

Quantityproduced

Quantity produced


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Quantity0

Price

Demand


Quantity0

Price

P= MC P= MR(demand

curve)


Markup

Excess capacity

MCATC

MCATC

MR

Marginalcost

Efficientscale

P

Quantityproduced

Quantity produced =Efficient scale


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The Long Run:Only a Normal Profit

In the long-run, firms will enter aprofitable monopolistically competitiveindustry and leave an unprofitable one.

A monopolistic competitor will earn onlya normal profit and price just equalsaverage total cost at the MR = MC

output.


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Because entry to the industry isrelatively easy, economic profits attractnew rivals.As new firms enter, the demand curve faced

by the typical firm shifts to the left, reducingits economic profit.When entry of new firms has reduced

demand to the extent that the demand curveis tangent to the ATC curve at the profit-maximizing output, the firm is just making anormal profit, leaving no incentive for newfirms to enter.


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When the industry suffers short-runlosses, some firms will exit in the longrun.

As firms exit, the demand curve of survivingfirms begins to shift to the right, reducinglosses until the firms are just making normalprofit.


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Pricing and Output inMonopolistic Competition


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Monopolistic Competitionand Efficiency

In monopolistic competition, neitherproductive nor allocative efficiencyoccurs in long-run equilibrium.Since the firms profit-maximizing price (and

average total cost) slightly exceed thelowest average total cost, productiveefficiency is not achieved.

Since the profit-maximizing price exceedsmarginal cost, monopolistic competitioncauses an underallocation of resources.


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Excess Capacity

The gap between the minimum ATCoutput and the profit-maximizing outputis a monopolistically competitive firmsexcess capacity.Plants and equipment are unused because

the firm is producing less than the minimum-ATC output.

Monopolistically competitive industries areovercrowded with firms each operatingbelow its optimal capacity.


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Product Varietyand Improvement

Despite the overcrowded feature,monopolistic competition does promoteproduct variety and productimprovement.A firm earning a normal profit will developand improve its product in order to regain its

economic profit.Successful product improvements by one

firm obligates rivals to imitate or improve onthat firms temporary market advantage orelse lose business.


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Oligopoly

Oligopoly is a market structuredominated by a few large producers ofhomogeneous or differentiated products.

Because of their fewness, oligopolistshave considerable control over theirprice.

Examples: tires, beer, cigarettes, copper,greeting cards, steel, aluminum,automobiles and breakfast cereals


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Characteristics of Oligopoly

A few large producers firms are generallylarge and together they dominate theindustry.

Either homogeneous or differentiatedproducts the products are standardized, ordifferentiated with heaving advertising.

Price maker the firm can set its price andoutput levels to maximize its profit.


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Characteristics of Oligopoly

Strategic behaviorSelf-interested behaviorthat takes into account the reactions ofothers.

Mutual interdependenceeach firms profitdepends not entirely on its own price andsales strategies but also on those of the

other firms. Blocked entry barriers to entry exist which

make it hard for new firms to enter.


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Collusive Tendencies

Oligopolists can often benefit fromcooperation, or collusion.

Collusion is a situation in which firms act

together and in agreement to fix prices,divide markets, or otherwise restrictcompetition.

In the example, firms A and B can agree toestablish and maintain a high-price strategy soeach can earn $12 million.


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Kinked-Demand Model

In the kinked-demand model, oligopolistsface a demand curve based on theassumption that rivals will ignore a price

increase and follow a price decrease.An oligopolists rivals will ignore a price

increase above the going price but follow aprice decrease below the going price.

The demand curve is kinked at this price andthe marginal-revenue curve has a vertical gap.


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Kinked-Demand Model


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Price Leadership

Price leadership involves an implicitunderstanding that other firms will followthe lead when a certain firm in theindustry initiates a price change.

A price leader is likely to observe thefollowing tactics: Infrequent price changes

CommunicationsAvoidance of price wars


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Collusion

Collusion, through price control, mayallow oligopolists to reduce uncertainty,increase profits, and possibly block

potential entry. One form of collusion is the cartel: a

formal agreement among producers to

set the price and the individual firmsoutput levels of a product.


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Joint-Profit Maximization

If oligopolistic firms produce an identicalproduct, and have identical cost,demand, and marginal-revenue curves,

than each firm can maximize profit usingthe MR=MC rule.


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A profitable oligopolist when rivals chargethe same price, Po

Price

Quantity of output

D

MR

MC

Po

Q0

ATC

EconomicProfit


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Joint-Profit Maximization

If rivals charge prices lower than Po,then the demand curve of the firmcharging Powill shift to the left as itscustomers turn to its rivals, and its

profits will fall.The firm can retaliate and cut its price, too,

however, all firms profits would eventuallyfall.

Firms will choose to charge Poandproduce Qobecause it is the mostprofitable price-output combination.


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Obstacles to Collusion

Barriers to collusion beyond the antitrustlaws include:Demand and cost differences

Number firmsCheating

Recession

Potential entry


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Oligopoly and Advertising

Each firms share of the total market isgenerally determined through productdevelopment and advertising for tworeasons:Product development and advertising

campaigns are less easily duplicated thanprice cuts.

Oligopolists have sufficient financialresources to engage in productdifferentiation and advertising.


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Oligopoly and Advertising

Positive effects of advertising are:Enhances competitionReduces consumers search time, direct

costs, and indirect costsFacilitates the introduction of new products

Negative effects of advertising include:Alters consumers preferences in favor of

the advertisers productBrand-loyalty promotes monopoly power


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Oligopoly and Efficiency

Many economists believe the oligopolymarket structure is neither productivelyefficient nor allocatively efficient.

This is because many oligopolistic firmsprice higher than average total cost andproduce less than the optimal output level.


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Oligopoly and Efficiency

A few believe that oligopoly is actuallyless desirable than pure monopoly,because government can guard against

abuses of monopoly power but notagainst informal collusion amongoligopolists that give the outwardappearance of competition involvingindependent firms.

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Monopolistic n Oligoploy