Monopolistic Competition & Oligopoly

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Monopolistic CompetitionPrice and Output in Monopolistic CompetitionMonopolistic Competition and EfficiencyOligopolyOligopolies and MergersCartels and CollusionOligopoly and EfficiencyGame Theory

Monopolistic Competition& Oligopoly

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Monopolistic CompetitionPrice and Output in Monopolistic CompetitionMonopolistic Competition and EfficiencyOligopolyOligopolies and MergersCartels and CollusionOligopoly and EfficiencyGame Theory Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

FOUR MARKET MODELSMonopolistic Competition:

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CHARACTERISTICS•Large Number of Sellers•Small Market Shares•No Collusion•Independent Action

•Easy Entry and Exit•Advertising

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•Differentiated Products• Product Attributes• Service• Location• Brand Names and

Packaging• Some Control Over

Price• Demand for Product is

Highly Elastic

CHARACTERISTICS

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Short-RunEconomic

Profits

Expect New Competitors

PRICE AND OUTPUT INMONOPOLISTIC COMPETITION

Quantity

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Expect New Competitors

Quantity

New competition providesother goods in the market

so demand for your good falls.

Short-RunEconomic

Profits

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Short-RunEconomic

Losses

Quantity

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Short-RunEconomic

Losses

Quantity

A2With economic losses, firms willexit the market. Fewer competitorsmeans your demand will increase.

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P3 = A3

Quantity

Long-Run EquilibriumNormalProfitOnly

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MONOPOLISTIC COMPETITIONAND EFFICIENCY

• Not Productively EfficientP Minimum ATC

• Not Allocatively EfficientP MC

• Excess Capacity

Graphically…

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P3 = A3

Q3Quantity

Long-Run EquilibriumPrice is Not= Minimum

Price MC

MONOPOLISTIC COMPETITIONAND EFFICIENCY

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Market Structure Continuum

PureCompetition

PureMonopoly

MonopolisticCompetition Oligopoly

FOUR MARKET MODELSOligopoly:• Control Over Price• Mutual Interdependence• Strategic Behavior

• Entry Barriers• Economies of Scale• Control of Resources

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OLIGOPOLIES AND MERGERS•Many Oligopolies Created by Mergers

•Measures of Industry Concentration•4 Firm Concentration Ratio

•50 to 80%•Half of US Industries

•Herfindahl Index

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OLIGOPOLIES AND MERGERSHerfindahl Index

Sum of the squared percentage market shares for all firms in the industry.

(%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2

A greater Herfindahl Index indicates a greater concentration of market power in the industry.

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If a few firms face similar demand and costs they will seek joint profit maximization as a monopoly.

Oligopoly is conducive to collusion.

CARTELS AND OTHER COLLUSION

Graphically…

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Colluding Oligopolists WillSplit the Monopoly Profits.

EconomicProfit

MR = MC

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Overt Collusion•Cartel•The OPEC Cartel

Covert Collusion•Illegal in the U.S.•Tacit Understandings

– “Gentlemen’s Agreements”

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Obstacles to Collusion• Demand and Cost

Differences• Number of Firms• Cheating• Price Wars• Potential Entry• Antitrust Law

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OLIGOPOLY AND EFFICIENCY

• Not Productively EfficientP Minimum ATC

• Not Allocatively EfficientP MC

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Game Theory

Introduction to Game Theory…

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OLIGOPOLY BEHAVIORA Game-Theory Overview

High LowU

gyRareAir’s Price Strategy

$12 $15

$12 $6

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High LowU

$12 $15

$12 $6

GreatestCombined

Profit

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High LowU

$12 $15

$12 $6

IndependentActions

StimulateResponse

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High LowU

$12 $15

$12 $6

IndependentActions

StimulateResponse

Gravitatingto the

Worst Case

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High LowU

$12 $15

$12 $6

CollusionInvites aDifferentSolution.

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High LowU

$12 $15

$12 $6

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High LowU

$12 $15

$12 $6

But, theincentiveto cheatis very real.

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Practical Uses of Game TheoryPricing Option 1$59 Web Only$125 Print Only

Pricing Option 2$59 Web Only$125 Print Only$125 Web & Print

68%32%

16%0%84%

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Practical Uses of Game Theory

• 1 Share of Federated stock is worth $100

• Macy’s is offering to buy it for $102• Campeau’s Bid

– If he gets less than 50% everyone gets $105– For 50% through 100% he pays a blended

rate which would max at $97.50– If he gets more than 50% of the stock and

you don’t sell he can buy your stock for $90

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Possibility 1: Campeau gets less than 50%

• Campeau = $105• Macy’s = $102• Hold = $100

• Dominant strategy is to sell to Campeau.

Possibility 2:Campeau gets more than 50%

• Campeau = $97.50• Macy’s = $0• Hold = $90

• Dominant strategy is to sell to Campeau.

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• Did you get that? • Everybody had stock worth $100. • Everyone could sell to Macy's for

$102.• Instead, everybody sold to

Campeau for $97.50. • Game Theory explains why.

Monopolistic Competition & Oligopoly

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