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Chapter 13Monopolistic Competition and
OligopolyCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
13-2
Monopolistic Competit ion
• Monopolistic competition• Relatively large number of sellers• Product differentiation• Easy entry and exit• Nonprice competition like advertising
LO1
13-3
Monopolistically Competit ive Industries
• Industry concentration• Measured by 4-firm concentration ratio• Percentage of sales by 4 largest firms
• Herfindahl index• Sum of squared market shares
4-firm CR = output of four largest firms total output in the industry
HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2
LO1
13-4
Low Concentration Industries
(1)Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
Index(1)
Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
Index
Textile machinery 30 360 Wood trusses 15 102
Women’s dresses 28 328 Metal stamping 14 88
Textile bags 28 318Metal windows and door 13 109
Plastic bags 27 299 Wood pallets 11 51
Ready-mix concrete 23 313 Sheet metal work 7 30
Jewelry 23 230 Signs 7 28
Asphalt paving 22 188 Stone products 7 23
Plastic pipe 21 187 Quick printing 4 8
Sawmills 15 98 Retail bakeries 4 7
Curtains and draperies 14 85 Bolts, nuts, and rivets 4 6
13-5
Price and Output in Monopolistic Competit ion
• Demand is highly elastic• Short run profit or loss• Produce where MR = MC
• Long run only a normal profit• Entry and exit
LO2
13-6
The Short Run: Profit or Loss
Quantity
Pric
e an
d co
sts
MR = MC
MC
MR
D1
ATC
Economicprofit
Q1
A1
P1
0
LO2
13-7
The Short Run: Profit or Loss
Quantity
Pric
e an
d co
sts
MC
MR
D2
ATC
Loss
Q2
A2
P2
0
MR = MC
LO2
13-8
The Long Run: Only a Normal Profit
Quantity
Pric
e an
d co
sts
MC
MR
D3
ATC
Q3
P3= A3
0
MR = MC
LO2
13-9
Monopolistic Competit ion and Efficiency
• Monopolistic competition inefficient• Productive inefficiency because P > min ATC• Allocative inefficiency because P > MC
• Excess capacity
LO3
13-10
Monopolistic Competit ion and Efficiency
P4
Q4
Price is lower
Excess capacity atminimum ATC
LO3
13-11
Product Variety
• The firm constantly manages price, product, and advertising• Better product differentiation• Better advertising
• The consumer benefits by greater array of choices and better products• Types and styles• Brands and quality
LO4
13-12
Oligopoly
• Oligopoly• A few large producers• Homogeneous oligopoly• Differentiated oligopoly• Limited control over price• Entry barriers• Mergers
LO5
13-13
Oligopolistic Industries
• Four-firm concentration ratio• 40% or more to be an oligopoly
• Shortcomings• Localized markets• Interindustry competition• Import competition• Dominant firms
LO5
13-14
High Concentration Industries
(1)Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
Index(1)
Industry
(2)4-Firm
Concentration Ratio
(3)Herfindahl
IndexPrimary copper 99 ND Petrochemicals 80 2,535
Cane sugar refining 95 ND Breakfast cereals 80 2,426
Cigarettes 98 ND Small-arms ammunition 79 2,447
Household laundry equipment 98 ND Primary aluminum 77 2,250
Household refrigerators and freezers 92 ND Men’s slacks and jeans 76 2,015
Beer 90 ND Electric light bulbs 75 2,258
Glass containers 87 2,507 Tires 73 1,540
Electronic computers 87 NDHousehold vacuum cleaners 71 1,519
Phosphate fertilizers 83 ND
Alcohol distilleries 70 1,915
Turbines and generators 68 1,937
Aircraft 81 ND Motor vehicles 68 1,744
13-15
Oligopoly Behavior
• Oligopolies display strategic behavior• Mutual interdependence• Collusion• Incentive to cheat• Game theory• Prisoner’s dilemma
LO6
13-16
Game Theory Overview
RareAir’s price strategy
Upt
own’
s pr
ice
stra
tegy
A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low•2 competitors•2 price strategies•Each strategy has
a payoff matrix•Greatest
combinedprofit
•Independent actionsstimulate a response
LO6
13-17
Game Theory Overview
RareAir’s price strategy
Upt
own’
s pr
ice
stra
tegy
A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low•Independently lowered prices in expectation of greater profit leads to worst combined outcome
•Eventually low outcomes make firms return to higher prices.
LO6
13-18
Three Oligopoly Models
• Kinked-demand curve• Collusive pricing• Price leadership• Reasons for 3 models• Diversity of oligopolies• Complications of interdependence
LO7
13-19
Kinked-Demand Theory
• Noncollusive oligopoly• Uncertainty about rivals reactions• Rivals match any price change• Rivals ignore any price change
• Assume combined strategy• Match price reductions• Ignore price increases
LO7
13-20
Kinked-Demand Curve
P0
MR2
D2
D1
MR1
e
f
g
Rivals ignoreprice increase
Rivals matchprice decrease
Q0
MR2
D2
D1
MR1Q0
MC1
MC2
P0
e
f
g
LO7
13-21
Kinked-Demand Curve
• Criticisms• Explains inflexibility, not price• Prices are not that rigid• Price war
LO7
13-23
Overt Collusion
• A cartel is a group of firms or nations that collude• Formally agreeing to the price• Sets output levels for members
• Collusion is illegal in the United States• OPEC
LO7
13-25
Obstacles to Collusion
• Demand and cost differences• Number of firms• Cheating• Recession• New entrants• Legal obstacles
LO7
13-26
Price Leadership Model
• Price leadership• Dominant firm initiates price changes• Other firms follow the leader
• Use limit pricing to block entry of new firms• Possible price war
LO7
13-27
Oligopoly and Advertising
• Oligopolies commonly compete though product development and advertising• Less easily duplicated than a price change• Financially able to advertise
LO8
13-28
Positive Effects of Advertising
• Low-cost way of providing information to consumers
• Enhances competition• Speeds up technological progress• Can help firms obtain economies of scale
LO8
13-29
Oligopoly and Advertising
The Largest U.S. Advertisers, 2011
CompanyAdvertising Spending
Millions of $Proctor & Gamble $4,971.5
General Motors 3,055.7
Verizon 2,523.0
Comcast 2,465.4
AT&T 2,359.0
JP Morgan Chase 2,351.8
Ford Motor 2,141.3
American Express 2,125.3
L’Oréal 2,124.6
Walt Disney 2,112.2LO8
13-30
Negative Effects of Advertising
• Can be manipulative• Contain misleading claims that confuse
consumers• Consumers may pay high prices for a good
while forgoing a better, lower priced, unadvertised version of the product
LO8
13-32
Oligopoly and Efficiency
• Oligopolies are inefficient• Productively inefficient because P > min ATC• Allocatively inefficient because P > MC
• Qualifications• Increased foreign competition• Limit pricing• Technological advance
LO9
13-33
Internet Oligopolies
• The Internet became accessible to the average person in the mid 1990’s
• Today it is dominated by a few very large firms• Google, Facebook, Amazon, Microsoft, Apple• Not satisfied with just revenues generated in
their respective sectors• Compete for advertising $s• Compete with their own electronic devices