Monopolistic Competition and Oligopoly Ch12

8/13/2019 Monopolistic Competition and Oligopoly Ch12

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12

Between Competitionand Monopoly

. . . Neither fish nor fowl.

JOHN HEYWOOD (CIRCA 1565)


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Monopolistic Competition

Oligopoly

Monopolistic Competition, Oligopoly, andPublic Welfare

A Glance Backward: Comparing the Four

Market Forms

Contents

Copyright 2006 South-Western/Thomson Learning. All rights reserved.


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Copyright 2006 Southwestern/Thomson Learning All rights reserved.


Characteristics of Monopolistic Competition

First three characteristics same as those for

perfect competition. Fourth is an important distinction.

Demand curve facing the firm is negatively

sloped. Majority of U.S. firms are in this type of

market structure.


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Price and Output Determination under


MR = MC rule applies for setting output. Long-run equilibrium: the firms demand

curve must be tangent to its average cost curve.


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FIGURE1:Short-Run EquilibriumUnder Monopolistic Competition

D

AC

P

1.40

PriceperGallon

Gallons of Gasoline per Week

12,000

$1.50

MR

MC

E

C


$1.80

$1.00


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FIGURE2:Long-Run EquilibriumUnder Monopolistic Competition

15,000

$1.35

PriceperGallon

Gallons of Gasoline per Week

10,000

$1.45

MR

MC

AC

D

E

P


M


8/37Copyright 2006 Southwestern/Thomson Learning All rights reserved.

The Excess CapacityTheorem

Under monopolistic competition, in the long

run the firm will produce an output lower

than that which minimizes its unit costs. Hence, unit costs will be higher than

necessary.


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Oligopoly

Oligopoly = market dominated by a few

sellers, at least several of which are large

enough relative to the total market that theycan influence the market price

Oligopoly more intense competition

than pure competition



Oligopoly

Why Oligopolistic Behavior is So Difficult

to Analyze

Oligopolistic firms interact with each other incomplex ways, and almost anything can and

sometimes does happen under oligopoly.



Oligopoly

A Shopping List

Ignore interdependence

Strategic interaction Cartels

Price leadership and tacit collusion

Sales maximization

Kinked demand curve

Game theory



Oligopoly

Sales Maximization: An Oligopoly Model

with Interdependence Ignored

Firms may attempt to maximize revenue ratherthan profit if

control is separated from ownership.

compensation of managers is related to the size ofthe firm.



Oligopoly

Sales Maximization: An Oligopoly Model

with Interdependence Ignored

Output set where marginal revenue = 0 (ratherthan marginal cost)

Compared to a profit-maximizer

Higher outputLower price


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FIGURE3:Sales-MaximizationEquilibrium

3.75

.69

.75.80

2.5

$1.00

MR

B

D

E

AC

PriceperBox

Millions of Boxes per Year

F

MC

A




The Kinked Demand CurveModel

Because the managers of a firm think that

other firms will match any cut they make in

price, but not any increase, they may thinkthey face an inelastic demand curve with

respect to price cuts and an elastic curve

with respect to price increases.

?



The Kinked Demand CurveModel

The demand curve is kinked, and the

marginal revenue curve is discontinuous.

If so, neither price nor output will change inresponse to moderate shifts in costs.

?


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FIGURE4:The Kinked DemandCurve

0

7

Quantity per Year

Price

$8

D (Competitorsprices are fixed)

D

1,4001,1001,000

(Competitors

respond to pricechanges)

d

d

A



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FIGURE5:The Kinked DemandCurve and Sticky Prices

mr

MR

Quantity Supplied per Year

Price

$8

1,000

MC

D

D

d

d

A

E

B

C




Oligopoly

The Game-Theory Approach

Each oligopolist is seen as a competing player

in a game of strategy. Managers act as though their opponents will

adopt the most profitable countermove to any

move they make.


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TABLE1:A Payoff Matrix



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Oligopoly


Games with dominant strategies

Dominant strategy = one that gives the biggerpayoff to the firm that selects it, no matter which of

the two strategies the competitor selects

Prisoners Dilemma


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TABLE2:A Payoff Matrix withDominant Strategies



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Oligopoly


Games with dominant strategies

A market with a duopoly serves the public interestbetter than a monopoly because of the competition

created between the duopolists.

It is damaging to the public to allow rival firms to

collude on what prices to charge for their productsand what quantity of product to supply.


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Oligopoly


Games without dominant strategies

Maximin = a strategy in which one seeks themaximum of the minimum payoffs to the available

strategies.


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TABLE3:A Payoff Matrix without aDominant Strategy



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Oligopoly


Other strategies: Nash Equilibrium

Nash equilibrium = both players adopt movessuch that each players move is its most profitable

response to the others move.

Often, no such mutually accommodating solution is

possible.


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Oligopoly


Zero-sum games

Zero-sum game = if one player gains, the othermust lose such


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Oligopoly


Repeated games

Most markets feature repeat buyers.

Repeated games give players the opportunity tolearn something about each others behavior

patterns and, perhaps, to arrive at mutuallybeneficial arrangements.

Threats and credibility

Induce rivals to change their behavior

Threat must be credible


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FIGURE6:Entry and Entry-Blocking Strategy

6 0

2 2

4 0

2 2

Profits (millions $)Old Firm New Firm

Possible Reactionsof New Firm

Possible Choicesof Old Firm



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Monopolistic Competition,Oligopoly, & Public Welfare

Behavior is so varied that it is hard to come

to a simple conclusion about welfare

implications. In many circumstances, the behavior of

monopolistic competitors and oligopolists

falls short of the social optimum.


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Monopolistic Competition,Oligopoly, & Public Welfare

When an oligopolistic market is perfectly

contestable--if firms can enter and exit

without losing the money they haveinvested--then the performance of the firms

is likely to be socially efficient.


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Comparing the Four MarketForms

Perfect competition and pure monopoly are

uncommon in reality.

Many monopolistically competitive firmsexist.

Oligopoly firms account for the largest

share of the economys output.


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Profits are zero in long-run equilibrium

under perfect competition and monopolistic

competition because of free entry and exit. Consequently, AC = AR in long-run

equilibrium under these two market forms.


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In equilibrium, MC = MR for the profit-

maximizing firm under any market form.

In the equilibrium of the oligopoly firm,MC may be unequal to MR.

C


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Perfectly competitivefirm and industry

theoreticallyefficient allocation of

resources. Monopolyand monopolisticcompetitionare

likelyinefficient allocation of resources.

Under oligopoly, almost anything canhappen,impossible to generalize about

its vices or virtues.

5 A ib f h F


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TABLE5:Attributes of the FourMarket Forms

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Monopolistic Competition and Oligopoly Ch12

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