MONOPOLISTIC COMPETITION, OLIGOPOLY, & GAME THEORY
Transcript
Slide 1
MONOPOLISTIC COMPETITION, OLIGOPOLY, & GAME THEORY
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MONOPOLISTIC COMPETITION Firms in monopolistically competitive
industry share some of the characteristics of perfect competition
market structure: 1.Presence of many firms. 2.Availability of
complete information 3.Freedom of exit and entry
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MONOPOLISTIC COMPETITION But unlike Firms in perfect
competition industry, monopolistically competitive industry firms
share one unique characteristic: 1.Products are not homogenous.
Each firm produces a product that differs in some slight way from
the products of its competitors.
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MONOPOLISTIC COMPETITION But competitors products are close
substitutes, therefore in this market structure, firms do have real
monopoly power. Example of monopolistic competition firms: gas
stations, dry-cleaning services, etc.
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MONOPOLISTIC COMPETITORS DEMAND CURVE Due to the presence of
substitutes for monopolistic firms products, but not perfect
substitutes Demand curve is downward sloping.
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REVENUE CURVES FOR MONOPOLISTIC FIRM Monopolistic firms are
assumed to maximize their profits. So, the relationship between MC
and MR determines the optimal quantity of output. Demand curve
determines the price at which output will be sold.
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REVENUE CURVES FOR MONOPOLISTIC FIRM Because product
differentiation, a monopolistic firm could alter the price of its
product to affect the quantity of output sold. But the price
alteration is limited by the existence of close substitutes. So,
monopolistic firm price P>MR
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REVENUE CURVES FOR MONOPOLISTIC FIRM A firms demand curve is
equivalent to its AR curve. Monopolistic firms demand curve is
downward-sloping, the MR curve lies below it. Remember: When the
average is falling, the marginal is below the average.
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PRICE AND MARGINAL COST As seen, monopolistic firms price,
P>MR. Monopolistic firm produces output at which MR=MC Thus,
monopolistic firm must produce at a level of output at which
P>MC. Monopolistic firm does not exhibit resource allocative
efficiency (PMC).
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SHORT-RUN PROFIT MAXIMIZATION Profit-Maximizing Output:
Additions to firms profit are positive as long as the MR received
from the sale of an additional unit of output exceeds the MC
incurred in producing that unit.
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SHORT-RUN PROFIT MAXIMIZATION Profit-Maximization price: The MR
curve used to determine profit maximizing output is based on the
firms demand curve. MR captures the firms revenues of selling
various levels of output at the corresponding prices on the demand
curve. Thus, to find the equilibrium price, find the point on the
demand curve directly above the profit-maximizing output.
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LONG-RUN PROFIT MAXIMIZATION Effects of entry on the
monopolistic firm: as new firms enter, the demand curves for
existing firms shift inward Given the relationship between MR and
Demand, MR also shifts inward Thus, the inward shift in the Demand
results in lower levels of AR, which leads to a profit
declines.
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LONG-RUN PROFIT MAXIMIZATION
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LONGT-RUN PROFIT MAXIMIZATION CHARACTERISTICS Excess Capacity
Theorem: profit maximizing output is at the point of tangency
between Demand curve and AC. This level output is to the left of
the output level corresponding to minimum AC. The difference
between these two output levels is known as excess capacity.
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EXCESS CAPACITY
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OLIGOPOLY Few sellers and many buyers Firms produce either
homogenous, or differentiated products There are barriers to entry
Concentration ratio: the percentage of industry sales accounted for
by x number of firms in the industry. Note, high concentration
implies few sellers.
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OLIGOPOLY Few sellers and many buyers Firms produce either
homogenous, or differentiated products There are barriers to entry
Concentration ratio: the percentage of industry sales accounted for
by x number of firms in the industry. Note, high concentration
implies few sellers.
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PRICE AND OUTPUT UNDER OLIGOPOLY Cartel Theory Kinked Demand
Curve Theory Price Leadership Theory.
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THE CARTEL THEORY A cartel exists when collusive behavior
between oligopolists takes the form of written agreements or other
formal arrangements regarding output price and quantity. So doing,
oligopolists act as if there were only one firm in the industry.
Thus, a cartel can reduce output and increase price in an effort to
increase joint profits.
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THE CARTEL THEORY
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The Benefits of Being Members of a Cartel We assume the
industry is in long-run equilibrium, producing Q 1, and charging P
1. There are no profits. A reduction in output to Q C through the
formation of a cartel raises price to P C and brings profits of CP
C AB
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THE CARTEL THEORY Problems with cartel: 1.Formation: each
potential member has an incentive to be a free rider. 2.Formulation
of Cartel Policy: there may be as many policy proposals as there
cartel members. 3.Entry: high profits provide incentives for new
suppliers to join the Cartel. The Cartel is likely to break up if
new members enter. 4.Cheating: Cartel members have incentive to
cheat on the agreement
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THE CARTEL THEORY
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THE KINKED DEMAND CURVE THEORY The key behavioral assumption is
that if a single firm lowers price, other firms will do likewise,
but if a single firm raises price, other firms will not follow
suit.
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The Kinked Demand Curve Theory
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Observations About Kinked Demand Theory Prices are sticky if
oligopolistic firms face kinked demand curves. The kinked demand
curve posits that prices in oligopoly will be less flexible than in
other market structures.
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Price Leadership Theory One firm in the industry, called the
dominant firm, determines price and all other firms take this price
as given. The dominant firm sets the price that maximizes its
profits, and all other firms take this price as given. All other
firms are seen as price takers. They will equate price with their
respective marginal costs.
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THE PRICE LEADERSHIP THEORY
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Game Theory Is a mathematical technique used to analyze the
behavior of decision makers who: 1.Try to reach an optimal position
through game playing or the use of strategic behavior. 2.Are fully
aware of the interactive nature of the process at hand.
3.Anticipate the moves of other decision makers.
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Prisoners Dilemma
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Cartels and Prisoners Dilemma
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Theory of Contestable Markets There is easy entry into the
market and costless exit from the market. New firms entering the
market can produce the product at the same cost as existing firms.
Firms exiting the market can easily dispose of their fixed assets
by selling them elsewhere.