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Price Determination under
Monopolistic Competition & Oligopoly
Dr. Utpal ChattopadhyayAsst. Professor, NITIE
.
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Monopolistic Competition
Many firms
Differentiated products (is in general a strategic
marketing goal) products are close substitutes toeach other;
Demand curve not completely flat
Firms do not react to each others actions (because
there are so many) Easy entry and exit
Examples: shirts, candy bars, restaurants
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Behavior of monopolisticallycompetitive firms
Firms in an industry group are similar (symmetric inextreme), i.e. they have the same incentives
What happens if firm changes price alone? (dd) Same incentive for other firms to change price (DD) ----> demand is steeper in this case
In the extreme: a very small firm changing the price alone has a very flat demand curve!
Marketing is important: firms want to make theirproduct unique, in other words: Demand for their product should get more inelastic (steep) Use advertising!
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Demand curve if the firm (dd) or the
industry (DD) changes price
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Short-run equilibrium
Like a monopolist: set price where
marginal revenue = marginal cost
Profits arise ---> market entry of similar products (firms)
Each firm competes for a percentage of totaldemand, new entry means demand for the individual
firm must be lower (shifts left/down) Shift must be so far, that profits disappear
I.e. Demand curve must finally be tangential to long-run average cost curve
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Perfect Competition Vs.
Monopolistic Competition PC: price equal to long-run marginal cost, in
MonC price is always higher as marginal cost:
there are people out there who value thegood more than the marginal cost to produceit. ==> in principle production should rise
PC produces at minimum of long-run average
cost, MonC not at the minimum Trade-Off between efficiency (cost) and variety Long-run profit situation is alike, because of
entry, but how short is the short-run??
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Summary-Monopolistic
Competition
Very common market form
No interaction between firms
Firm could reduce average cost by producing more Firms try to bind their costumers to the firm:
Marketing, advertising plays a role (not in perfectcompetition)
Make the product different from the crowd
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OligopolyA. Few Sellers / Recognized
Interdependence
B. Cournot Model
Firms choose quantity
Assume that other firm does changeoutput
Example compared to PC and Monopoly
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Oligopoly - Bertrand Model Firms choose price rather than output.
With identical goods and constant MC, thenP=?
If products are differentiated. - Example
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Oligopoly - Chamberlin
(Monopolistic Competition) Criticized Bertrand and Cournot models
because they failed to recognize their
interdependence. He argued that intelligentmanagers would know where the profit-maximizing price is and would be reluctantto reduce price and leave all members of
the industry worse off.
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Oligopoly - Stackelberg Model
-Price Leadership Designate one firm as a dominant firm and all
the other's in the industry follow this firm's
cues. I.e. one firm announce price changes andall the others follow.
Examples
Automotive industry
Banking Industry
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Oligopoly - Stigler's Theory Incentive to collude is strong so as to
maximize joint profits but so is theincentive to cheat. If any member cansecretly violate the agreement, he willgain larger profits than by conforming
to it. Therefore enforcement, i.e.detecting significant deviations from theagreed-upon prices, is paramount
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Stigler example Suppose 3 identical firms with zero
costs , facing a market demand curve ofQ=180-5P. The monopoly price andquantity is $18 and 90 and the threefirms agree to each supply 30. The
$1620 industry profits are split $540 toeach.
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Oligopoly
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Oligopoly d is the demand curve when everyone knows
(everyone makes 533.33), d' is when there
are secret cuts(if offered to all his customersthen $640, if only to "new" customers -$700), d'' is secret cut that steals away otherfirms customers without the other firmreacting - $800).
Conclusion - there is a great temptation tosecretly cut prices. Key is detection andresponse.
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Oligopoly - Game Theory Prisoner's Dilemma - Two suspected
criminals A and B are arrested and put in
separate cells unable to communicate. If oneconfesses while the other does not, the onewho confesses is granted immunity and goesfree and the other goes to jail for 20 years. If
both confess they both go to jail for 5 years.If both are silent, both go to jail for only oneyear, for a lesser crime (concealed weapons).The payoff matrix looks like this:
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Oligopoly Duopolist's Dilemma
Dominant Strategy is to cut price but both firms are better offby fixing prices.
Firm A Firm B
Cut Price (Rs. 12) Fix Price (Rs. 18)
Cut Price (Rs. 12) [720,720] [1440,0]
Fix Price (Rs. 18) [0, 1440] [810,810]
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Can Collusion be beneficial? It reduces uncertainty in profit rate , demand
uncertainty in the face of production
indivisibilities Example
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Can Collusion be beneficial? Indivisibilities in production.
Other problems - large fixed and someavoidable costs with uncertain demand.