9 Econ Chapter 25 Honors

7/21/2019 9 Econ Chapter 25 Honors

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Chapter 25 Monopolistic Competition and Oligopoly

Key characteristics of Monopolistic Competition:

1. Large number of sellers individual rms have relatively small market share no collusion independent action (i.e. not signicant interdependence)

. !i"erentiated #roducts #roduct $ttributes %ervice location &randing ' erchandising ' signicant advertising ependitures

product diferentiation provides some controlover price

*. +asy entry and eit


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Monopolistic Competition:Price and Output

,he rm faces highly elastic demand. many rivals producing closesubstitutes product di"erentiation means

demand is notperfectlyelastic

Shortrun:MR = MC maximizes profts (orminimi-es losses)Longrun:the rm ill tend to earn a normal prot onl

y/but no economic prots

+asy entry'eit

0omplicating factors (theory v. practice): #roduct di"erentiation can be strong (branding/ location/ etc.)some rms are able to sustain long run prots $lays some restriction to entry (e.g. start2up costs) economicprots may linger into the long run


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Monopolistic Competition and Economic EciencyReview:$llocative e3ciency: P = MC (at 0 4 !) price 4 marginal cost 2 the right amount of resources are allocated to the product

#roductive e3ciency: P = min! "#C (at $,0 4 !) price 4 minimumaverage total cost

2 production occurs using the loest cost combination ofresources

MONOPOLISTIC COMPETITION IS NOT EFFICIENT:

Allocative Ecienc not ac!ieved

Long run # 5 0 consumers ant additional units not being produced

Productive Ecienc not ac!ieved although long run # 4 $,0 at the given level of output/ rms do

not produce the output that coincides ith the lo"est$,0 costs associated ith product di"erentiation (not incurred in


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Monopolistic Competition $cont!%$ producer may be able to postpone the long2run outcome of -eroeconomic prot

2 ne product development/ current product improvement/merchandising

$lthough the consumer pays a higher price in monopolisticcompetition (and the producers don6t supply 7enough8)/ oneconsumer &eneft eists:

22 additional product choice (close but not eact substitutes)

,he monopolistically competitive rm 9uggles three factors in seekingmaimum prot.

product attributes product price

advertising

T!eor v# Practice:+very possible combination of price/ product/ and advertising

poses a di"erent demand and cost situation for the

individual rm.,he o timal combination cannot be easil redicted.


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'(! Explain how the entry of rms into its industry aects the demandcurve facing a monopolistic competitor and how that, in turn, aects itseconomic prot

+conomic prots attract competing rms to enter:

2 putting donard pressure on prices2 decreasing the portion of market demand held by the individual

rm.,his reduces economic prot for the individual rm.


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http:''.youtube.com'atchv4;cdibc?@feature4relmfu

%purlock on branding'advertising
http://www.youtube.com/watch?v=6c0VtOdibcI&feature=relmfuhttp://www.youtube.com/watch?v=6c0VtOdibcI&feature=relmfuhttp://www.youtube.com/watch?v=6c0VtOdibcI&feature=relmfuhttp://www.youtube.com/watch?v=6c0VtOdibcI&feature=relmfu


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OligopolyKey characteristics: a 7fe8 large producers di"erentiated or homogeneous product some monopoly poer over price/ butA

limited by mutual interdependence strong barriers to entry+conomies of scale/ initial costs of capital/

control'onership of resources

ergers may lead to and are prevalent in oligoply. increase monopoly poer


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)etermining the Mar*et +tructure o, an -ndustry

0oncentration Batio:22 a measure of the total output produced in an industry by a givennumber of rms in the industry.

22 a four rm concentration ratio is the most commonly used22 a high concentration ratio is associated ith less competition

$ssume ?ndustry $/ ith 1< producers that have market shares (C)of:

./0 2.0 (50 (/0 10 0 3020(0(0,he four rm concentration ratio is: DEC

$ssume ?ndustry &/ ith 1< producers that have market shares (C)of:

(20 ((0 (/0 (/0 (/0 (/0 (/0 (/0 4010

,he four rm concentration ratio is: F*C

?ndustry & appears much more competitive than ?ndustry $.

< G


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)etermining the Mar*et +tructure o, an -ndustry

Herndahl ?nde:22 a measure of the si-e of rms in relation to the industry22 an indicator of the amount of competition in an industry.

22 named after economist >rris 0. Herndahl22 idely applied in competition la and antitrust inIuiry22 a relatively high Herndahl ?nde is associated ith lo competition

22 dened as the sum of the sIuares of the market shares of all therms in the industry

$ssume ?ndustry $/ ith 1< producers that have market shares (C)of:

./0 2.0 (50 (/0 10 0 3020(0(0

,he Herndahl ?nde is:

$ssume ?ndustry &/ ith 1< producers that have market shares (C)of:

(20 ((0 (/0 (/0 (/0 (/0 (/0 (/0 4010


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Oligopoly 6ame #heory

$ominant Strate%: Jo matter hat the opponent

does/ a strategy that earns a

player a payo" better than anyother strategy.

!oes not mean player gets thebest possible payo".

Nas! E&uili'rium:- set of strategies/ one for each player/ such that

no player has incentive to unilaterallchange his strategy

- does not mean either player gets the best possible payo"- one eample of eIuilibrium is if both players have a dominant

strategy

- players are in Jash eIuilibrium if each one is making the best decisithat he can/ taking into account the potential decisions of the other

Prisoner(s $ilemma:- situation in hich both players could improve the +Iuilibrium

outcome by collusion


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1. !oes either rm have a dominant strategy

. ?s there a Jash +Iuilibrium

*. 0an you predict a likely outcome (no collusion)

F. ?s it a #risoner6s !ilemma game

G. ?s there an incentive for collusive strategy?f so/ hat is the likely result of binding collusion


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*uestions +or eac! matri):1. !oes either rm have a dominant

strategy

. ?s there a Jash +Iuilibrium

*. 0an you predict a likely outcome (nocollusion)

F. ?s it a #risoner6s !ilemma game

G. ?s there an incentive for collusivestrategy


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*uestions +or eac! matri):1. !oes either rm have a

dominant strategy

. ?s there a Jash+Iuilibrium

*. 0an you predict a likelyoutcome (no collusion)

F. ?s it a #risoner6s !ilemmagame

G. ?s there an incentive forcollusive strategy ?f so/

hat is the likely result of

airlines Co*e Pepsi Mc)7s 89

both maintain fare

Mes bothmaintain fare

Mes bothmaintain fare

Mes

Mes bothraise fare

both advertise

Mes bothadvertise

Mes bothadvertise

Jo

Jo

Jo

Jo

Jo

Jo

#erhaps

d li i i i di f i i l


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'(! !ow does monopolistic competition dier from pure competition"

#ure 0ompetition onopolistic 0ompetitionverylarge number of rms many rmsstandardi-ed product di"erentiated productno control over price little control over price

no entry barriers very small barriers to entryno non2price comp. signicant non2price comp.

Explain fully what product dierentiation involves

#roduct di"erentiation hether based on real or perceiveddi"erences is hat the monopolistic competitor needs to gain somemonopoly poer in the market.

,he real di"erences can be in Iuality/ in services/ in location/ or inmarketing.

,o the etent that product di"erentiation eists in fact or in the mindof the consumer/ monopolistic competitors have some control overprice/ because they have built up some loyalty to their brand.

#rom pure monopoly"

#ure onopolyone rm

NniIue product no closesubs.

#rice maker&locked entry

little'no nonprice comp.


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,-# 0ritically evaluate and eplain:$In monopolisticall competitive industries economic pro.tsare competed a"a in t!e lon% run/ !ence0 t!ere is no validreason to critici1e t!e per+ormance and ecienc o+ suc!industries%

,he rst part of the statement is ,BN+ (theoretically) .,he second part of the statement is O$L%+.

,he ine3ciency of monopolistic competition is not related to theprot level but to the fact that the rms do not produce at the point

of minimum $,0 (not productively e3cient) and do not eIuate priceand 0 (not allocatively e3cient).

,his is an inevitable conseIuence of imperfect competition.

2In t!e lon% run monopolistic competition leads to a

monopolistic price 'ut not to monopolistic pro.ts#3,BN+.

0ompetition of close substitutes tends to move price of the averagerm don to eIuality ith $,0. ,hus/ there is no economic prot.

Hoever/ price is higher than in pure competition (and therefore7monopolistic8) because hile the # 4 $,0 it does not eIual

,4 &h d li li i t"


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,4# &hy do oligopolies exist"

economies o, scale (automobiles/ steel industry) onership'control of resources (cigarettes/ mining industries) ergers (banking)

Porcester 0ounty Jational/ %hamut/ Oleet/ &anknorth/ ,!&anknorth/ ,! &ank

List ve or six oligopolists whose products you own or regularly purchase

0oca20ola/ 0hrysler/ Qeneral +lectric/ Phirlpool/%anford.

&hat distinguishes oligopoly from monopolistic competition">ligopoly onopolistic 0ompetitionferms many rms

standard or di". productdi"erentiated productprice2maker/ butA little control over price

strong entry barriersvery small barriers to entrysi nicant non2 rice com si nicant non2 rice com .


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,5a# &hat is the meaning of a four'rm concentration ratio of () percent" *)percent"

$ four2rm concentration ratio states the percentage of sales that

the largest four rms in an industry generate.

$ ratio of ;< percent means the largest four rms in the industryaccount for ;< percent of sales a four2rm concentration ratio of R

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9 Econ Chapter 25 Honors