Chapter 14 Oligopoly and Monopolistic Competitionhomepage.ntu.edu.tw/~luohm/econ2019f/chapter14.pdf · Another type of oligopoly model where sellers compete on quantities rather than

Outline Two More Structures Oligopoly Monopolistic Competition The “Broken" Invisible Hand Four Mkt. Structures

Part III:Market Structure12. Monopoly13. Gameaeory and Strategic Play14. Oligopoly andMonopolistic Competition

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Chapter 14Oligopoly andMonopolistic

Competition

2019.11.20.

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Two MoreMarket Structures

Oligopoly

Monopolistic Competition

ae “Broken" InvisibleHand

Summing Up: FourMarket Structures

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Q:Howmany ûrms are necessary to make amarketcompetitive?

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● Two market structures that lie between perfectcompetition andmonopoly are oligopoly andmonopolistic competition.● In both of thesemarkets the sellermust recognizeactions of competitors.● In oligopolies, economic proûts in the long runcan be positive.

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● In monopolistically competitivemarkets, entryand exit drive economic proûts to zero in the longrun.● aere are several important variables such as thenumber of ûrms in the industry, the degree ofproduct diòerentiation, entry barrier, and thepresence or absence of collusion that determinethe competitiveness of amarket.

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14.1 Two MoreMarket Structures

● Diòerentiated products are goods that are similarbut not identical.● Homogeneous products are goods that areidentical,making them perfect substitutes.● Two characteristics of the classiûcation ofmarketstructures:1. ae number of ûrms2. ae degree of product diòerentiation

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Exhibit 14.1 Characteristics of FourMarket Structures● Oligopoly: only a few suppliers, homogeneous or

diòerentiated products● Monopolistic competition: facing downward-sloping

demand curve (monopolistic), free entry (competitive),manyûrms selling diòerentiated products.

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14.2 Oligopoly

● Greek origins: oligoimeaning “a few" and poleinmeaning “to sell."● Oligopolies sell homogeneous goods (for example,hard drive or oil) or diòerentiated goods (forexample, cigarettes or soda).

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ae Oligopolist’s Problem● Due to cost advantage associated with theeconomies of scale of oligopoly or other barrier toentry, entry and exit will not necessarily push themarket to zero economic proûts in the long run.● Because of relatively few competitors, there is animportant interaction between the few sellers thatdo occupy themarket.

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OligopolyModel with Homogeneous Products● One of the simplest cases of oligopoly is an industry with

only two competing ûrms— a duopoly.● Suppose that these two ûrms compete against one another

by setting prices— Bertrand competition.● Suppose that the industry of interest is landscaping and that

there are two ûrms: your company, Dogwood and acompetitor, Rose Petal.

● Both companies have the samemarginal cost which is $30per landscape job.

● Consumers view services from two companies as identical.aey will hire services from the company that sells at a lowerprice.

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Exhibit 14.2Market Demand Curve for an Oligopolywith Homogeneous Products

● If both companies charge the same price, each company willget half of the demand.

● aemarket has a total demand of 1,000 landscaping jobs perweek, provided that the price is $50.

● At any price above $50, themarket demand is zero.12 / 41


● What is directly relevant for a ûrm’sproût-maximizing decisions is its residualdemand curve, which is the demand that is notmet by other ûrms.● Your residual demand curve is

⎧⎪⎪⎪⎪⎪⎪⎨⎪⎪⎪⎪⎪⎪⎩

1000, if PDW < PRP ,10002 , if PDW = PRP ,

0, if PDW > PRP

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Doing the Best You Can:How Should You Price to Maximize Proûts?● You should choose the price thatmaximizes yourproûts.● Marginal cost is $30.● How does your behavior aòect Rose Petal’sbehavior?● To start with some simple strategies, suppose youcharge a price of $50 and Rose Petal charges $45.● What happens? Is this a Nash Equilibrium? Canyou do better?

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Exhibit 14.3 Dueling Duopolies and a Pricing Response

● A series of price-cutting between you and Rose Petal.● When does all of this price-cutting end? Or, what is theNash

equilibrium?● PDW = PRP = MC = $30 is the unique Nash Equilibrium.● In this equilibrium, each company ends up supplying half of

themarket and earn zero economic proûts.

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OligopolyModel with Diòerentiated Products● Amore realistic description of an industry is a setof ûrms thatmake similar but not homogeneousproducts.● Because products are diòerentiated, the demandfunction is not “all-or-nothing."● Firms can charge higher prices and not lose allsales because the diòerentiation createspreferences on the part of consumers.

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Example: Coke and Pepsi● If Coke raises its price, it will lose sales to Pepsi, but Coke’s

sales won’t go to zero because of diòerentiation. Someconsumers would still rather have Coke.

● How should Coke and Pepsi decide on their prices?● Each ûrmmust predict how its prices will aòect the prices of

its competitor.● In Nash equilibrium, both ûrms set their prices as best

responses to each other.● In a oligopoly with diòerentiated products, ûrms typically

make positive economic proûts, and some oligopolistspersist in the long run with positive proûts because ofbarriers (such as established brands) to entry.

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● What happens if there is a third ûrm supplyingsoda to themarket?● Price will typically be lower with three ûrmscompeting compared to two ûrms competing.● As the number of ûrms in an oligopolisticmarketincreases further, prices tend to decline towardmarginal cost.● If enough entry occurs, it could cause themarketto turn into amonopolistically competitivestructure.

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Apple versus Samsung

Oligopoly with diòerentiated products

1 these diòerentiated products are substitutes, so when onecompany reduces prices ormake its productmore attractive,this will reduce the demand for the product of the otherûrms.

2 no company will be able to capture the entiremarket.

3 when the consumers view the products as less substitutable,prices will be higher.

● ae competition between Apple and Samsung illustrates allthree points.

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● Whenever one company has released a new phone, it hasgainedmarket share at the expense of the other.

● Some Apple devotes are attracted to the iPhone as a distinctproduct.

● Newmodels are priced signiûcantly higher than older ones.20 / 41


Collusion: OneWay to Keep PricesHigh● Collusion occurs when rival ûrms conspireamong themselves to set prices or to controlproduction quantities rather than let the freemarket determine them.● Imagine that you and the CEO of Rose Petaldecide to collude by setting your prices jointlyrather than independently.● Oligopoliesmight coordinate and collectively actas amonopolist and then split themonopolyproûts among themselves.

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● Your ûrm and Rose Petal can collude and set pricesat $50. At this price, themarket demand is 1,000jobs. Half of the consumers will go to each ûrm.● Two reasons that collusion among oligopoliesmight not always be formed:● Even ûrms agree on collusion, they have an incentive to

engage in secret price-cutting to capturemore of theproûts for themselves. (For example, you can charge$49.50 for landscaping jobs and get the whole demand.)

● Price-ûxing is illegal.

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When Collusion CanWorkTwo important considerations that determine howsuccessful a collusive arrangement is:● Detection and punishment of cheaters.● For example: Keep my price at $50 provided that you

also keep your price at $50; if you ever cut your price,then I will cutmy price to $30, forever. ais type ofpunishment is called a grim strategy (冷酷策略).

● ae long-term value of themarket.● A colluder who values futuremonopoly proûtsmore

than current cheating proûts will abide by the collusionagreement.

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To Cheat or Not To Cheat: aat Is the Question● Another type of oligopolymodel where sellers compete on

quantities rather than prices is called Cournot competition.● aemost famous group that chooses to collude by choosing

quantities is OPEC (Organization of the PetroleumExporting Countries).

● OPEC is an oil cartel that coordinates the policies of severalmajor oil-producing countries.

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● OPEC has a problem of keeping the price of its good—oil—high.

● ais problem arises from the natural inability of collusivearrangement: each country can increase its proûts bypumping more oil, but if they all do so they will depressprices, reducing everybody’s proûts.

● In only 17 of the 178months shown in Exhibit 14.4 is actualproduction at or below the agreed-upon quota.

Exhibit 14.4 OPEC’s Production Quota Agreements and Actual Production, 2001-201525 / 41


Exhibit 14.4 OPEC’s Production Quota Agreements and Actual Production, 2001-2015

● OPEC has not been able to control oil prices not onlybecause of the tensions among OPECmembers, but alsobecause non-OPEC countries such as U.S. and Russia havebecome very important suppliers.

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14.3 14.3Monopolistic CompetitionaeMonopolistic Competitor’s Problem

Exhibit 14.6 Dairy Queen’s (resdual) Demand CurveandMarginal Revenue Curve

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Doing the Best You Can:How aMonopolistic CompetitorMaximizing Proûtsae decision rule is identical to that for themonopolist:

Exhibit 14.7 Optimal Pricing Strategy for aMonopolistic Competitor

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How aMonopolistic Competitor Calculates Proûts

Exhibit 14.8 Economic Proûts and Economics Losses

Proûts=Total revenue-Total cost=(P × Q) − (ATC × Q) = (P − ATC) × Q

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Long-Run Equilibrium in aMonopolistically CompetitiveIndustry

Exhibit 14.9ae Eòect ofMarket Entry on an Existing Firm’s Demand Curve

● With positive proûts, sellers will be attracted to thismarket.● When there aremore substitutes for a good, a ûrm’s residual

demand curve shi�s to the le� and becomesmore elastic(less steep).

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Exhibit 14.10 Zero Proûts in Long-Run Equilibrium

● When does entry stop?● Entry stops when there are no longer economic proûts.● Monopolistically competitive ûrms have an incentive to

continually try to distinguish themselves from rivals.

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14.4ae “Broken" InvisibleHand

● One important factor that can “break" thepowerful result of the invisible hand ismarketpower.● In both market structures ofmonopoly andoligopoly, ûrms havemarket power and are able tocharge prices greater than marginal cost, reducingtotal surplus.

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Exhibit 14.11 Equilibria for a Perfectly CompetitiveMarketand aMonopolistically CompetitiveMarket

● Is total surplusmaximized undermonopolisticallycompetition? ae answer is no.

● Monopolistic competitors produce at a level below theeõcient scale of production (theminimum of the ATC).

● aeymark up price above itsmarginal cost.● aemonopolistic competitor produces too little compared

to the socially eõcient level. 33 / 41


Regulating Market Power● Should the government regulate oligopolistic andmonopolistically competitivemarkets?● It depends.● A clear case in which government regulation iswarranted is successful collusion.● ae Sherman Antitrust Act of 1890 and theClayton Act of 1914 are concerned with theregulation ofmergers (購併).● One of themain approaches the Department ofJustice (DOJ) adopts in its analysis ofmergers is tocalculate how concentrated an industry is.

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● One of the tools that the DOJ uses to guide its enforcementof the Sherman Act is theHerûndahl-Hirschman Index(HHI).

● aeHHI is ameasure ofmarket concentration, which iscalculated by squaring themarket share of each ûrmcompeting in themarket and then summing the resultingnumbers.

● For example, if there are two ûrms in an industry and oneûrm accounts for 75 percent of the sales and the other 25percent, theHHI is equal to 752 + 252=6,250.

● ae higher theHHI, themore concentrated the industry.● aeHHI approaches zero when amarket consists of a large

number of ûrms of relatively equal size.

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● aere are limits to how eòectively the governmentcan use regulation to reducemarket power,particularly in monopolistically competitivemarkets with many producers.● Imagine if the government had to regulate pricesfor every product sold in monopolisticallycompetitive industries.● And Imagine further that it would set the numberand type of entrants for each production line.● ais type of intervention would border on acommand economy.

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14. Summing Up: FourMarket Structures

Exhibit 14.12 FourMarket Structures

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Q:Howmany ûrms are necessary to make amarketcompetitive?

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● Two economists, Timothy Bresnahan and PeterReiss reasoned that if amarket is alreadyeòectively competitive, the addition of onemoreûrm should not change prices.● When ûrms have signiûcantmarket power,further entry reduces prices, while in acompetitivemarket, further entry should leaveprices unchanged.● Bresnahan and Reiss obtained information onprices and the number of tire dealers acrossdiòerent towns in the western United States.

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Exhibit 14.13 Tire Prices and Tire Quality in Selected U.S. Towns

● aere is practically no diòerence in prices betweenmarkets with four and ûve dealers.● Once the diòerence in tire quality (timemileagerating) is accounted for, there is no evidence thatprices are diòerent between markets with three orfour dealers.● In sum, the evidence suggests that three or fourûrms are suõcient for the tiremarket to be(eòectively) competitive.

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● Two economists,Martin Dufwenberg and Uri Gneezydesigned an experiment in which a number of sellers eachchose a bid (selling price) between 2 and 100.

● Whichever sellermade the lowest bid kept the dollar amountequal to his or her bid.

● Dufwenberg and Gneezy found that in a duopoly, averagebids were just below 50.

● When the number of sellers increased to four, the sellersactedmuch more competitively.

● In fact, with four sellers, the average winning bid at the endof ten rounds of play was close to 2!

● aus, it the lab too, it appears that four competitors aresuõcient to drive the equilibrium toward the competitiveoutcome.

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Documents

Chapter 14 Oligopoly and Monopolistic Competitionhomepage.ntu.edu.tw/~luohm/econ2019f/chapter14.pdf · Another type of oligopoly model where sellers compete on quantities rather than