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Between Competition and Monopoly: Monopolistic Competition and Oligopoly Contents ● Monopolistic Competition ● Oligopoly ● Monopolistic Competition, Oligopoly, and Public Welfare ● A Glance Backward: Comparing the Four Market Forms Copyright© 2006 South-Western/Thomson Learning. All rights reserved. A Dose of Reality ● Monopolistic Competition is the most widespread industry structure in the U.S. ● Output generated by oligopolistic industries generates more than half of U.S. GDP ♦ GDP – gross domestic product ♦ Roughly speaking – total annual output ● Analysis is complicated – won’t say much Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Monopolistic Competition ● Characteristics of Monopolistic Competition ♦ Many sellers ♦ Freedom of entry and exit ♦ Perfect information ♦ Heterogeneous products Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Monopolistic Competition ● Characteristics of Monopolistic Competition ♦ First three characteristics same as those for perfect competition. ♦ Fourth is an important distinction. ♦ Demand curve that every firm faces is negatively sloped. ♦ Majority of U.S. firms are in this type of market structure. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Monopolistic Competition ● Price and Output Determination under Monopolistic Competition ♦ MR = MC rule applies for setting output. ■i.e. individual firm acts like monopoly ♦ Long-run equilibrium: the firm’s demand curve must be tangent to its average cost curve. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 1: Short-Run Equilibrium Under Monopolistic Competition FIGURE MC Price per Gallon AC $1.80 $1.50 1.40 $1.00 P C E D MR 12,000 Gallons of Gasoline per Week Copyright© 2006 South-Western/Thomson Learning. All rights reserved. 2: Long-Run Equilibrium Under Monopolistic Competition FIGURE MC Price per Gallon AC $1.45 $1.35 P M E D MR 10,000 15,000 Gallons of Gasoline per Week Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Excess Capacity Theorem ● 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. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Excess Capacity Theorem ● Achievement of minimum average costs would require fewer but larger firms. ● This inefficiency may, however, be a reasonable price to pay for providing a large range of consumer choice. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Oligopoly ● Oligopoly = market dominated by a few sellers, at least several of which are large enough relative to the total market that they can influence the market price ● Oligopoly more intense competition than pure competition Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Oligopoly ● Why Oligopolistic Behavior is So Difficult to Analyze ♦ Oligopolistic firms interact with each other in complex ways, and almost anything can and sometimes does happen under oligopoly. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Oligopoly ● Lines of Attack: ♦ Ignore interdependence ♦ Strategic interaction ♦ Cartels ♦ Price leadership and tacit collusion ● To understand everything except first point, you must understand Game Theory Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Oligopoly and Game Theory ● Game Theory analyzes problems where agents account for others’ actions when taking a decision ● Ex: duopoly – two firms serving one market ♦ Each firm supplies half of total quantity ♦ Choice of firm 1 affects choice of firm 2 and vice versa ● Will study Game Theory after Midterm 2 Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 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. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Monopolistic Competition, Oligopoly, & Public Welfare ● Oligopolistic market can be perfectly contestable: ♦ If firms can enter and exit without losing the money they have invested ● If so, then the performance of the firms is likely to be close to perfectly competitive ● And thus, socially efficient Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Comparing the Four Market Forms ● Perfect competition and pure monopoly are uncommon in reality. ● Many monopolistically competitive firms exist. ● Oligopoly firms account for the largest share of the economy’s output. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Comparing the Four Market Forms ● Profits are zero in long-run equilibrium under perfect competition and monopolistic competition because of free entry and exit. ● Consequently, AC = AR = P in long-run equilibrium under these two market forms. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Comparing the Four Market Forms ● In equilibrium, MC = MR for the profitmaximizing firm under any market form. ● In the equilibrium of the oligopoly firm, MC may be unequal to MR. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Comparing the Four Market Forms ● Perfectly competitive firm and industry theoretically efficient allocation of resources. ● Monopoly and monopolistic competition are likely inefficient allocation of resources. ● Under oligopoly, almost anything can happen, impossible to generalize about its vices or virtues. Copyright© 2006 Southwestern/Thomson Learning All rights reserved. 5: Attributes of the Four Market Forms TABLE Copyright© 2006 South-Western/Thomson Learning. All rights reserved.