Download Chapter #14 & 15

Monopolistic
Competition and
Oligopoly
Copyright © 2006 Pearson Education Canada
14 & 15
CHAPTER
Searching the Globe for a Niche
Globalization brings enormous diversity in products and
thousands of firms seek to make their own product special
and different from the rest of the pack.
Two firms produce the chips that drive most PCs.
Firms in these markets are neither price takers like those
in perfect competition nor are they protected from
competition by barriers to entry like a monopoly.
How do such firms choose the quantity to produce and
price?
Copyright © 2006 Pearson Education Canada
Monopolistic Competition
Monopolistic competition is a market structure in which
 A large number of firms compete.
 Each firm produces a differentiated product.
 Firms compete on product quality, price, and marketing.
 Firms are free to enter and exit the industry.
Copyright © 2006 Pearson Education Canada
Monopolistic Competition
Large Number of Firms
The presence of a large number of firms in the market
implies:
 Each firm has only a small market share and therefore
has limited market power to influence the price of its
product.
 Each firm is sensitive to the average market price but no
firm pays attention to the actions of others. So no one
firm’s actions directly affect the actions of other firms.
 Collusion, or conspiring to fix prices, is impossible.
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Monopolistic Competition
Product Differentiation
A firm in monopolistic competition practises product
differentiation if the firm makes a product that is slightly
different from the products of competing firms.
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Monopolistic Competition
Competing on Quality, Price, and Marketing
Product differentiation enables firms to compete in three
areas: quality, price, and marketing.
Quality includes design, reliability, and service.
Because firms produce differentiated products, the
demand for each firm’s product is downward sloping.
But there is a tradeoff between price and quality.
Because products are differentiated, a firm must market its
product. Marketing takes the two main forms: advertising
and packaging.
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Monopolistic Competition
Entry and Exit
There are no barriers to entry in monopolistic competition,
so firms cannot make an economic profit in the long run.
Examples of Monopolistic Competition
Figure 13.1 on the next slide shows market share of the
largest firms and the HHI for each of ten industries that
operate in monopolistic competition.
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Monopolistic Competition
The red bars
refer to the 4
largest firms.
Blue is the next
4 largest.
Orange is the
next 12 largest.
The numbers
are the HHI.
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Price and Output Monopolistic
Competition
The Firm’s Short-Run Output and Price Decision
A firm that has decided the quality of its product and its
marketing program produces the profit-maximizing
quantity at which its marginal revenue equals its marginal
cost (MR = MC).
Price is determined from the demand curve for the firm’s
product and is the highest price that the firm can charge
for the profit-maximizing quantity.
Figure 13.2 on the next slide shows a short-run equilibrium
for a firm in monopolistic competition.
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Price and Output in Monopolistic
Competition
The firm in monopolistic
competition operates much
like a single-price
monopoly.
The firm produces the
quantity at which MR
equals MC and sells that
quantity for the highest
possible price.
It earns an economic profit
(as in this example) when
P > ATC.
Copyright © 2006 Pearson Education Canada
Price and Output in Monopolistic
Competition
Profit Maximizing Might
be Loss Minimizing
A firm might incur an
economic loss in the short
run.
Here is an example.
At the profit-maximizing
quantity, P < ATC and the
firm incurs an economic
loss.
Copyright © 2006 Pearson Education Canada
Price and Output in Monopolistic
Competition
Long Run: Zero Economic Profit
In the long run, economic profit induces entry.
And entry continues as long as firms in the industry earn
an economic profit—as long as (P > ATC).
In the long run, a firm in monopolistic competition
maximizes its profit by producing the quantity at which its
marginal revenue equals its marginal cost, MR = MC.
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Price and Output in Monopolistic
Competition
As firms enter the industry, each existing firm loses some
of its market share. The demand for its product decreases
and the demand curve for its product shifts leftward.
The decrease in demand decreases the quantity at which
MR = MC and lowers the maximum price that the firm can
charge to sell this quantity.
Price and quantity fall with firm entry until P = ATC and
firms earn zero economic profit.
Copyright © 2006 Pearson Education Canada
Price and Output in Monopolistic
Competition
Figure 13.4 shows a firm
in monopolistic
competition in long-run
equilibrium.
If firms incur an economic
loss, firms exit to achieve
the long-run equilibrium.
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Product Development and Marketing
Innovation and Product Development
We’ve looked at a firm’s profit-maximizing output decision
in the short run and in the long run, for a given product
and with given marketing effort.
To keep earning an economic profit, a firm in monopolistic
competition must be in a state of continuous product
development.
New product development allows a firm to gain a
competitive edge, if only temporarily, before competitors
imitate the innovation.
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Product Development and Marketing
Innovation is costly, but it increases total revenue.
Firms pursue product development until the marginal
revenue from innovation equals the marginal cost of
innovation.
Production development may benefit the consumer by
providing an improved product, or it may only the
appearance of a change in product quality.
Regardless of whether a product improvement is real or
imagined, its value to the consumer is its marginal benefit,
which is the amount the consumer is willing to pay for it.
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Product Development and Marketing
Advertising
Firms in monopolistic
competition incur heavy
advertising expenditures.
Figure 13.6 shows
advertising expenditure as
a percentage of the total
price in some industries.
Cleaning supplies and toys
top the list at almost 15
percent.
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Product Development and Marketing
Selling Costs and Total Costs
Selling costs, like advertising expenditures, fancy retail
buildings, etc. are fixed costs.
Average fixed costs decrease as production increases, so
selling costs increase average total costs at any given
level of output but do not affect the marginal cost of
production.
Selling efforts such as advertising are successful if they
increase the demand for the firm’s product.
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Product Development and Marketing
Advertising costs might
lower the average total
cost by increasing
equilibrium output and
spreading their fixed costs
over the larger quantity
produced.
Here, with no advertising,
the firm produces 25 units
of output at an average
total cost of $60.
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What is Oligopoly?
Small Number of Firms
Because an oligopoly market has a small number of firms,
the firms are interdependent and face a temptation to
cooperate.
Interdependence: With a small number of firms, each
firm’s profit depends on every firm’s actions.
Cartel: A cartel and is an illegal group of firms acting
together to limit output, raise price, and increase profit.
Firms in oligopoly face the temptation to form a cartel, but
aside from being illegal, cartels often break down.
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What is Oligopoly?
Examples of Oligopoly
Figure 13.10 shows some
examples of oligopoly.
An HHI that exceeds
1800 is generally
regarded as an
oligopoly.
An HHI below 1800 is
generally regarded as
monopolistic
competition.
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Two Traditional Oligopoly Models
I) The Kinked Demand Curve Model
In the kinked demand curve model of oligopoly, each firm
believes that if it raises its price, its competitors will not
follow, but if it lowers its price all of its competitors will
follow.
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Two Traditional Oligopoly Models
Figure 13.11 shows the
kinked demand curve
model.
The demand curve that a
firm believes it faces has a
kink at the current price
and quantity.
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Two Traditional Oligopoly Models
Above the kink, demand is
relatively elastic because
all other firm’s prices
remain unchanged.
Below the kink, demand is
relatively inelastic because
all other firm’s prices
change in line with the
price of the firm shown in
the figure.
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Two Traditional Oligopoly Models
The kink in the demand
curve means that the MR
curve is discontinuous at
the current quantity—
shown by that gap AB in
the figure.
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Two Traditional Oligopoly Models
Fluctuations in MC that
remain within the
discontinuous portion of the
MR curve leave the profitmaximizing quantity and
price unchanged.
For example, if costs
increased so that the MC
curve shifted upward from
MC0 to MC1, the profitmaximizing price and
quantity would not change.
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Two Traditional Oligopoly Models
The beliefs that generate
the kinked demand curve
are not always correct and
firms can figure out this
fact
If MC increases enough,
all firms raise their prices
and the kink vanishes.
A firm that bases its
actions on wrong beliefs
doesn’t maximize profit.
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Two Traditional Oligopoly Models
II) Dominant Firm Oligopoly
In a dominant firm oligopoly, there is one large firm that
has a significant cost advantage over many other, smaller
competing firms.
The large firm operates as a monopoly, setting its price
and output to maximize its profit.
The small firms act as perfect competitors, taking as given
the market price set by the dominant firm.
Copyright © 2006 Pearson Education Canada
Copyright © 2006 Pearson Education Canada