Download Chapter 25: Monopolistic Competition

Chapter 25:
Monopolistic Competition
And
Oligopoly
Monopolistic Competition
1) Relatively Large Number of Sellers
 Small Market Shares
 No Collusion
(collusion needs few producers)
 Independent Action
(each firm sets its price without considering the
possibility of rival reactions)
2) Differentiated Products
Product Attributes, Service, Location (accessibility),
Brand Names and Packaging, Some Control Over Price
3) Role of Advertising
To differentiate their products (Non-price competition)
4) Easy Entry and Exit (relative to monopoly)
Relatively small, don’t heavily rely on economies of scale.
Price and Output in Monopolistic Competition
The firm’s demand curve
The firm faces a highly, but not perfectly, elastic
demand curve.
Reasons:
• The seller has many competitors.
• Close substitutes to its product.
Elasticity of demand for the producer depends on:
• The number of rivals (+)
• The degree of product differentiation (-)
Optimal Output: The Short Run
Rule: MC = MR
There are tow possibilities:
 Profit
 Losses
Optimal Output: The long run:
Only a Normal Profit (i.e. economic profit = zero)





Profits: Firms enter.
In the short run economic profits attract new
entrants.
Demand facing the firm shifts to the left
Profits decline
Demand curve is tangent to ATC
No further incentive for entry





Losses: Firms leave
In the short run economic losses force some firms
to leave
Demand facing the firm shifts to the right
losses disappear
Demand curve is tangent to ATC
No further incentive to exit
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
Price and Costs
ATC
P1
A1
Economic
Profits
New competition drives down the
price level – leading to economic
losses in the short run
D
MR
Q1
Quantity
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
Price and Costs
ATC
A2
P2
Economic
Losses
With economic losses, firms will
exit the market – Stability occurs
when economic profits are zero
D
MR
Q2
Quantity
Price and Costs
PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Long-Run Equilibrium MC
Normal
Profit
Only
ATC
P3
= A3
D
MR
Q3
Quantity
MONOPOLISTIC COMPETITION
AND EFFICIENCY
In Pure Competition only
• Economic Efficiency: P = MC = Minimum ATC
• Productive Efficiency: P = ATC
Goods are produced in the least costly way.
Price is just efficient to cover total costs including a
normal profit
• Allocative Efficiency: P = MC
The right amount of output is being produced.
The right amount of the society’s scarce resources is
being devoted to this specific use.
MONOPOLISTIC COMPETITION
AND EFFICIENCY
In Monopolistic Competition
• Not Productively Efficient:
price  Minimum ATC
P > Minimum ATC
• Not Allocatively Efficient:
Price  MC
•
• Monopolistic competition results in underallocation of
the society’s resources.
• Monopolistic competition is not allocatively efficient.
• Consumers pay a higher than the competitive price and
obtain a less than optimal output.
• Monopolistic competition producers must charge a
higher than the competitive price in the long run in order
to achieve a normal profit.
• The price-marginal cost gap experienced by each firm
creates an industrywide efficiency loss.
Excess Capacity
• Optimal capacity is to produce at minimum ATC.
• The gap between minimum ATC and the profit
maximizing price identifies excess capacity:
• Plant and equipment are underused because production
is at less than minimum ATC.
MONOPOLISTIC COMPETITION
AND EFFICIENCY
Price and Costs
Long-Run Equilibrium
MC
Price is Not
= Minmum
ATC
ATC
P3
= A3
Price  MC
D
MR
Excess capacity
Q3
Quantity
Q4
Oligopoly
1. Oligopoly exists where a few large firms producing
a homogeneous or differentiated product dominate a
market.
2. There are few enough firms in the industry that
firms are mutually interdependent—each must
consider its rivals’ reactions in response to its
decisions about prices, output, and advertising.
3. Some oligopolistic industries produce standardized
products (steel, zinc, copper, cement), whereas others
produce differentiated products (automobiles,
detergents, greeting cards).
Barriers to entry
1. Economies of scale may exist due to technology and
market share.
2. The capital investment requirement may be very
large.
3. Other barriers to entry may exist, such as patents,
control of raw materials, preemptive and retaliatory
pricing, substantial advertising budgets, and
traditional brand loyalty.
Cartels and collusion agreements
constitute another oligopoly model
1. Collusion reduces uncertainty, increases profits, and
may prohibit the entry of new rivals.
2. A cartel may reduce the chance of a price war
breaking out particularly during a general business
recession.
3. A cartel is a group of producers that creates a formal
written agreement specifying how much each
member will produce and charge.
4. Cartels are illegal in the U.S., thus any collusion that
exists is covert and secret.
There are many obstacles to collusion:
a. Differing demand and cost conditions among firms in
the industry;
b. A large number of firms in the industry;
c. The incentive to cheat;
d. Recession and declining demand (increasing ATC);
e. The attraction of potential entry of new firms if prices
are too high; and
f. Antitrust laws that prohibit collusion.
Oligopoly and Advertising
A. Product development and advertising campaigns are
more difficult to combat and match than lower prices.
B. Oligopolists have substantial financial resources with
which to support advertising and product development.
C. By providing information about competing goods,
advertising diminishes monopoly power, resulting in
greater economic efficiency.
D. By facilitating the introduction of new products,
advertising speeds up technological progress.
E. If advertising is successful in boosting demand,
increased output may reduce long run average total cost,
enabling firms to enjoy economies of scale.
Oligopoly and Efficiency
1. The economic efficiency of an oligopolistic industry is
hard to evaluate.
2. Allocative and productive efficiency are not realized
because price will exceed marginal cost and, therefore,
output will be less than minimum average-cost output
level.
3. Informal collusion among oligopolists may lead to price
and output decisions that are similar to that of a pure
monopolist while appearing to involve some
competition.
Economic inefficiency may be lessened because:
1. Foreign competition has made many oligopolistic
industries much more competitive when viewed on a
global scale.
2. Oligopolistic firms may keep prices lower in the short run
to deter entry of new firms.
3. Over time, oligopolistic industries may foster more rapid
product development and greater improvement of
production techniques than would be possible if they
were purely competitive.