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Chapter 11
Monopolistic
Competition and
Oligopoly
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Characteristics of monopolistic
competition
• Normal profit in the long run
• Characteristics of oligopoly
• Game theory
• The oligopolist’s kinked demand
curve
• Collusion among oligopolists
• The effects of advertising
11-2
Monopolistic Competition
• Large number of sellers
–Small market shares
–No collusion
–Independent action
• Differentiated Products
–Product attributes
–Service
–Location
–Brand names and packaging
–Some control over price
11-3
Monopolistic Competition
• Easy entry and exit
• Need for advertising
–Nonprice Competition
• Which industries?
–Degree of concentration
–Four-firm concentration ratio
–Herfindahl index
11-4
Monopolistic Competition
• Firm’s demand curve
–Highly elastic
• Short run profit or loss
–Produce where MR=MC
• Long run normal profit
–Entry and exit
• Inefficient
• Product variety
11-5
Monopolistic Competition
Short-Run Profits
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
11-6
Monopolistic Competition
Short-Run Losses
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
11-7
Monopolistic Competition
Long-Run Equilibrium
MC
Price and Costs
ATC
P3= A3
D3
MR = MC
MR
0
Q3
Quantity
11-8
Monopolistic Competition
P=MC=Min ATC for pure competition (recall)
Price and Costs
MC
ATC
P3= A3
P4
Price is Lower
D3
MR = MC
Excess Capacity at
Minimum ATC
0
MR
Q3
Q4
Quantity
Monopolistic competition is not efficient
11-9
Oligopoly
• A few large producers
• Homogeneous or
differentiated products
• Control over price
–Mutual interdependence
–Strategic behavior
• Entry barriers
• Mergers
11-10
Oligopoly
• Four-firm concentration ratio
–Needs to be more than 40%
–Half of U.S. manufacturing
• Localized markets
• Interindustry competition
• World trade
–Import Competition
• Herfindahl index
11-11
Game Theory
RareAir’s Price Strategy
High
Uptown’s Price Strategy
• 2 competitors
• 2 price
strategies
• Each strategy
has a payoff
matrix
• Greatest
combined
profit
• Independent
actions
stimulate a
response
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-12
Game Theory
RareAir’s Price Strategy
High
Uptown’s Price Strategy
• Independently
lowered prices
in expectation
of greater profit
leads to the
worst
combined
outcome
• Eventually low
outcomes make
firms return to
higher prices
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-13
Game Theory
• Mutual interdependence
–Pricing policy
• Collusion
–Enhances profit
• Incentive to cheat
• Prisoner’s dilemma
11-14
Three Oligopoly Models
•
•
•
•
Kinked-demand curve
Collusive pricing
Price leadership
Why three models?
–Diversity of oligopolies
–Complications of interdependence
11-15
Kinked-Demand Curve
• Noncollusive oligopoly
• Strategies
–Match price changes
–Ignore price changes
• Combined strategy
• Price inflexibility
• The kinked-demand curve
11-16
Kinked-Demand Curve
Competitor and rivals strategize versus each other
Consumers effectively have 2 partial demand curves
and each part has its own marginal revenue part
e
P0
f
D2
Rivals Match g
Price Decrease
0
Q0
MR1
Quantity
MR2
Price and Costs
Price
Rivals Ignore
Price Increase
MC1
D2
P0
e
MR2
f
MC2
g
D1
D1
0
Q0
MR1
Quantity
Resulting in a kinked-demand curve
to the consumer – price and output
are optimized at the kink
11-17
Kinked-Demand Curve
• Criticisms of the model
–How does price get to P0
–Explains inflexibility, not price
–Prices are not that rigid
–Price wars
11-18
Cartels and Other Collusion
• Price and output
–Joint profit maximization
Price and Costs
MC
Effectively Sharing
The Monopoly Profit
P0
ATC
A0
MR=MC
Economic
Profit
D
MR
Q0
Quantity
11-19
The OPEC Cartel
Daily oil production (barrels) , November 2008
Saudi Arabia
Iran
Kuwait
Venezuela
Iraq
Nigeria
UAE
Angola
Libya
Algeria
Qatar
Indonesia
Ecuador
8,904,000
3,843,000
2,538,000
2,368,000
2,297,000
2,183,000
2,117,000
1,804,000
1,737,000
1,417,000
848,000
843,000
530,000
Source: A. T. Kearney, Foreign Policy
11-20
Cartels and Other Collusion
• Covert collusion
–Tacit understandings
• Obstacles to collusion
–Demand and cost differences
–Number of firms
–Cheating
–Recession
–Potential entry
–Legal obstacles: antitrust law
11-21
Price Leadership Model
•
•
•
•
•
Leadership tactics
Infrequent price changes
Communications
Limit pricing
Breakdowns in price leadership:
–Price wars
11-22
Advertising
• Prevalent in monopolistic
competition and oligopoly
• Capture market share
• Better than a price cut
• Information for consumers
• Manipulation
11-23
Oligopoly and Advertising
The Largest U.S. Advertisers, 2006
Company
Advertising Spending
Millions of $
Proctor and Gamble
AT&T
General Motors
Time Warner
Verizon
Ford Motor
GlaxoSmithKline
Walt Disney
Johnson & Johnson
Unilever
$4898
3345
3296
3089
2822
2577
2444
2320
2291
2098
Source: Advertising Age
11-24
Oligopoly and Advertising
World’s Top 10 Brand Names, 2007
Coca-Cola
Microsoft
IBM
General Electric
Nokia
Toyota
Intel
McDonald’s
Disney
Mercedes-Benz
Source: Interbrand
11-25
Oligopoly and Efficiency
• Not productively efficient
• Not allocatively efficient
• Tendency to share the monopoly
profit
• Qualifications
–Increased foreign competition
–Limit pricing
–Technological advance
11-26
Oligopoly in the Beer Industry
• From hundreds to a few firms
• Demand side changes
– Taste shifts to lighter beers
– Shift from tap to cans or bottles
• Supply side changes
– Technological change increased
minimum efficient scale
– National brands enjoy cost advantages
• Consolidation into oligopoly
11-27
Key Terms
• monopolistic
competition
• product differentiation
• nonprice competition
• four-firm concentration
ratio
• Herfindahl index
• excess capacity
• oligopoly
• homogeneous
oligopoly
• differentiated oligopoly
• strategic behavior
• mutual interdependence
• interindustry
competition
• import competition
• game theory
• collusion
• kinked-demand curve
• price war
• cartel
• price leadership
11-28
Next Chapter Preview…
Technology, R&D,
And Efficiency
11-29