Download adjusting toward equilibrium

MICROECONOMICS: Theory & Applications
Chapter 13: Monopolistic Competition and Oligopoly
By
Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College
Learning Objectives

Explain how price and output are determined
under monopolistic competition.
 Understand the characteristics of oligopoly.
 Explore several key non-cooperative
oligopoly models: Cournot, Stackelberg, and
dominant firm.
 Show how price and output are determined
under the cooperative oligopoly model of
cartels.
Copyright 2012
John Wiley & Sons, Inc.
2
Price and Output Under
Monopolistic Competition

Monopolistic competition – a market
characterized by:
unrestricted entry and exit
 a large number of independent sellers
producing differentiated products


Differentiated product – a product that
consumers view as different from other
similar products.
Copyright 2012
John Wiley & Sons, Inc.
3
Determination of Market Equilibrium

The demand curve facing each firm is downward-sloping but
fairly elastic, reflecting a firm’s market power.

Differs from a monopoly:
 Firm demand curve is not the market demand.
 Entry into the market is not restricted.

Firms compete on product differentiation as well as price.

Long-run equilibrium:



attained as a result of firms entering (or leaving) the industry in response to
profit incentives.
Price > MC
zero economic profit
Copyright 2012
John Wiley & Sons, Inc.
4
Figure 13.1 - Determination of Market
Equilibrium
Copyright 2012
John Wiley & Sons, Inc.
5
Monopolistic Competition and Efficiency

Excess capacity – the result of firms failing
to produce at lowest possible average
cost
1.
2.
The firm does not operate at the minimum
point on the LR average cost curve.
Total output is wrong from a social
perspective due to deadweight loss

Copyright 2012
Deadweight loss is analytically reduced if the
interdependence between individual firms’ demand
is taken into account
John Wiley & Sons, Inc.
6
Figure 13-2 – Alleged Deadweight Loss
of Monopolistic Competition
Copyright 2012
John Wiley & Sons, Inc.
7
Is Government Intervention
Warranted?
3 reasons why government intervention is
probably not warranted:
1.
Any deadweight loss is likely to be small, due to the
presence of competing firms and free entry.
2.
Any possible inefficiency cost must be weighed against
the product variety produced and the benefits of such
variety to consumers.
3.
The costs of intervention must be balanced against the
potential gain from expanding output.
Copyright 2012
John Wiley & Sons, Inc.
8
Oligopoly

Oligopoly – an industry structure
characterized by:




Copyright 2012
a few firms producing all or most of the output
of some good that may or many not be
differentiated
mutual interdependence: a firm’s actions have
an effect on its rivals and induce a react by
the rivals
barriers to entry which can influence pricing
behavior
many theoretical models
John Wiley & Sons, Inc.
9
The Cournot Model

Duopoly – an industry with two firms

Cournot Model – a model of oligopoly that assumes each
firm determines its output based on the assumption that
any other firms will not change their outputs.

Equilibrium is reached when neither firm has any incentive
to change output
Copyright 2012
John Wiley & Sons, Inc.
10
Figure 13.3 - The Cournot Model
Copyright 2012
John Wiley & Sons, Inc.
11
Reaction Curves

Reaction Curve – a relationship showing one firm’s
most profitable output as a function of the output
chosen by other firms

Cournot equilibrium occurs at the intersection of two
reaction curves:




Total output is usually between that of pure monopoly and
competition.
Price exceeds MC.
Price exceeds AC => economic profit > 0
Collusion can increase combined profits of firms.
Copyright 2012
John Wiley & Sons, Inc.
12
Figure 13.4 – The Cournot Model with
Reaction Curves
Copyright 2012
John Wiley & Sons, Inc.
13
Evaluation of the Cournot Model
The assumption that each firm takes the
output of a rival firm as constant is
implausible if the market is adjusting toward
equilibrium. However,


Copyright 2012
if equilibrium is established, firms will not see
the assumption invalidated.
the assumption is more plausible the larger the
number of firms in the market.
John Wiley & Sons, Inc.
14
Other Oligopoly Models
The Stackelberg Model – a model of
oligopoly in which a leader firm selects its
output first, taking the reactions of follower
firms into account
 Dominant Firm Model – a model of
oligopoly in which the leader or dominant
firm assumes its rivals behave like
competitive firms in determining their output

Copyright 2012
John Wiley & Sons, Inc.
15
The Stackelberg Model

Residual demand curve – a firm’s demand curve
based on the assumption that the firm knows how
much output rivals will produce for each output the
firm may choose

Key point: a firm’s conjectures in an oligopoly about
how rivals will respond can affect firms’ outputs,
profits, and total industry output.

Which model is better? It depends upon the
particular market under examination
Copyright 2012
John Wiley & Sons, Inc.
16
Figure 13.5 - The Stackelberg Model
Copyright 2012
John Wiley & Sons, Inc.
17
The Dominant Firm Model

The leader assumes its rivals behave like competitive firms in
determining their output.

Also known as “the dominant firm with a competitive fringe” model.

At any price, the dominant firm can sell an amount equal to the total
quantity demanded at that price minus the quantity the fringe firms
produce.

At equilibrium, price > MC for the dominant firm but price = MC for the
fringe firm

Total output < output for a competitive industry

Model is applicable if there are many fringe firms.
Copyright 2012
John Wiley & Sons, Inc.
18
Figure 13. 6 - The Dominant Firm Model
Copyright 2012
John Wiley & Sons, Inc.
19
The Elasticity of the Dominant Firm’s
Demand Curve
ηD = ηM (1/MS) + εSF((1/MS) – 1)
where:
ηD = elasticity of the dominant firm’s demand
ηM = elasticity of the market demand
MS = the dominant firm’s market share
εSF = elasticity of supply of the fringe firms
(continued)
Copyright 2012
John Wiley & Sons, Inc.
20
The Elasticity of the Dominant Firm’s
Demand Curve
(continued)
Copyright 2012
John Wiley & Sons, Inc.
21
Cartels and Collusion
Cartel – an agreement among independent
producers to coordinate their decisions so
each of them will earn monopoly profit
 Collusion – coordinated decisions among
independent producers in an industry
 Cartels are illegal under antitrust laws in the
United States.

Copyright 2012
John Wiley & Sons, Inc.
22
Figure 13.7 – A Cartel
Copyright 2012
John Wiley & Sons, Inc.
23
Why Cartels Fail

Each firm has a strong incentive to cheat on the
cartel agreement.

Members of the cartel will disagree over
appropriate cartel policy regarding pricing,
output, allowable market shares, and profit
sharing.

Profits of the cartel members will encourage
entry into the industry.
Copyright 2012
John Wiley & Sons, Inc.
24
Oligopolies and Collusion

Firms in an oligopolistic industry can increase their profits by
colluding.
 The limited number of firms makes it easier to reach
agreements.
 When few firms are involved, it is easier to detect
cheaters.

Factors that inhibit the formation and maintenance of cartels:
 Incentive to cheat
 Higher price achieved by collusion prompts entry by new
firms

It is not necessary for all firms in the industry to participate in
the cartel for it to be worthwhile.
Copyright 2012
John Wiley & Sons, Inc.
25
The Case of OPEC

Reasons for Success:




The price elasticity of demand for oil is low in the
short run.
The price elasticity of supply of oil from non-OPEC
suppliers is low in the short run.
Oil-importing nations frequently adopted policies
that strengthened OPEC’s position.
In general, the magnitude of any response in
consumption and production will be greater the
more time consumers and producers are given
to respond.
Copyright 2012
John Wiley & Sons, Inc.
26
Figure 13.8 – OPEC Cartel as a Dominant
Firm
Copyright 2012
John Wiley & Sons, Inc.
27
Copyright © 2012 John Wiley & Sons, Inc. All
rights reserved. Reproduction or translation of this
work beyond that permitted in section 117 of the
1976 United States Copyright Act without express
permission of the copyright owner is unlawful.
Request for further information should be
addressed to the Permissions Department, John
Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for
distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages
caused by the use of these programs or from the
use of the information herein.
Copyright 2012
John Wiley & Sons, Inc.
28