Download Product differentiation

By: Adrian Morales and Angelica Morgan
Characterized by
•
(1) Relatively large number of sellers; competitive
aspect
•
(2) Differentiated products; monopolistic aspect
•
(3) Easy entry/exit to industry; competitive aspect
In general, monopolistically competitive industries are more
competitive than they are monopolistic
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
Fairly large number of firms but less then pure
competition. Therefore,
1. Small market shares
2. No collusion
3. Independent action
• Product differentiation- Monopolistic competitive
firms turn out variations of a particular product.
Product differentiation may occur through:
• Product Attributes
• Service
• Location
• Brand Names and Packaging
•
•
•
•
•
Easy entry and exit is easy.
Financial barriers such as copyrights trademarks makes it
difficult/costly to imitate their products.
Nothing keeps monopolistic competitor from shutting down.
Advertising- goal of product differentiation and advertising is
non-price competition
Monopolistic Competitive Industries- Retail establishments:
grocery stores, gas stations, barbershops, clothing stores, and
restaurants. Professional services: medical care, legal
assistance, and real estate sales.
•
•
•
1)
2)
Assumptions: each firm in an industry is producing a
specific differentiated product and engaging in a particular
amount of advertising.
The Firms Demand Curve- monopolistic competitor’s
demand is more elastic than demand faced by a pure
monopolists
Not perfectly elastic for two reasons:
Monopolistic competitor has fewer rivals,
Product differentiation
MC
Price and Costs
ATC
P1
A1
Short-Run
Economic
Profits
D
MR
Q1
Quantity
MC
Price and Costs
ATC
A2
P2
Short-Run
Economic
Losses
D
MR
Q2
Quantity
MC
Normal
Profit
Only
ATC
Price and Costs
P3
= A3
D
MR
Q3
Quantity
•
•
Some firms may have sufficient product
differentiation such that firms cannot duplicate them
even in the long run. Example: Well known brand
names.
Product differentiation can lead to financial barriers
making entry more difficult than if the product
where standardized. This suggests some monopoly
power with small economic profits continuing even
in the long run.
Long-Run Equilibrium MC
Price is ≠ Minimum
ATC
ATC
Price and Costs
P3
= A3
Price  MC
D
MR
Q3
MC
ATC
Price and Costs
P3
= A3
D
MR
Q3
Q4
Excess Capacity
(1) In the eyes of monopolistic competitors:
•
A firm can attempt to stay ahead of competitors and keep profits
through further product differentiation and better advertising.
•
Rivals must imitate/improve on the product or lose business
•
If demand ↑ by more than enough cover advertising costs, then the firm
has improved financial position.
(2) In the eyes of consumers:
•
Consumers are offered a wide range of types, styles brands and quality
gradations of a product.
•
Product differentiation creates a tradeoff between consumer choice and
product efficiency.
•
Stronger product differentiation = greater excess capacity (product
inefficiency) = greater satisfaction of diverse consumer tastes.
•
•
•
Assumptions: a constant given product and given level of
advertising expenditures.
However, monopolistic competitors must determine what
variety of a product, at what price, and what level of
advertising will result in the greatest profit.
Moreover, this optimal combo can only be found through trial
and error.
Characterized by:
• A market demanded by a few large producers
• Selling either a homogenous or differentiated product
• Considerable control over prices
• Strategic behavior or self interested behavior that takes into
account the reactions of other firms
• Mutual interdependence or a situation where a firm’s profit
depends on not only their own price and sales strategies but also
that of other firms.
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
Entry Barriers:
•
New firms tend to be high-cost producers
•
Large expenditures for capital
•
Ownership of raw materials
•
Patents, copyrights, and trademarks
•
Retaliatory pricing and advertising strategies
Mergers:
•
Increase market share
•
Greater economies of scale, greater control over market supply and thus
the price of it product.
•
•
•
Concentration Ratio
Percentage total output produced and sold by an industry’s largest
firms
Example: Four largest U.S. producers of breakfast cereal account for
83% of cereals made in the U.S.
If the four largest firms control 40% of the market than the industry is
considered oligopolistic.
Shortcomings:
1. Localized Markets
2. Interindustry Competition
3. World Trade
•
•
•
•
•
Herfindahl Index
The sum of the squared percentage market shares of all the firms in industry.
Formula: (%S1)2 + (%S2)2 + (%S3)2 + … + (%Sn)2
Problem: Suppose you have industry X and Y. X is pure monopoly with a
100% concentration ratio. Y is an oligopoly with 100% as well but each firm
has a 25% market share.
Which has a a greater market share?
Herfindahl Index is the solution:
Industry X → 1002 = 100,000
Industry Y → 252+252+252+252 = 25,000
• The Game Theory is the study of how people behave in
strategic situations
• Game Theory model assumptions: (1) Duopoly; (2) Price
high or Price low
Nike’s Price Strategy
Reebok’s Price Strategy
High
High
Low
Low
Greatest
Combined
Profit
Nike’s Price Strategy
Reebok’s Price Strategy
High
High
Low
Low
Independent
Actions increases
the profits at the
expense of the
other
Independent
Actions increases
the profits at the
expense of the
other
Nike’s Price Strategy
Reebok’s Price Strategy
High
Low
High
Collusion
increases the
profits of both
firms
Low
Nike’s Price Strategy
Reebok’s Price Strategy
High
Low
High
The incentive
to cheat
becomes very
tempting
Low
Three distinct models for oligopolistic pricing and output behavior:
1.
The Kinked Demand Curve
2.
Collusive Pricing
3.
Price Leadership
Why not a single model, as in our discussions of the other market structures?
•
Diversity of oligopolies
•
Complications of Interdependence
The diversity of oligopolies and the presence of mutual interdependence
are reflected in the models that follow…
Price
The Anheuser’s demand and
marginal revenue curves
when rivals match price
changes
P
0
D1
Quantity
Q0
MR1
Price
The Anheuser’s demand and
marginal revenue curves
when rivals ignore price
changes
P
0
D2
D1
Quantity
Q0
MR
MR2
Price
Rivals
Follow any price cuts
P
0
D2
D1
Quantity
Q0
MR
MR2
Price
Rivals ignore
price any increase
P
0
D2
D1
Quantity
Q0
MR
MR2
Price
Behold!
The Kinked Demand Curve
P
0
D2
D1
Quantity
Q0
MR1
MR2
Price
Anheuser Busch’s Demand Curve
P
0
D
Q0
Price
MC1 Prices are generally stable in
noncollusive oligopolies for
both demand and cost reasons
P0 MR2
MC2
D
Quantity
Q0
MR
Profit maximization
at the kink
Price
MC1
P
0
MR2
MC2
D
Quantity
Q0
MR
Price
MC1
P
0
MR2
This behavior can set
off a price war.
MC2
D
Quantity
Q0
MR
Price and costs
Economic
Profit
MC
P0
ATC
A0
D
MR = MC
MR
Q0
Colluding
Oligopolists Will
Split the
Monopoly
Profits.
Price ≠
Minimum ATC
Price ≠
MC
• Demand and Cost Differences
• Number of Firms
• Cheating
• Recession
• Potential Entry
• Legal Obstacles
• An understanding by which oligopolists can coordinate prices
without outright collusion
• Most efficient firm initiates price changes and all the other
firms follow the leader
Leadership tactics include:
• Infrequent Price Changes
• Communications
• Limit Pricing
• Increased foreign competition
• Limit Pricing
• Advances in Technology