colander ch13 monocomp&oligopoly
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Introduction
In discussing real-world competition, thefocus uic!ly "ecomes mar!et structure#
Market structureis the physicalcharacteristics of the mar!et withinwhich firms interact#
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Introduction
Mar!et structure in$ol$es the num"er offirms in the mar!et and the "arriers to
entry# Perfect competition, with an infinite
num"er of firms, and monopoly, with a
single firm, are polar opposites#
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Introduction
Monopolistic competition and oligopoly lie"etween these two e%tremes#
& Monopolistic competitionis a mar!etstructure in which there are many firmsselling differentiated products#
& Oligopolyis a mar!et structure in whichthere are a few interdependent firms#
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Introduction
Most '#S# industry structures fall almostentirely "etween monopolistic competition
and oligopoly# Perfectly competiti$e and monopolisticindustries are nearly none%istent#
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Pro"lems (etermining Mar!etStructure
(efining a mar!et has pro"lems)& *hat is an industry and what is its
geographic mar!et -- local, national, orinternational+
& *hat products are to "e included in thedefinition of an industry+
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Classifying Industries
One of the ways in which economistsclassify mar!ets is "y cross-price
elasticities#& Cross-price elasticitymeasures theresponsi$eness of the change in demand for agood to change in the price of a related good#
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Classifying Industries
Industries are classified "y go$ernmentusing the orth merican Industry
Classification System .ICS/#& 0he North American IndustryClassification System.NAICS/ is aclassification system of industries adopted"y Canada, Me%ico, and the '#S# in 12#
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Classifying Industries
*hen economists tal! a"out industrystructure the general practice is to refer
to three-digit industries#& 'nder the ICS, a two-digit industry
is a "roadly "ased industry#
& three-digit industry is a specific typeof industry within a "roadly defined two-digit industry#
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0wo- and our- (igit Industry 4roups
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(etermining Industry Structure
5conomists use one of two methods tomeasure industry structure)
1# 0he Concentration 6atio
7# 0he 8erfindahl Inde%
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Concentration 6atio
0he concentration ratiois thepercentage of industry output that aspecific num"er of the largest firmsha$e#
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Concentration 6atio
0he most commonly used concentrationratio is the four-firm concentration ratio#
0he higher the ratio, the closer to anoligopolistic or monopolistic type ofmar!et structure#
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0he 8erfindahl Inde%
0he 8erfindahl inde% isan alternati$emethod used "y economists to classifythe competiti$eness of an industry#
It is calculated "y adding the suared$alue of the mar!et shares of all firms inthe industry#
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0he 8erfindahl Inde%
0wo ad$antages of the 8erfindahl inde%is that it ta!es into account all firms in anindustry as well as gi$ing e%tra weight toa single firm that has an especially largemar!et share#
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0he 8erfindahl Inde%
0he 8erfindahl Inde% is important"ecause it is used as a mar!er "y the9ustice (epartment for allowing ordisallowing mergers to ta!e place#
& If the inde% is less than 1,:::, the industry
is considered competiti$e thus allowing themerger to ta!e place#
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Concentration 6atios and the8erfindahl Inde%
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Conglomerate irms and ;igness
either the four-firm concentration ratioor the 8erfindahl inde% gi$es a completepicture of corporations< si=e#
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Conglomerate irms and ;igness
0his is "ecause many firms areconglomerates>huge corporations whoseacti$ities span $arious unrelatedindustries#
h f l f
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0he Importance of ClassifyingIndustry Structure
Classifying industry structure isimportant "ecause structure affects firm"eha$ior#& 0he greater the num"er of sellers, the more
the li!elihood the industry is competiti$e#
h f l f
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0he Importance of ClassifyingIndustry Structure
0he num"er of firms in an industry playsa role in determining whether firmse%plicitly ta!e other firms< actions intoaccount#
Oligopolies ta!e into account thereactions of other firms? monopolisticcompetitors do not#
0h f Cl if i
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0he Importance of ClassifyingIndustry Structure
In monopolistic competition, the largenum"er of firms ma!es it unli!ely that anindi$idual firm will e%plicitly ta!e intoaccount ri$al firms< responses to theirdecisions#
0h I f Cl if i
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0he Importance of ClassifyingIndustry Structure
In oligopoly, with fewer firms, each firme%plicitly engages in strategic decisionma!ing#
Strategic decision making& ta!inge%plicit account of a ri$al
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Monopolistic CompetitionMonopolistic Competition
0he four distinguishing characteristics ofmonopolistic competition are)& Many sellers#
& (ifferentiated products#
& Multiple dimensions of competition#
& 5asy entry of new firms in the long run#
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Many Sellers
*hen there are many sellers as inmonopolistic competition, they do notta!e into account ri$als< reactions#
0he e%istence of many sellers also ma!escollusion difficult#
Monopolistically competiti$e firms actindependently#
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(ifferentiated Products
0he @many sellersA characteristic gi$esmonopolistic competition its competiti$easpect#
Product differentiation gi$es monopolisticcompetition its monopolistic aspect#
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(ifferentiated Products
(ifferentiation e%ists so long asad$ertising con$inces "uyers that ite%ists#
irms will continue to ad$ertise as longas the marginal "enefits of ad$ertising
e%ceed its marginal costs#
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Multiple (imensions of Competition
One dimension of competition is productdifferentiation#
nother is competing on percei$eduality#
Competiti$e ad$ertising is another#
Others include ser$ice and distri"utionoutlets#
5 5 t f i
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5asy 5ntry of ew irmsin the Bong 6un
0here are no significant "arriers toentry#
;arriers to entry pre$ent competiti$epressures#
5ase of entry limits long-run profit#
P d P f f
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Output, Price, and Profit of aMonopolistic Competitor
monopolistically competiti$e firm pricesin the same manner as a monopolist>where MC M6#
;ut the monopolistic competitor is notonly a monopolist "ut a competitor as well#
P d P f f
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Output, Price, and Profit of aMonopolistic Competitor
t euili"rium, 0C euals price andeconomic profits are =ero#
0his occurs at the point of tangencyof the 0Cand demand cur$e at theoutput chosen "y the firm#
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Monopolistic Competition
MC
ATC
MR D
QM
PM
Price
0 Quantity
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Comparing Monopolistic Competitionwith Perfect Competition
;oth the monopolistic competitor and the
perfect competitor ma!e =ero economicprofit in the long run#
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Comparing Monopolistic Competitionwith Perfect Competition
0he perfect competitorsdemand cur$e is
perfectly elastic# 5asy entry, =ero economic profits, and a
uniform product means that the perfect
competitorproduces at the minimumofthe 0Ccur$e#
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Comparing Monopolistic Competitionwith Perfect Competition
monopolistic competitorfaces a
downward sloping demand cur$e, andproduces where MC M6#
0he 0Ccur$e is tangent to thedemand cur$e at that le$el, which is notat the minimum pointof the 0Ccur$e#
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Comparing Monopolistic Competitionwith Perfect Competition
Increasing mar!et share is a rele$ant
concern for a monopolistic competitor "utnot for a perfect competitor#
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Comparing Monopolistic Competitionwith Perfect Competition
In the real world of monopolistic
competition, increasing output and mar!etshare lowers a$erage total cost#
Comparing Perfect and Monopolistic
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Perfect competition Monopolistic competition
Comparing Perfect and MonopolisticCompetition
MC
PC
D
QC
Price
0 Quantity
ATC
PM
MC
ATC
DMR
QM
Quantity0
Price
QC
PC
C i M li ti C titi
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Comparing Monopolistic Competitionwith Monopoly
0he difference "etween a monopolist anda monopolistic competitor is in theposition of the a$erage total cost cur$e inlong-run euili"rium#
C i M li ti C titi
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Comparing Monopolistic Competitionwith Monopoly
or a monopolist, the a$erage total costcur$e can "e, "ut need not "e, at aposition "elow price so that themonopolist ma!es a long-run economicprofit#
Comparing Monopolistic Competition
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Comparing Monopolistic Competitionwith Monopoly
or a monopolistic competitor, thea$erage total cost cur$e is tangent to thedemand cur$e at the price and outputchose "y the monopolistic competitor sothat there are =ero economic profits inthe long run#
d$ertising and Monopolistic
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d$ertising and MonopolisticCompetition
irms in a perfectly competiti$e mar!etha$e no incenti$e to ad$ertise) they cansell all they produce at the mar!et price#
Monopolistic competitors ha$e a strongincenti$e to do so#
d$ertising and Monopolistic
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d$ertising and MonopolisticCompetition
0he primary goals of the ad$ertiser isto
1# mo$e the demand cur$e to the right and
7# ma!e it more inelastic#
d$ertising and Monopolistic
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d$ertising and MonopolisticCompetition
d$ertising shifts the demand cur$eshifts out and shifts the 0Ccur$e up#
0hat way the firm can sell more,charge more, or "oth#
d$ertising
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d$ertisingD the Creation of ame ;rands
0here is a sense of trust in "uying "rands we!now#
d$ertising creates ame ;rand 6ecognition#
Consumers are sometimes willing to pay more toreduce their uncertainty a"out the uality ofthe product#
Companies that de$elop name "rands can oftencharge more than for @no nameA homogeneousproducts#
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OligopolyOligopoly
Oligopoly is a mar!et structure wherethere are a small num"er of mutuallyinterdependent firms#
5ach firm must ta!e into account thee%pected reactionof other firms to itsprofit ma%imi=ing output decision#
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Models of Oligopoly ;eha$ior
o single general model of oligopoly"eha$ior e%ists#
0wo models of oligopoly "eha$ior are thecartel model and the contesta"le mar!etmodel#
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Models of Oligopoly ;eha$ior
In the cartel model, the firms in theindustry .oligopolies/ collude to set amonopoly price#
In the contesta"le mar!et model, anoligopolistic firm with no "arriers toentry sets a competiti$e price#
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0he Cartel Model
cartel.sometimes called a trust/ is acom"ination of firms that acts as it werea single firm#
cartel is a shared monopoly#
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0he Cartel Model
If oligopolies can limit the entryof otherfirms and form a cartel, they canincrease the profits going to thecom"ination of firms in the cartel#
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0he Cartel Model
0he model assumes that oligopolies act asif they were monopolists that ha$eassigned output uotas to indi$idualmem"er firmsso that total output isconsistent with Eoint profit ma%imi=ation#
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Implicit Price Collusion
ormal collusion is illegal in the '#S# whileinformal collusion is permitted#
Implicit price collusione%ists whenmultiple firms ma!e the same pricingdecisions e$en though they ha$e notconsulted with one another#
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Implicit Price Collusion
Sometimes the largest or most dominantfirm ta!es the lead in setting prices andthe others follow#
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Cartels and 0echnological Change
Cartels can "e destroyed "y an outsiderwith technological superiority#
0hus, cartels with high profits willpro$ide incenti$es for significanttechnological change#
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*hy re Prices Stic!y+
Informal collusion is an important reasonwhy prices are stic!y#
nother is the !in!ed demand cur$e#
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*hy re Prices Stic!y+
*hen there is a !in! in the demand cur$e,there has to "e a gap in the marginalre$enue cur$e#
0he !in!ed demand cur$e is not atheory of oligopoly "ut a theory of
stic!y prices#
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D2
0he Fin!ed (emand Cur$e
D1
MR2
MR1
Price
Quantity0 Q
P
ab
c
d
MC0
MC1
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0he Contesta"le Mar!et Model
ccording to the contestable marketmodel, "arriers to entry and "arriers toe%it determine a firm
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0he Contesta"le Mar!et Model
0he stronger the a"ility of theoligopolists to collude and pre$ent mar!etentry, the closer it is to a monopolisticsituation#
0he wea!er the a"ility to collude is,
the more competiti$e it is#
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Strategic Pricing and Oligopoly
;oth the cartel and contesta"le mar!etmodels use strategic pricing decisions>they set their prices "ased on thee%pected reactions of other firms#
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Strategic Pricing and Oligopoly
Carteli=ation strategy is limited "y entryof new firms "ecause the newcomer maynot want to cooperate with the otherfirms#
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Price *ars
Price wars are the result of strategicpricing decisions gone wild#
Sometimes a firm engages in this acti$ity"ecause it hates its competitor#
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Price *ars
firm may de$elop a predatory pricingstrategy as a matter of policy
& predatory pricing strategy in$ol$estemporarily pushing the price down in orderto dri$e a competitor out of "usiness#
4ame 0heory
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4ame 0heoryand Strategic (ecision Ma!ing
Most oligopolistic strategic decisionma!ing is carried out with e%plicit orimplicit use of game theory#
Game theoryis the application ofeconomic principles to interdependentsituations#
0he Prisoner
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0he Prisoner s (ilemma and a (uopoly5%ample
0he prisonerGs dilemma can "e used toillustrate the "eha$ior of a duopoly#
0heprisoners dilemmais one well-!nowngame that demonstrates the difficulty ofcooperati$e "eha$iorin certaincircumstances#
0he Prisoner
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he r soner s ( lemma and a (uopoly5%ample
0he prisoners dilemma has its simplestapplication when the oligopoly consists ofonly two firms>a duopoly#
0he Prisoner
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h r son r s ( mma an a (uopo y5%ample
;y analy=ing the strategies of "oth firmsunder all situations, all possi"ilities areplaced in a payoffmatri%#
payoff matriis a "o% thatcontains the outcomes of a strategic
game under $arious circumstances#
irm and Industry (uopoly
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irm and Industry (uopolyCooperati$e 5uili"rium
Price
Price
575
$800
700
600
500
400
300
200
100
0
(a) Firm's cost cures
1 2 3 4 5 6 7 8
!uantit" (in t#ousans)
MC ATC
$800
700
600
500
400
300
200
100
01 2 3 4 5 6 7 8 % 10 11
Monopolistsolution
MR
D
&ompetitiesolution
MC
() nustr" &ompetitie an monopolist solution
!uantit" (in t#ousans)
irm and Industry (uopoly 5uili"rium *hen
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irm and Industry (uopoly 5uili"rium *henOne irm Cheats
Price
Price
Price
$800
700
600
500
400
300
200
100
0
$800
700
600
500
400
300
200
100
0
$%00
800
700
600
500
400
300
200
100
0
550 550 550
1 2 3 4 5 6 7 1 2 3 4 5 6 7
A
MCATC
!uantit" (in t#ousans)
(a) *onc#eatin+ firm,s loss
A
MCATC
!uantit" (in t#ousans)
() eatin+ firm,s profit
AB
C
1 2 3 4 5 6 7 8
!uantit" (in t#ousans)
(c) eatin+ solution
*on-c#eatin+
firm,soutput
eatin+firm,s
output
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(uopoly and a Payoff Matri%
0he duopoly is a $ariation of theprisonerGs dilemma game#
0he results can "e presented in a payoffmatri% that captures the essence of theprisonerGs dilemma#
0he Payoff Matri% of Strategic
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. eats
. /oes notc#eat
/oes not c#eat eats
. $200000 . 0
0
$200000
. $75000
$75000
$75000
. $75000
y ff f gPricing (uopoly
Oligopoly Models, Structure, and
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g p y , ,Performance
Oligopoly models are "ased either onstructure or performance#& 0he four-fold di$ision of mar!ets considered
so far are "ased on mar!et structure#& Structuremeans the num"er, si=e, and
interrelationship of firms in the industry#
Oligopoly Models, Structure, and
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g p y , ,Performance
monopoly is the least competiti$e,perfectly competiti$e industries are themost competiti$e#
Oligopoly Models, Structure, and
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g p y , ,Performance
0he contesta"le mar!et model gi$es lessweight to mar!et structure#
& Mar!ets in this model are Eudged "yperformance, not structure#
& Close relati$es of it ha$e pre$iously "eencalled the "arriers-to-entry model, the
stay-out pricing model, and the limited-pricing model#
Oligopoly Models, Structure, and
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g p y , ,Performance
0here is a similarity in the twoapproaches#
& Often "arriers to entry are the reasonthere are only a few firms in an industry#
& *hen there are many firms, that suggeststhat there are few "arriers to entry#
& In such situations, which ma!e up themaEority of cases, the two approachescome to the same conclusion#
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Monopolistic Competition,Monopolistic Competition,
Oligopoly, and Strategic PricingOligopoly, and Strategic Pricing
5nd of Chapter 135nd of Chapter 13