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