Monopolistic Competition

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Monopolistic Competition Oligopoly
Chapter 12, Fall 2006
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What is Monopolistic Competition?

• Attributes of Monopolistic competition
• Many Sellers
• Product Differentiation
• Easy entry and exit

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Short-Run Operation in Monopolistic Competition

• In SR, a monopolistic competitive firm follows
  the monopolists rule for profit-maximization.
• MR MC
• Price gt ATC
• Price lt ATC

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Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market
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(No Transcript)
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Long-Run Operation in Monopolistic Competition

• If firms are making economic profits (above
  normal profits) in the short-run, new firms are
  encouraged to enter the market.
• Increases the number of products offered
• Reduces demand faced by each firm already in
  market
• Demand curves shift to the left ? decreasing
  profit
• Firms will enter and exit until the firms are
  making exactly zero economic profits (i.e.,
  normal profit)

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What Happens to Profits in the Long Run?
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Advertising and Brand Names

• The firm attempts to establish its product as a
  different product from that offered by its
  rivals.
• Differentiation means that in the consumers
  mind, the product is not the same. Product
  differentiation leads to advertising and brand
  names.
• Firms may differentiate products by perceived
  quality, reliability, color, style, safety
  features, packaging, purchase terms, warranties
  and guarantees, location, availability (hours of
  operation) or any other features.
• Brand names may signal information regarding the
  product, reducing consumer risk.

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Advertising and Brand Names (cont.)

• Critics of monopolistic competition contend that
  advertising and brand name exploit consumers and
  reduce competition
• Defenders argue that advertising increases
  competition by offering a greater variety of
  products and prices

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Advertising, Prices, and Profits
Product differentiation reduces the price
elasticity of demand, which appears as a steeper
demand curve. Successful product differentiation
enables the firm to charge a higher price.
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Benefits of Brand Names

• Provide consumers information about quality when
  quality cannot be easily judged in advance of
  purchase.
• Give firms an incentive to maintain high quality.

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Monopolistic Competition vs. Perfect Competition

• Differences in LR between monopolistic
  competition and perfect competition.
• Excess Capacity
• Could increase production
• Markup

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Comparing Perfect Competition and Monopolistic
Competition
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Oligopoly(Fall 2006, Chap. 13)

• An Oligopoly is characterized by
• Few sellers
• Standardized or differentiated products
• Difficult to enter industry
• Economies of Scale
• Ownership of a Key Input
• Government-Imposed Barriers (patent)
• Interdependent on other firms in industry
• Best policy is to cooperate and act like a
  monopolist by producing a small quantity of
  output (Q) and charging a price above marginal
  cost (MC).

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Oligopoly and Barriers to Entry
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Interdependence

• The importance of interdependence is that it
  leads to strategic behavior.
• Strategic behavior is the behavior that occurs
  when what is best for A depends upon what B does,
  and what is best for B depends upon what A does.
• Such behavior has been analyzed using the
  mathematical techniques of game theory.
• Game theory is the study of how people behave in
  strategic situations. Strategic decisions
  means that each person (firm) in deciding what
  actions to take, must consider how others (firms)
  might respond to that action.

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Prisoners Dilemma

• In this game between 2 criminals suspected of
  committing a crime, the sentence that each
  receives depends both on his or her decision
  whether to confess or remain silent and on the
  decision made by the other.
• The dominant strategy is the strategy that is
  best for a player (firm) in a game regardless of
  the strategies chosen by the other players
  (firms).

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Using Game Theory to Analyze Oligopoly

• A Duopoly Game Price Competition between Two
  Firms

• Payoff matrix A table that shows the payoffs that
  each firm earns from every combination of
  strategies by the firms.

Collusion An agreement among firms to charge the
same price, or to otherwise not compete.
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Cooperation Self-Interest

• Cooperation is difficult to maintain, because
  cooperation is not in the best interests of the
  individual (firm).
• Self-Interest makes it difficult for the
  oligopoly to maintain the cooperative outcome
  with low production, high prices, and monopoly
  profits.

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Collusion Cartels

• Collusion, which leads to secret cooperative
  agreements, is illegal in the U.S., although it
  is legal and acceptable in many other countries.
• A cartel is an organization of independent firms
  whose purpose is to control and limit production
  and maintain or increase prices and profits.
• Firms in oligopolies have a strong incentive to
  collude in order to reduce production, raise
  prices, and increase profits.