Ch. 13 Monopolistic Competition and Oligopoly

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Ch. 13 Monopolistic Competition and Oligopoly

• A monopolistically competition is a form of
  industry (market) structure has the following
  characteristics
• A large number of firms
• No barriers to entry
• Product differentiation
• An oligopoly is a form of industry (market)
  structure characterized by a few dominant firms.
  
• Products may be homogeneous or differentiated.
• There tend to be barriers to entry
• ? The behavior of any one firm in an oligopoly
  depends to a great extent on the behavior of
  others.

Monopoly
Monopolist Competition
Oligopoly
Perfect Competition
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Monopolistic Competition

• Monopolistic competition is a common form of
  industry (market) structure in the United States,
  characterized by a large number of firms, none of
  which can influence market price by virtue of
  size alone.
• Some degree of market power is achieved by firms
  because they produce differentiated products.
• New firms can enter and established firms can
  exit such an industry with ease.
• What is product differentiation?

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Nine Industries with Characteristics of
Monopolistic Competition
Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992 Percentage of Value of Shipments Accounted for by the Largest Firms in Selected Industries, 1992
SIC NO. INDUSTRYDESIGNATION FOURLARGESTFIRMS FOURLARGESTFIRMS EIGHTLARGESTFIRMS EIGHTLARGESTFIRMS TWENTYLARGESTFIRMS TWENTYLARGESTFIRMS NUMBEROFFIRMS NUMBEROFFIRMS
3792 Travel trailers and campers 41 57 72 270
3942 Dolls 34 47 67 204
2521 Wood office furniture 26 34 51 611
2731 Book publishing 23 38 62 2504
2391 Curtains and draperies 22 32 48 1004
2092 Fresh or frozen seafood 19 28 47 600
3564 Blowers and fans 14 22 41 518
2335 Womens dresses 11 17 30 3943
3089 Miscellaneous plastic products 5 8 13 7605
Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997. Source U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997.
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Product Differentiation, Advertising, and Social
Welfare
Total Advertising Expenditures in 2001 Total Advertising Expenditures in 2001 Total Advertising Expenditures in 2001 Total Advertising Expenditures in 2001
DOLLARS(BILLIONS) DOLLARS(BILLIONS)
Newspapers 89.5
Television 54.4
Direct mail 44.7
Internet 5.8
Yellow pages 13.6
Radio 17.9
Magazines 11.1
Total 231.3
. . . .
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More Advertising Data
Magazine Advertising Revenues by Category, 2001 Magazine Advertising Revenues by Category, 2001 Magazine Advertising Revenues by Category, 2001 Magazine Advertising Revenues by Category, 2001
DOLLARS(MILLIONS) DOLLARS(MILLIONS)
Automotive 1,688
Technology Telecommunications Computers and software 223817
Home furnishings and supplies 1,196
Toiletries and cosmetics 1,401
Apparel and accessories 1,316
Financial, insurance and real estate 962
Food and food products 1,207
Drugs and remedies 1,217
Retail stores 692
Beer wine and liquor 307
Sporting goods 279

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The Case for Product Differentiation and
Advertising

• The advocates of free and open competition
  believe that differentiated products and
  advertising give the market system its vitality
  and are the basis of its power.
• Product differentiation helps to ensure high
  quality and efficient production.
• Advertising provides consumers with the valuable
  information on product availability, quality, and
  price that they need to make efficient choices in
  the market place.

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The Case Against Product Differentiation and
Advertising

• Critics of product differentiation and
  advertising argue that they amount to nothing
  more than waste and inefficiency.
• Enormous sums are spent to create minute,
  meaningless, and possibly nonexistent differences
  among products.
• Advertising raises the cost of products and
  frequently contains very little information.
  Often, it is merely an annoyance.
• People exist to satisfy the needs of the economy,
  not vice versa.
• Advertising can lead to unproductive warfare and
  may serve as a barrier to entry, thus reducing
  real competition.

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Product Differentiation Reduces the Elasticity of
Demand Facing a Firm

• Based on the availability of substitutes, the
  demand curve faced by a monopolistic competitor
  is likely to be less elastic than the demand
  curve faced by a perfectly competitive firm, and
  likely to be more elastic than the demand curve
  faced by a monopoly.

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Monopolistic Competition in the Short Run

• A profit-maximizing monopolistically competitive
  firm will produce up to the point where MR MC.

• This firm is earning positive profits in the
  short-run.

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Monopolistic Competition in the Short-Run

• Profits are not guaranteed. Here, a firm with a
  similar cost structure is shown facing a weaker
  demand and suffering short-run losses.

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Monopolistic Competition in the Long-Run
Positive economic profits in the short-run will
attract entry in the long-run, shifting D inwards
until..profits are zero

• The firms demand curve must end up tangent to
  its average total cost curve for profits to equal
  zero. This is the condition for long-run
  equilibrium in a monopolistically competitive
  industry.

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Economic Efficiencyand Resource Allocation

• In the long-run, economic profits are
  eliminated thus, we might conclude that
  monopolistic competition is efficient, however

• Price is above marginal cost. More output could
  be produced at a resource cost below the value
  that consumers place on the product.
• Average total cost is not minimized. The typical
  firm will not realize all the economies of scale
  available. Smaller and smaller market share
  results in excess capacity.

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Oligopoly

• An oligopoly is a form of industry (market)
  structure characterized by a few dominant firms,
  causing a high degree of concentration. Products
  may be homogeneous or differentiated.
• The behavior of any one firm in an oligopoly
  depends to a great extent on the behavior of
  others.

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Ten Highly Concentrated Industries
Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997 Percentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1997
INDUSTRYDESIGNATION FOURLARGESTFIRMS FOURLARGESTFIRMS EIGHTLARGESTFIRMS EIGHTLARGESTFIRMS NUMBEROFFIRMS NUMBEROFFIRMS
Cellulosic man-made fiber 100 100 4
Primary copper 95 99 11
Household laundry equipment 90 99 10
Cigarettes 99 100 9
Malt beverages (beer) 90 95 494
Electric lamp bulbs 89 94 54
Cereal breakfast foods 83 94 48
Motor vehicles 83 92 325
Small arms ammunition 89 94 107
Household refrigerators and freezers 82 97 21

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The Collusion Model

• A group of firms that gets together and makes
  price and output decisions jointly is called a
  cartel.
• Collusion occurs when price- and quantity-fixing
  agreements are explicit.
• Tacit collusion occurs when firms end up fixing
  price without a specific agreement, or when
  agreements are implicit.

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The Price-Leadership Model

• Price-leadership is a form of oligopoly in which
  one dominant firm sets prices and all the smaller
  firms in the industry follow its pricing policy.
• Assumptions of the price-leadership model
• The industry is made up of one large firm and a
  number of smaller, competitive firms
• The dominant firm maximizes profit subject to the
  constraint of market demand and subject to the
  behavior of the smaller firms
• The dominant firm allows the smaller firms to
  sell all they want at the price the leader has
  set.
• Outcome of the price-leadership model
• The quantity demanded in the industry is split
  between the dominant firm and the group of
  smaller firms.
• This division of output is determined by dominant
  firms power
• The dominant firm has an incentive to push
  smaller firms out of the industry in order to
  establish a monopoly.

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Predatory Pricing

• The practice of a large, powerful firm driving
  smaller firms out of the market by temporarily
  selling at an artificially low price is called
  predatory pricing.
• Such behavior became illegal in the United States
  with the passage of antimonopoly legislation
  around the turn of the century.

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Game Theory

• Game theory analyzes oligopolistic behavior as a
  complex series of strategic moves and reactive
  countermoves among rival firms.
• In game theory, firms are assumed to anticipate
  rival reactions.

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Payoff Matrix for Advertising Game
Bs STRATEGY Bs STRATEGY
As STRATEGY Do not advertise Advertise
Do not advertise As profit 50,000Bs profit 50,000 As loss 25,000Bs profit 75,000
Advertise As profit 75,000Bs loss 25,000 As profit 10,000Bs profit 10,000

• The strategy that firm A will actually choose
  depends on the information available concerning
  Bs likely strategy.

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Payoff Matrix for Advertising Game
Bs STRATEGY Bs STRATEGY
As STRATEGY Do not advertise Advertise
Do not advertise As profit 50,000Bs profit 50,000 As loss 25,000Bs profit 75,000
Advertise As profit 75,000Bs loss 25,000 As profit 10,000Bs profit 10,000

• Regardless of what B does, it pays A to
  advertise. This is the dominant strategy, or the
  strategy that is best no matter what the
  opposition does.

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The Prisoners Dilemma
ROCKY ROCKY ROCKY ROCKY
GINGER Do not confess Confess Confess
Do not confess Ginger 1 yearRocky 1 year Ginger 7 yearsRocky free
Confess Ginger freeRocky 7 years Ginger 5 yearsRocky 5 years

• Both Ginger and Rocky have dominant strategies
  to confess. Both will confess, even though they
  would be better off if they both kept their
  mouths shut.

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Contestable Markets

• A market is perfectly contestable if entry to it
  and exit from it are costless (easy).
• In contestable markets, even large oligopolistic
  firms end up behaving like perfectly competitive
  firms. Prices are pushed to long-run average
  cost by competition, and positive profits do not
  persist.

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Oligopoly is Consistent witha Variety of
Behaviors

• The only necessary condition of oligopoly is that
  firms are large enough to have some control over
  price.
• Oligopolies are concentrated industries. At one
  extreme is the cartel, in essence, acting as a
  monopolist. At the other extreme, firms compete
  for small contestable markets in response to
  observed profits. In between are a number of
  alternative models, all of which stress the
  interdependence of oligopolistic firms.

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Oligopoly and Economic Performance

• Oligopolies, or concentrated industries, are
  likely to be inefficient for the following
  reasons
• They are likely to price above marginal cost.
  This means that there would be underproduction
  from societys point of view.
• Strategic behavior can force firms into deadlocks
  that waste resources.
• Product differentiation and advertising may pose
  a real danger of waste and inefficiency.

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Regulation of Mergers

• The Celler-Kefauver Act of 1950 extended the
  governments authority to ban vertical and
  conglomerate mergers.
• The Herfindahl-Hirschman Index (HHI) is a
  mathematical calculation that uses market share
  figures to determine whether or not a proposed
  merger will be challenged by the government.

Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms Calculation of a Simple Herfindahl-Hirschman Index for Four Hypothetical Industries, Each With No More Than Four Firms
PERCENTAGE SHARE OF PERCENTAGE SHARE OF PERCENTAGE SHARE OF PERCENTAGE SHARE OF HERFINDAHL-HIRSCHMANINDEX
FIRM 1 FIRM 2 FIRM 3 FIRM 4 HERFINDAHL-HIRSCHMANINDEX
Industry A 50 50 - - 502 502 5,000
Industry B 80 10 10 - 802 102 102 6,600
Industry C 25 25 25 25 252 252 252 252 2,500
Industry D 40 20 20 20 402 202 202 202 2,800
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Department of Justice Merger Guidelines
ANTITRUST DIVISION ACTION ANTITRUST DIVISION ACTION ANTITRUST DIVISION ACTION
HHI 1,800 1,000 0 ConcentratedChallenge if Index is raised by more than 50 points by the merger
HHI 1,800 1,000 0 Moderate ConcentrationChallenge if Index is raised by more than 100 points by the merger
HHI 1,800 1,000 0 UnconcentratedNo challenge
HHI 1,800 1,000 0