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Session 9 Monopoly, Competition, Oligopoly

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Session 9 Monopoly, Competition, Oligopoly Chapter 10 and 11 in the text * Tips for Navigation in the presentation: Right mouse click to advance, or – PowerPoint PPT presentation

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Title: Session 9 Monopoly, Competition, Oligopoly


1
Session 9 Monopoly, Competition, Oligopoly
  • Chapter 10 and 11 in the text

2
Monopolistic Competition Example
  • Many similar products, with little price
    difference. Advertising seeks to create a niche
    image for each, with the goal of persuading the
    customer to buy their item.

Which one do you select? Is it because of price,
quality, image, subliminal impulse, or some
combination?
3
Example of Domestic Cartels
  • The price fixing among sellers is generally
    illegal in the US. In price fixing agreements
    firms collude to maximize profits. Price fixing
    is an excellent illustration of the cartel model
    we will learn about in this session.  Collusion
    allows small firms, which would other wise be
    similar to perfectly competitive firms, to
    enlarge profits by acting a monopolist.

SEPTEMBER 23, 2008 Federal Prosecutors Probe
Food-Price Collusion
4
Example of Price Wars
  • The price war behavior -- where Vanguard is
    following the price cuts of Fidelity, is an
    excellent illustration of the Kinked Demand Curve
    model that we will learn about in this session. 
    The price cut war is represented by the lower
    inelastic portion of the kinked demand curve.  It
    is inelastic because initially the first firm to
    drop price gets a few customers, but the other
    firms quickly follow thus reducing the advantage
    of price cut.

Vanguard Ups Ante In Fee Wars Move Gives
Thousands of Fund Investors Access To Lowest-Cost
Shares Follows Fidelity's Cuts
5
Lecture Outline
  • 1.0 First Slide
  • 2.0 Monopolistic Competition Market Structure
  • 3.0 Profit Maximization
  • 4.0 Oligopoly Market Structure
  • 5.0 Models of Oligopoly
  • 6.0 Comparison with Perfect Competition
  • 7.0 Last Slide

6
2.0 Market Structure
  • 2.1 Monopolistic Competition Market Structure
  • 2.2 Key Characteristics
  • Product Differentiation
  • Low Barriers to Entry
  • 2.3 Comparison to other structures

7
2.1 Market Structures Mon. Comp.
  • Key Characteristics Describing Market Structure
  • Number of suppliers
  • Many or few MC--Many
  • Products degree of uniformity
  • Do firms in the market supply identical products
    or are there differences across firms? MCslight
    differences, thussome control over price
  • The ease of entry into the market
  • Can new firms enter easily or are they blocked by
    natural or artificial barriers? MCEasy (low
    barriers), thus zero profits in the long run
  • Control over Price
  • Do firms have control over price? MCSome but
    with in narrow limits

8
2.2 Product Differentiation
  • Sellers differentiate their products in four
    basic ways
  • Physical differences and qualities For example
    The choices in laptops weight, screen size, hard
    drive, video card, chip, RAM
  • Location restaurants For example similar
    Italian menu but some nearer home, or located in
    a trendy area v off a highway.
  • Accompanying service For example extended
    warranties or zero percent financing, or a
    rebate.
  • Product image For example A basket ball with
    Larry Birds signature v Kobe Bryantsame ball
    different image

9
2.3 Market Structure Matrix
of suppliers Product Standardized Entry/Exit Control over Price
Perfect Competition Many Yes Very easy None
Monopoly One Unique, no close substitutes Blocked Considerable
Monopsony One buyer
Monopolistic Competition Many Not much as much differences as they want you to think Relatively easy Some, but within narrow limits
Oligopoly Few Not much Significant obstacles Limited by interdependence, but considerable with collusion
10
3.0 Profit Maximization
  • 3.1 Substitutes Price Elasticity
  • 3.2 Short Run MCMR
  • 3.3 Shut Down Point Min Pt. of AVC
  • 3.4 Long Run Zero Economic Profit
  • 3.5 Comparison with Perfect Competition
  • Excess Capacity,
  • PricegtMC,
  • Higher price,
  • Lowerl output
  • Example

11
3.1 Price Elasticity of Demand
  • The price elasticity of the monopolistic
    competitors demand depends on
  • The number of rival firms that produce similar
    products
  • The firms ability to differentiate its product
    from those of its rivals
  • A firms demand curve will be more elastic the
    greater the number of competing firms and the
    less differentiated its product

(a) Demand and Marginal Revenue
Elastic
o
Unit elastic
i
r
3,750
r
Inelastic
o
0
D Average revenue
Marginal revenue
1-carat diamonds per day
12
3.2 Profit Maximization MCMR
In the short run, a firm that can at least cover
its variable cost will increase output as long as
marginal revenue exceeds marginal cost ? profits
are maximized where marginal revenue equals
marginal cost. This occurs at point e.
MC
The profit maximizing price for that quantity is
found on the demand curve ? point b.
b
ATC
p

Profit
c
Average total cost is measured as c which is
below the price.
c
D
e
Price minus average total cost is the firms
profit per unit, which, when multiplied by the
quantity is economic profit, shown by the blue
shaded rectangle.
Dollars per unit
MR
The monopolistic competitor, like the monopolist,
has no supply curve ? there is no curve that
uniquely relates price and quantity supplied.
0
q
Quantity per period
13
3.3 Shut Down Point
The monopolistic competitor is not assured
economic profit. Here the firms average total
cost curve lies entirely above the demand curve ?
all quantities result in losses ? the firm must
decide whether to shut down temporarily.
MC
c
ATC
t
i
c
n
u
Loss
b

r
p
AVC
The rule here is the same as long as the price
covers average variable cost, the firm should
produce in the short run. Alternatively, it
should shut down if no price covers average
variable cost.
e
p

s
r
a
D
l
e
l
o
D
The loss-minimization solution is for the firm to
produce quantity q and charge the price p.
However, since per unit costs are c, the firm
incurs a loss shown by the red shaded area.
MR
Quantity per period
0
q
14
3.4a Long-run Equilibrium
In the long run, entry and exit will shift each
firms demand curve until economic profit
disappears ? price equals average total cost.
MC
ATC
This long-run outcome occurs where the marginal
revenue curve intersects the marginal cost curve
at point a ? equilibrium q, and the average total
cost curve is tangent to the demand curve at
point b ? no economic profit.
t
i
n
u

r
b
e
p
p

s
r
a
l
l
o
D
a
D
In the case of short-run losses, some firms will
leave the industry ? the demand curve shifts to
the right and become less elastic until the loss
disappears and remaining firms earn just a normal
profit.
MR
0
q
Quantity per period
15
3.4b Long Run Equilibrium
Short Run Positive Economic Profits
Long Run Zero Economic Profits
16
3.5a Monopolistic Comp. V Perfect Competition
PgtMC
(a) Perfect Competition)
(b) Monopolistic Competition
MC
MC
t
ATC
i
n
ATC
u

r
p'
e
d Marginal revenue Average revenue
p
p

s
r
a
l
l
o
D
D Average revenue
MR
0
q
Quantity per period
0
q'
Quantity per period
Here we are assuming that the two firms have
identical cost curves. In each case, the
marginal cost curve intersects the marginal
revenue curve at the quantity where the average
total cost curve is tangent to the firms demand
curve.
The point of tangency between d, MC and ATC in
perfect competition implies that the firm is
producing at the lowest possible average cost in
the long run.
In monopolistic competition, the price and
average cost, identified as p in the right
panel, exceed the price and average cost under
perfect competition, identified as p in the left
panel.
17
3.5b Example The Cachet Single Malt Scotch
Outline MC
  • Single malt" is malt whiskey sourced from a
    single distillery. Single malts take at least 10
    years to mature and are distilled using
    centuries-old techniques and are made from malted
    barley.
  • Blended scotches, about 95 of Scotch whisky
    brands -- including leaders such as Johnnie
    Walker and Chivas include malts from more than
    one distillery and some are a mixture of malted
    barley and grain .
  • In the past few years,. global sales pf single
    malt scotch grew by 37 from 1992 to 2002,
    according to Impact Databank, compared with a 1
    contraction in sales of Scotch whisky as a whole.
  • How did they do it? By creating cachet
  • The scotch industry has come a long way in
    shaking off the slippers-and-fireside image of
    your grandfather's whiskey Today distillers pitch
    high-end scotch, or "single malts," as a hip
    drink with origins as exclusive as a fine vintage
    wine. Sales of single malts have taken off in
    recent years with affluent baby boomers and
    increasingly sophisticated 30-somethings seeking
    new status symbols.
  • The industry investing heavily in educating
    consumers about the differences in whiskey brands
    from different regions. Single malts from the
    island of Islay, for instance, taste smoky and
    briny because a lot of peat is used in the
    process distillers near the River Spey, on the
    other hand, use little or no peat, producing a
    scotch with a sweeter taste..

18
3.5c Example The Cachet Single Malt Scotch
  • An economic analysis of the sales growth would
    include
  • Change in tastes and preferences -- An increase
    in demand for single malt, a decrease in demand
    for blended scotch
  • Slope of the Demand Curve customers may be
    willing to pay a slightly higher price for single
    malt than blended scotch becomes of the cachet
    status.
  • Thus, the demand curve for the single malt scotch
    may become downward sloping and producers will
    then be able to pick a price and output, whereas
    the demand curve for blended scotch may remain
    horizontal and those producers will have to
    accept the market price and only worry about
    choosing the output to produce.
  • Adapted from Scotch on the Rocks? 'Single Malt'
    DiversifiesDeborah Ball. Wall Street
    Journal. (Eastern edition). New York, N.Y.  Dec
    30, 2003

19
Example Air Lines
  • Hidden Slide
  • Charge different prices for different services
  • Luggage fees
  • Then can charge lower average fare price
  • Lower fees for standby and toursist

20
4.0 Oligopoly Market Structure
  • 4.1 Key Characteristics
  • 4.2 Barriers to Entry
  • Economies of Scale
  • Large Minimum Plant Size
  • Brand Names
  • 4.3 Matrix

21
4.1 Market Structures Oligopoly
  • Key Characteristics Describing Market Structure
  • Number of suppliers
  • Many or few OFew, thus control over price, but
    each must consider the effect of its own actions
    on competitors behavior ? the firms in an
    oligopoly are interdependent
  • Products degree of uniformity
  • Do firms in the market supply identical products
    or are there differences across firms? O--slight
    differences
  • The ease of entry into the market
  • Can new firms enter easily or are they blocked by
    natural or artificial barriers? ODifficult
    (high barriers), thus positive economic profits
    in the long run
  • Buyer information
  • Do buyers have full information of prices and
    product attributes? O--No

22
4.2a Economies of Scale as a Barrier to Entry
Here we have a long-run average cost curve for a
typical firm in the industry.
a
c
a
If a new entrant sells only S cars, the average
cost per unit, ca, far exceeds the average cost,
cb, of a manufacturer that sells enough cars to
reach the minimum efficiency scale, M.
b
If autos sell for a price less than ca, a
potential entrant can expect to lose money. This
tends to discourage entry into the industry.
c
Long-run average cost
b
0
S
Autos per year
M
23
4.2b Barriers to Entry High Advertising Costs
  • Established Brand Names
  • High start up cost for advertising a new product
    enough to compete with established brands may
    also require enormous outlays
  • Oligopolists often compete with existing rivals
    and try to block new entry by offering a variety
    of models and products
  • Firms often spend billions trying to
    differentiate their products
  • Some of these expenditures have the beneficial
    effects of providing valuable information to
    consumers and offering them a wide variety of
    products

24
4.3 Market Structure Matrix
of suppliers Product Standardized Entry/Exit Control over Price
Perfect Competition Many Yes Very easy None
Monopoly One Unique, no close substitutes Blocked Considerable
Monopsony One buyer
Monopolistic Competition Many Not much as much differences as they want you to think Relatively easy Some, but within narrow limits
Oligopoly Few Not much Significant obstacles Limited by interdependence, but considerable with collusion
25
5.0 Models of Oligopoly
  • 5.1 Cartels
  • 5.2 Price Leadership
  • 5.3 Kinked demand curve

26
5.1a Cartel
  • Formal collusion and cartels are illegal in the
    United States other countries are more tolerant
    and some even promote cartels ? OPEC
  • The next slide provides us with an illustration
    of the impact of firms colluding and forming a
    cartel

27
5.1b Cartel Model
  • The market demand curve is shown as D. The two
    key issues are
  • what price will maximize the cartels profit
  • how will production be allocated among
    participating firms?

MC
p
The first task of the cartel is to determine its
marginal cost of production. Since the cartel
acts as a monopoly operating many plants, the
marginal cost curve is the horizontal sum of the
marginal cost curves of all firms in the cartel .
c
Profit maximization occurs where the cartels
marginal cost curve intersects the markets
marginal revenue curve. This intersection yields
price p, industry output Q, and marginal cost of
production c.
D
Dollars per unit
MR
Quantity per period
0
Q
28
5.1c Cartel Model
  • To maximize cartel profit, output must be
    allocated so that the marginal cost for the final
    unit produced by each firm is identical
  • Assuming two firms with identical costs, output
    and profit are determined from the intersection
    of industry MR and MC ? each firm charges the
    industry Price, and sells ½ the industry output.

29
5.1d Cheating
  • Perhaps the biggest obstacle to keeping the
    cartel running smoothly is the powerful
    temptation to cheat on the agreement
  • By offering a price slightly below the
    established price, a firm can usually increase
    its sales and economic profit

30
5.1e Cheating
  • However, as more cheat the outcome approaches
    that of perfect competition

With increases in ? market price is forced down
until Price min ATC, as in perfect competition
31
5.2 Leadership Model
  • An informal, or tacit, type of collusion occurs
    in industries that contain price leaders who set
    the price for the rest of the industry
  • A dominant firm or a few firms establish the
    market price, and other firms in the industry
    follow that lead, thereby avoiding price
    competition
  • Price leader also initiates price changes

32
5.3a Kinked Demand Curve Model
  • A type of Price Leadership Model
  • In the kinked demand curve model, each
    oligopolistic firm believes that
  • if it raises its price all its competitors will
    not follow suit.
  • if it lowers its price all its competitors will
    follow suit.
  • These assumptions imply that
  • the firms demand curve is elastic above the
    current price
  • the firms demand curve is inelastic below that
    price.
  • the firms demand curve is kinked at the current
    price, P
  • Prices increase only when all firms raise them at
    the same time

33
5.3b Kinked Demand Curve Model
  • the firms demand curve is elastic above the
    current price
  • the firms demand curve is inelastic below that
    price.
  • the firms demand curve is kinked at the current
    price, P
  • The kink in the demand curve means that the MR
    curve is discontinuous immediately below the kink
    (as indicated by the vertical dotted segment of
    the MR curve).
  • Kink discourages competitors from changing prices
  • Thus, fluctuations in MC that remain within the
    discontinuous portion of the MR curve do not
    cause changes in either the firms price or
    quantity produced .

34
5.3c Diaper War Example of Kinked Demand Curve
  • the firms demand curve is elastic above the
    current price (Huggies)
  • the firms demand curve is inelastic below that
    price. (Pampers)
  • In the summer of 2003 Kimberly Clark (producer of
    Huggies) covertly raised the price of its diaper
    5 by reducing the number of diapers in each
    package and reducing the package price by a few
    cents.
  • Procter Gamble (producer of Pampers) responded
    by keeping the number of diapers per pack
    constant and reducing its package price by the
    same amount .
  • Huggies market share fell and Pampers share rose
  • Source WSJ 9/5/03, In Lean Times Big Companies
    Make A Grab for Market Share, By Sarah Ellison

35
6.0 Comparison of Oligopoly Perfect Competition
  • Higher price, lower output, positive economic
    profits
  • Price is usually higher under oligopoly
  • With fewer competitors after the merger,
    remaining firms would become more interdependent
    ? they will try to coordinate pricing policies ?
    if they engage in some sort of implicit or
    explicit collusion, industry output would be
    lower and price would be higher than under
    perfect competition
  • Higher profits under oligopoly
  • If there are barriers to entry into the
    oligopoly, profits will be higher than under
    perfect competition in the long run

36
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