Chapter Thirteen: Between Competition and Monopoly

Characteristics of Monopolistic Competition Oligopoly: A market structure in which a few large firms dominate the market. Examples include the steel, automobile, and airplane industries. Oligopolies care a lot about what other firms in the industry do. Monopolistic Competition: A market in which products are heterogeneous but which is otherwise the same as a market that is perfectly competitive. A market is said to operate under the conditions of monopolistic competition if it satisfies these requirements: - Numerous participants - Freedom of exit and entry - Perfect information - Heterogeneous products Each sellers product differs at least somewhat from every others Monopolistic differs from perfect competition in that monopolist competition has heterogeneous products and perfect competition does not. A monopolistic demand curve has a negative slope since each sellers product is different Monopolistic competitors will obtain economic profits in the short run, but in the long run, high economic profits will attract new entrants into the market. Price and Output Determination Under Monopolistic Competition Since the firm faces a downward sloping demand curve in the short run, its MR curve will be below its demand curve A monopolistic competitor maximizes profits by producing the output at which MR = MC When more firms enter the market, each firms demand curve will shift downward (to the left) Long run equilibrium under monopolistic competition requires that the firms demand curve be tangent to its average cost curve The Excess Capacity Theorem and Resource Allocation The demand curve hits the average cost curve in a region where average costs are still declining Under monopolistic completion in the long run, the firm will tend to produce an output lower than that which minimizes its unit costs, and hence unit costs of the monopolistic competitor will be higher than necessary. Because the level of output that corresponds to minimum average cost is naturally considered to be the firms optimal capacity, this result has been called the excess capacity theorem of monopolistic competition. Thus, monopolistic competition tends to lead firms to have unused or wasted capacity Oligopoly Oligopoly: A market dominated by a few sellers, at least several of which are large enough relative to the total market to be able to influence the market price. Big Businesses Oligopolies can sell similar products (steel plate from different steel manufacturers) or different products (Hondas, BMW, Toyota). Some also contain many smaller firms (Different pop manufacturers) but they are still oligopolies because a few large firms carry out the bulk of the industrys business and smaller firms must follow the larger firms. Why Oligopolistic Behavior is So Hard to Analyze Firms in an oligopolistic industry have some freedom in choosing prices and outputs. To survive and thrive in an oligopolistic environment, firms must take direct account of rivals responses Makes it hard to analyze Oligopolies are more difficult to analyze because decisions are interdependent. The outcomes of their decisions depend on rivals responses. A Shopping List Ignoring Interdependence Strategic Interaction

Cartels - Cartels A group of sellers of a product who have joined together to control its production, sale, and price in the hope of obtaining the advantages of monopoly. Price Leadership and Tacit Collusion - Price Leadership: One firm sets the price for the industry and the others follow - Price War: Each competing firm is determined to sell at a price that is lower than the prices of its rivals, usually regardless of whether that price covers the pertinent cost. Typically in such a price war, Firm A cuts its price below Firm Bs; then FB retaliates by undercutting A

Sales Maximization: An Oligopoly Model with Interdependence Ignored Only when MR = 0 can management have the maximum sales revenue If a firm is maximizing sales revenue, it will produce more output and charge a lower price than it would if it were maximizing profits The Game-Theory Approach Economists most widely used approach to analyze oligopoly behavior. Work under the assumption that their rivals are extremely ingenious strategic decision makers. Each oligopoly acts as a competing player in a strategic game. Uses two concepts: Strategy and the payoff matrix The payoff matrix reports the profits that each firm can expect to earn, given its own pricing choice and that of its rival The Maximin Strategy and the Prisoners Dilemma: - Maximin Criterion: Requires you to select the strategy that yields the maximum payoff on the assumption that your opponent does as much damage to you as they can. - To best protect a company, game theory suggests that the firm should base their strategy based on the minimum payoff Other Strategies: The Nash Equilibrium: - Nash Equilibrium: Results when each player adopts the strategy that gives her the highest possible payoff if her rival sticks to the strategy he has chosen Repeated Games: - Repeated Games: One that is played over again a number of times - Give players the opportunity to learn something about each others behavior patters to arrive at mutually beneficial arrangements Threats and Credibility: - Credible Threat: A threat that does not harm the threatener if it is carried out Monopolistic Competition, Oligopoly, and Public Welfare Perfectly Contestable Market: If entry and exit and costless and unimpeded. Here, the constant threat of possible entry by new firms forces even the largest existing firm to behave wellto produce efficiently and never overcharge In a perfectly contestable market, firms can enter it and exit without losing the money they invested Firms undertake little risk by going into such a market Two socially desirable characteristics of a perfectly contestable market: - Freedom of entry eliminates any excess economic profits so that in this respect contestable markers resemble perfectly competitive markets - Inefficient enterprises cannot survive in a perfectly contestable industry because cost inefficiencies invite replacement of the existing firms by entrants who can provide the same outputs at lower cost and lower prices Four Market Forms Perfect competition and pure monopoly are concepts useful primarily for analytical purposesneither are found often in reality. There are many monopolistically competitive firms, and oligopoly firms account for the largest share of the economys output

Profits are zero in the long run under perfect competition and monopolistic competition because entry is so easy that high profits attract new rivals into the market AC = AR in long run equilibrium under these two market forms. In equilibrium, MC = MR for the profitmaximizing firm under any market form. However, under oligopoly, firms may adopt the strategies such as game theory. In an oligopoly, MC may be unequal to MR. The behavior of the perfectly competitive firm and industry theoretically leads to an efficient allocation of resources that maximizes the benefits to consumers, given the resources available to consumers. Monopoly, however, can misallocate resources by restricting output in order to raise prices and profits. Under monopolistic competition, excess capacity and inefficiency are apt to result. An under oligopoly, almost anything can happen, so it is impossible to generalize about its vices or virtues.