Econ Unit 10: Monopolistic competition & oligopoly

Characteristics of monopolistic competition

1. there are many firms

2. easy entry and exit (no barriers or little to none)

3. firms compete by selling similar but differentiated products

   • monopolistically competitive firms stress product differentiation

Product differentiation

Many forms:

1. product attributes

2. service

3. location

4. brand names and packaging

Graph

Demand faced by an individual firm is downwards sloping and more elastic than the market demand

Graph

Any firm maximizes profits at the quantity where MRj = MCj

• this is the short run

Long run equilibrium in a monopolistically competitive market

• if π_i > 0 new firms enter

• when new firms enter, demand of existing firms decreases

Long run equilibrium monopolistic competition

(Photos from November 25th)

• in the long run, these positive profits (π_i^* > 0) induce entry

• entry continues until π₁ = 0

Photo 2 (new graph)

• long run equilibrium occurs where MR_i^Ω = MC_i

  and P_i^Ω > ac_i  => Π_i = 0

  but  P_i^Ω  > mc_i

  P_MC > P _{perfect competition} 

  • Paying for product variety

Hotelling’s boardwalk

Why does product variety diminish over time?

• Harold Hotelling (ice cream example on doc)

Oligopoly characteristics

1. market is dominated by a small number of firms

2. entry barriers exist

3. firms are mutually interdependent

• firm must be aware of its rival’s reactions to the firm’s decisions on price, quantity, advertising, product development, etc.

Game theory

• the prisoner’s dilemma (notes)

• chicken (notes)

?

Repeated games

• in notes/ textbook

		Gear
		Compete	Cooperate
Trick	Compete	0, 0  → Nash	-1, 4.5
	Cooperate	4.5, -1	2, 2

• chicago: cartels are not stable

• play the game 4 times

Period		Playoffs
	Collusion		Competition
	Gear	Trick	Gear	Trick
1	2	2	0	0
2	2	2	0	0
3	2	2	0	0
4	2	2	0	0
	8	8	0	0

^ Nash     ^

Cartel

• group of firms acting together like a monopoly

Cooperation or competition?

1. cooperation is more likely for small number of sellers

2. cooperation is more likely for producers of similar products rather than sharply differentiated products

3. cooperation is more likely in markets that are expanding

4. cooperation is more likely when market has a dominant firm

5. cooperation is more likely when nonprice rivalry is absent

Four firm concentration ratio

• percentage of the value of sales accounted for by the 4 largest firms

  • add up value of sales for each firm (4)

  • divide by the total market sales (total sales of the industry)

  • times by 100

Market 1
Firm 1	250
Firm 2	200
Firm 3	150
Firm 4	100
Total market sales	875

CR₄ = 700/875 x 100 = 80%

Market 2
Firm 1	25
Firm 2	20
Firm 3	15
Firm 4	10
Total market sales	70

Total market sales = 1000

Cautionary points of the concentration ratio

1. definition of the industry

   • apply some care with firms that produce products in more than one market

2. geographical region

   • region in which competition occurs

HHI (Herfindahl- Hirschmann index

HHI = ((sales of firms) / (market sales) x 100)²

Sequential games

• consider a monopolist who knows that another firm is considering entering the market

  • monopolistic choices