Test 3: Chapters 12-13 (Oligopoly and Monopolistic Competition Overview)

What is oligopoly?

A market structure in which a few firms sell either standardized or differentiated products, entry is difficult, firms have limited control over product price due to mutual interdependence, and there is typically nonprice competition.

What are the characteristics of an oligopoly market structure?

Few firms, standardized or differentiated products, difficult entry, limited price control due to mutual interdependence, and nonprice competition.

What does the term 'Big Three' refer to in the context of oligopoly?

It refers to a few dominant firms in an industry, such as Google, Facebook, and Amazon in the online advertising industry.

What are examples of homogeneous oligopolies?

Examples include the steel and aluminum markets.

What are examples of differentiated oligopolies?

Examples include markets for automobiles, household appliances, electronics equipment, and breakfast cereals.

Why is control over price limited in an oligopoly?

Because there are few sellers, and rivals may react negatively to price changes, leading firms to engage in strategic pricing behavior.

What is strategic pricing behavior in oligopoly?

It is when a firm's pricing decisions are influenced by the anticipated reactions of rival firms.

What role do economies of scale play in oligopoly?

Act as entry barriers, making it difficult for new firms to compete with established firms that have sufficient sales.

How do ownership and control of raw materials contribute to oligopoly?

Create barriers to entry, allowing existing firms in industries like mining to maintain oligopolistic structures.

What is the significance of patents in oligopoly?

Serve as entry barriers in industries like computers, chemicals, and pharmaceuticals, preventing new competitors from entering the market.

How do network effects impact competition in oligopoly?

Make it challenging for startups to compete with dominant firms that already have large user bases, such as Facebook or Twitter.

What are two ways oligopolies can emerge in an industry?

Through the growth of dominant firms or through mergers of competing firms.

What is the 4-firm concentration ratio for an industry to be considered an oligopoly?

Ratio must be at least 40%.

What percentage of U.S. manufacturing is considered oligopolistic?

About 50%

What is mutual interdependence in oligopoly?

Exists when each firm's profit depends on its own pricing strategy and that of its rivals, leading to strategic behavior.

What does strategic behavior mean in the context of oligopoly?

Refers to self-interested actions that consider the reactions of rival firms.

In which market structure is game theory utilized?

Used for analyzing the pricing behavior of oligopolists.

What does game theory reveal about oligopolistic firms?

It reveals that rivals may increase profits through collusion.

What is a profit payoff matrix?

A tool used in game theory to analyze the potential outcomes of different pricing strategies among oligopolistic firms.

What incentive do firms have in the absence of collusion according to the payoff matrix?

To cheat and charge higher prices to reap higher payoffs.

What does the kinked-demand model explain in non-collusive oligopolies?

It explains the behavior and pricing strategies of firms that do not collude.

How do firms in a kinked-demand model react to price increases and price cuts?

They assume rivals will match price cuts but ignore price increases.

What shape does the demand curve take in the kinked-demand model?

It is kinked, being steeper below the going price than above.

What assumption is the kinked demand curve based on?

Competitors will ignore price increases but match price cuts.

How does the kinked-demand theory explain price stability in oligopolies?

It suggests price rigidity due to a gap in the marginal revenue curve where changes in marginal cost do not affect output or prices.

What happens to price and quantity when marginal cost shifts in the kinked demand model?

Remain the same.

Why do firms in an oligopolistic market structure choose to collude?

To limit joint output and set a common price for profit maximization.

What conditions encourage firms in an oligopolistic market to collude?

Identical or highly similar demand and cost conditions, and the production of homogeneous goods.

What does the kinked-demand model imply about the frequency of price changes in oligopolies?

Prices might change infrequently due to price rigidity.

What risk is associated with changing prices in an oligopoly?

There is a chance that changing prices could lead to a price war.

What does the term 'price rigidity' refer to in the context of the kinked-demand model?

The tendency for oligopolistic prices to remain stable despite changes in marginal costs.

What is the significance of the gap in the marginal revenue curve in the kinked-demand model?

It indicates that changes in marginal cost will not affect output or prices within that gap.

What is the primary goal of colluding firms in an oligopoly?

To maximize joint profits by acting as a single monopolist.

How does the kinked-demand model reflect the uncertainty faced by firms in an oligopoly?

Firms do not know with certainty how rivals will react to price changes.

What is the relationship between collusion and the homogeneity of goods in an oligopoly?

Collusion is more likely when the goods produced are homogeneous.

What conditions encourage firms to collude in an oligopolistic market?

Conditions include similar cost and demand curves, a small number of firms producing a homogeneous product, easy detection and punishment of cheating, a booming economic environment, blocked entry for potential firms, and no legal obstacles.

What are the three major means of collusion?

Cartels, price leadership, and informal understandings.

What is a cartel? Provide an example.

A group of producers that create a formal written agreement specifying production and pricing. An example is the Organization of Petroleum Exporting Countries (OPEC).

What is the significance of OPEC as a cartel?

Successful in increasing oil prices by restricting supply, despite being illegal in the US.

What are some obstacles to collusion?

Demand and cost differences among members, difficulty in maintaining agreements with more firms, tendency for members to cheat, declining demand during recessions, new producers entering the market, and laws prohibiting cartels.

What is the price leadership model?

An economic model where a dominant firm initiates price changes and others in the industry follow, often communicated through speeches or press releases.

What is a price war? When does it occur?

A breakdown in price leadership leading to successive price cuts, typically occurring when firms compete aggressively on price.

What happens after a price war?

One leading firm usually regains price leadership and begins to raise prices, prompting others to follow.

How does advertising enhance economic efficiency in oligopolies?

Communicates product differences, increases market share, reduces consumer search time, enhances competition, speeds up technological progress, and helps firms achieve economies of scale.

What negative effects can advertising have on economic efficiency?

Can impede economic efficiency by leading to greater monopoly power.

Are oligopolistic market structures efficient?

No, oligopolistic markets do not achieve productive efficiency (P = min ATC) or allocative efficiency (P = MC).

What are the characteristics of monopolistic competition?

Characterized by a fairly large number of firms selling differentiated products, relatively easy entry, some control over products, and considerable nonprice competition.

What is product differentiation?

A strategy where a firm's product is distinguished from competitors' products through design, services, quality, location, packaging, and other attributes.

Why do monopolistic competitors advertise their products?

To ensure consumers are aware of product differences, making price less of a factor in purchases and emphasizing product differences.

What is the commonality between monopolistically competitive markets and pure competition?

Both have ease of entry due to low barriers, but monopolistically competitive firms sell differentiated products while purely competitive firms sell identical products.

What is the long-term profit outcome for firms in monopolistically competitive and purely competitive markets?

Both monopolistically competitive firms and purely competitive firms realize normal profits in the long run.

How is the four-firm concentration ratio calculated?

Calculated as the output of the four largest firms divided by the total output in the industry.

What does a low four-firm concentration ratio indicate?

Indicates a lower level of industry concentration.

What is the Herfindahl Index?

The sum of the squared percentages of market shares of all firms in the industry, indicating industry concentration.

What does a lower Herfindahl Index signify?

Signals higher competition within the industry.

How is the Herfindahl Index calculated?

Calculated as (%S1)^2 + (%S2)^2 + (%S3)^2 + ... + (%Sn)^2, where S1, S2, etc. are the market shares of each firm.

What can be said about the demand curve faced by a monopolistically competitive seller?

More elastic than that faced by a pure monopoly but less elastic than that faced by a pure competitor due to product differentiation.

What profit-maximizing rule do firms in monopolistically competitive markets follow?

By producing the level of output where marginal revenue (MR) equals marginal cost (MC).

Is price equal to marginal revenue for firms in monopolistically competitive environments?

No, price (P) is not equal to marginal revenue (MR); in fact, P is greater than MR at the output level where MR equals MC.

What is the primary condition for a monopolistically competitive firm to maximize profits or minimize losses?

Firms produce the quantity where MR = MC.

What can monopolistically competitive firms experience in the short run?

They can either make a profit or incur a loss.

How is economic profit calculated for a monopolistically competitive firm?

= (Price - ATC) * Q.

What happens to economic profits when Price (P) is greater than Average Total Cost (ATC)?

Economic profits will be positive.

What happens to economic profits when Price (P) is less than Average Total Cost (ATC)?

Economic profits will be negative.

Do firms in a monopolistically competitive market earn positive economic profits in the long run?

No, they can only earn normal profits (P = ATC) in the long run.

What occurs in the long run if firms in a monopolistically competitive market enjoy economic profits?

Firms will enter the industry, shifting demand left and causing profits to fall.

What occurs in the long run if firms in a monopolistically competitive market incur economic losses?

Firms will exit the industry, shifting demand right and causing losses to shrink.

What is the long-run equilibrium condition for monopolistically competitive firms?

P = ATC, MR = MC, but P > MR and P > MC.

What happens to the demand curve of existing firms when new firms enter a monopolistically competitive market?

Shifts to the left (down).

What happens to the demand curve of existing firms when firms exit a monopolistically competitive market?

Shifts to the right (up).

Do firms in a monopolistically competitive market achieve productive efficiency?

No, they do not achieve productive efficiency.

Do firms in a monopolistically competitive market achieve allocative efficiency?

No, they do not achieve allocative efficiency.

What is the condition for economic efficiency in terms of output?

Requires P = MC = min ATC.

What is excess capacity in a monopolistically competitive industry?

Means that firms are producing below minimum ATC output.

How does excess capacity affect the utilization of plant and equipment in monopolistically competitive firms?

Plant and equipment are underutilized.

How do monopolistically competitive firms attempt to maintain profits despite inefficiencies?

Through product development, improvement, and advertising.

What advantage does product differentiation provide in monopolistic competition?

It offers consumers a diversity of choices and potentially better quality products.

What is the trade-off associated with product differentiation in monopolistic competition?

The greater the number of choices, the greater the excess capacity problem.

What is the relationship between product variety and economic efficiency in monopolistic competition?

Product variety helps compensate for the failure to achieve economic efficiency.