Microeconomics Chapter 13: Monopolistic Competition and Oligopoly

monopolistic competition

A market structure in which many firms sell a differentiated product, entry is relatively easy, each firm has some control over its product price, and there is considerable nonprice competition.

product differentiation

A distinguishing feature of monopolistic competition (compared to pure competition). Can include differences in product attributes, service, location, brand names and packaging, and some control over price.

nonprice competition

The goal of product differentiation and advertising: to make price less of a factor in consumer purchases and make product differences a greater factor.

four-firm concentration ratio

The output of the four largest firms in the industry divided by the total output of the industry. Number reflect national output (sales numbers) and would not be reflective of a localized monopoly. The lower the ratio, the less concentration and subsequently, the more competitive the industry.

Herfindahl index

A measure of industry concentration. This index is the sum of the squared percentage market shares of all firms in the industry. Generally, the lower the HI, the lower the industry concentration.

(productive efficiency and allocative efficiency)

The firm is producing in the least costly way when P = minimum ATC.

The firm is producing the right amount of product when P = MC.

Neither is met in monopolistic competition

excess capacity

The plant and equipment are underutilized because firms are producing below minimum ATC output.

(product variety)

The stronger the product differentiation, the greater is the excess capacity and, therefore, the greater is the productive efficiency. The consumer benefits from a greater variety of products.

oligopoly

A market dominated by a few large producers of a homogeneous or differentiated product. Considerable control over prices (because of their "fewness").

A market structure in which a few firms sell either a standardized or differentiated product, into which entry is difficult, in which the firm has limited control over product price because of mutual interdependence (except when there is collusion among firms), and in which there is typically nonprice competition. So each firm is affected by the decisions of its rivals.

homogeneous oligopoly

Produces standardized (homogeneous) products. For example, many industrial products (steel, zinc, copper, aluminum, lead, cement, and industrial alcohol) are virtually standardized products.

differentiated oligopoly

Produces differentiated products. For example, many consumer goods industries (automobiles, tires, household appliances, electronics equipment, breakfast cereals, cigarettes, and more sporting goods) are differentiated oligopolies. These typically engage in considerable nonprice competition supported by heavy advertising.

(oligopolistic industries)

The four-firm concentration ratio must be at least 40%.

strategic behavior

Self-interested behavior that takes into account the reactions of others. How a firm's decisions are based on the actions and reactions of rivals

mutual interdependence

A situation in which each firm's profit depends not just on its own price and sales strategies but also on those of the other firms in its highly concentrated industry.

interindustry competition

Competition between tow products associated with different industries.

import competition

game theory

The study of how people behave in strategic situations

(prisoner's dilemma)

A classic example of mutual interdependence and game theory.

(incentive to cheat)

There is an incentive for firms to cheat on their agreement to collude because cheating can result in increased revenues for the cheater.

collusion

Cooperating with rivals and can benefit the firm. Illegal in the US.

(obstacles to collusion)

Demand and cost differences, number of firms, cheating, recession, new entrants, legal obstacles.

kinked-demand curve

Used for noncollusive oligopolies to explain their behaviors and pricing strategies.

price war

Successive and continuous rounds of price cuts by rivals as they attempt to maintain their market shares.

cartel

Most comprehensive form of collusion. A group of producers that typically creates a formal written agreement specifying how much each member will produce and charge. Output must be controlled in order to maintain the agreed-upon price.

price leadership

An economic model where a dominant firm initiates price changes and the others in the industry follow the leader.

A(n) ____ is a market dominated by a few large producers of a homogeneous or differentiated product.

oligopoly

Oligopolies are comprised of:

a few large producers.

Firms in oligopolistic industries are "price makers" because:

they are few in number.

Firms in an oligopoly may produce

either a homogeneous product or a differentiated product.

Advertising may decrease economic efficiency if it

increases monopoly power.

Oligopolies typically are not desirable because they

do not achieve allocative efficiency because their price exceeds marginal cost.

Compared to pure monopolies, oligopolies

may be less desirable because they are not regulated by government to protect consumers.

Oligopolistic behavior implies that oligopolists prefer competition

through product development; through advertising

A good way to describe ____ competition is that it mixes a small amount of monopoly power with a large amount of competition, while ____ blends a large amount of monopoly power, a small amount of competition through entry, and considerable rivalry among firms.

monopolistic; oligopoly

____ ____ is a market characterized by having many sellers, differentiated products, and with ease of entry and exit from the industry.

Monopolistic competition

To achieve economic efficiency that reduces the number of resources used but increases the number of socially optimal outputs requires a triple equality. The three components that must be equal are which of the following?

Price, marginal cost, and minimum average total cost

Firms often merge, forming oligopolies, in order to

Gain greater control over market supply, become a larger buyer of inputs, and increase control over price

If a monopolistically competitive firm is producing where its marginal revenue is less than its marginal cost, then the firm

Should shut down in the long run

Should shut down in the short run

Should produce more output to increase profits

Should produce less output to increase profits or reduce losses

Is maximizing its profits

Should produce less outputs to increase profits or reduce losses.

____ means illegal cooperation with rivals.

Collusion

A monopolistically competitive firm's demand curve is

highly but not perfectly elastic.

Entry of new firms into monopolistically competitive industries is relatively easy because

capital requirements are low.

In the long run, if a monopolistic competitive firm is earning normal profits (breaking even), then it should

not exit the industry because both explicit and implicit costs are covered.

When firms in an oligopoly ____, their payoffs will be greater than that if they did not.

collude

Which of the following are shortcomings of the kinked-demand analysis of oligopoly?

The kinked-demand curve explains price inflexibility but not price itself; During macroeconomic instability, oligopoly prices are not as rigid as the kinked-demand theory implies

Non-____ competition is competition illustrated through product differentiation and advertising.

price

When measuring industry concentration, the four-firm concentration ratio is the percentage ratio of total ____ (one word) for the four largest firms in an industry relative to total industry sales.

output

Monopolistic competition normally consists of 25 to 75 firms rather than hundreds or thousands and involves which of the following characteristics?

no collusion; small market shares; independent action

Price leaders make price adjustments

by communicating impending price adjustments to the industry; by establishing a price that discourages new entrants into the industry; infrequently, due to the uncertainty in rivals' response to these price changes.

Advertising increases efficiency by

facilitating the introduction of new products; lowering search costs for consumers

Allocative efficiency in monopolistically competitive markets does not occur in the long run because firms will set the price where

ATC = demand to obtain normal profit as consumers demand more of that product and forgo other products reducing optimal societal output.

In the graph, the price elasticity of demand is higher ______ above the price of P(0).

elastic

Price leadership in an oligopoly entails a type of

implicit collusion.

Which of the following is true about the oligopolist if rivals match a price cut but ignore a price increase?

Its marginal revenue curve would consist of two segments.

No single model is used to gain insights into oligopolistic pricing and output because of

diversity and complications from interdependence.

Which of the following are attributes that provide real differences in differentiations between goods and services?

Functional features; design; materials

The equality of price and minimum average total cost yields technical ____ efficiency; the equality of price and marginal cost yields ____ efficiency.

productive; allocative