Monopolistic competition - Relatively large number of sellers, differentiated products, easy entry/exit

Relatively large # of sellers

• Small market shares

• No collusion - The presence of a relatively large number of firms ensures that collusion by a group of firms to restrict output and set prices is unlikely

• Independent action - Each firm can determine its own pricing policy without considering the possible reactions of rival firms

Product differentiation - Variations of particular product

• Product attributes

• Service

• Location

• Brand names + packaging

• Some control over product prices

Easy entry + exit

• Few economies of scale

• Low capital requirements

Non-price competition - Product differentiation + advertising

Four firm concentration ratio - Ratio of the output (sales) of the four largest firms in an industry relative to total industry sales

• Very low in purely competitive industries

Herfindahl index - Sum of the squared percentage market shares of all firms in the industry

• Important to assess oligopolistic industries

• Lower index → Greater chance of being competitive

Monopolistic competition’s demand curve

• Highly elastic

• No perfect product substitutes

• Price elasticity depends on # of rivals + degree of product differentiation

Short run

• Produces where MR = MC

• May incur loss in short run

Long run

• Only normal profit (break even)

• Economic profits → Firms enter industry → Quantity increases → Economic profit decreases

• Economic losses → Firms leave industry → Quantity decreases → Economic profit increases

• Complications

  • Product differentiation can prevent duplication

  • In reality, entry is not as free

Efficiency

• Neither productive nor allocative efficiency

• Average total cost slightly higher than optimal

• P > MC → Underallocation of resources

Excess capacity - Plant and equipment that are underused because firms are producing less than the minimum-ATC output

Product differentiation

• Stay ahead of competitors

• Provides more range to consumers

• Trade-off b/w consumer choice + productive efficiency

Oligopoly - Market dominated by a few large producers of a homogeneous or differentiated product

• 3-5 firms

Homogeneous oligopoly - Standardized products

Differentiated oligopoly - Differentiated products

Strategic behavior - Self-interested behavior that takes into account reactions of others

Mutual interdependence - A situation in which each firm’s profit depends not entirely on its own price and sales strategies but also on those of the other firms

Entry barriers

• Economies of scale

• Large capital expenditures

• Ownership + control of raw resources

Merge 2 competing firms → Increase market share + achieve greater economies of scale + greater monopoly power

Shortcomings of concentration ratios

• Localized markets

• Interindustry competition - Competition b/w 2 products associated w/ different industries

• Import competition - Competition b/w foreign products

Game theory - Study of how people behave in strategic situations

• Payoff matrix shows payoff to each firm resulting from different combinations of strategies

• Collusion - Cooperation w/ rivals rather than work competitively/independently

• Incentive to cheat - Cheating on collusive agreement to increase own profit

3 oligopoly models

• (1) the kinked-demand curve, (2) collusive pricing, and (3) price leadership

• Why isn’t there only a single model?

  • Diversity of oligopolies - Oligopoly encompasses a greater range and diversity of market situations than do other market structures

  • Complications of interdependence - The mutual interdependence of oligopolistic firms complicates matters significantly

Kinked demand curve - Demand is highly elastic above the going price P0 but much less elastic or even inelastic below that price

• Rivals can either match price changes or ignore price changes

• Prices stable in non-collusive oligopolistic industries

• Even if costs change significantly, may not need to change price

• Price war - Successive and continuous rounds of price cuts by rivals as they attempt to maintain their market shares

Cartels + other collusion

• Cartel - A group of producers that typically creates a formal written agreement specifying how much each member will produce and charge

• Obstacles to collusion

  • Demand + cost differences - When oligopolists face different costs and demand curves, it is difficult for them to agree on a price

  • Number of firms - Other things equal, the larger the number of firms, the more difficult it is to create a cartel or some other form of price collusion

  • Cheating - Collusive oligopolists are tempted to engage in secret price cutting to increase sales and profit

  • Long-lasting recession - Slumping markets increase average total cost

  • Potential entry of new firms - The greater prices and profits that result from collusion may attract new entrants, including foreign firms

  • Anti-trust law - U.S. antitrust laws prohibit cartels and price-fixing collusion

Price leadership - The dominant firm initiates price changes and all other firms more or less automatically follow the leader

• Infrequent price changes

• Communications of price changes

• Limit pricing

Oligopoly + advertising

• Product development + advertising less easily duplicated than price cuts

• Positive effects

  • Diminishes monopoly power

  • Lowers consumers’ search costs

  • More economic efficiency

• Negative effects

  • No info about price or quality

  • Based on misleading claims

  • Establishes brand loyalty + monopoly power

Oligopoly + efficiency

• Neither productive nor allocative efficiency

• No regulation of loophole monopoly power