Lecture 7: Monopolistic Competition and Oligopoly
Lecture 7: Monopolistic Competition and Oligopoly
Why are Imperfect Markets Imperfect?
Objectives
Understand monopolistic competition and how firms determine equilibrium in the short run and long run.
Learn how failure to adapt to changes can cause monopolistic firms to close down.
Understand strategic behavior of Oligopolists.
Outline of Lecture
Monopolistic Competition
Monopolistic Competition equilibrium in short run and long run
Product differentiation
Oligopoly
Game theory
Monopolistic Competition
Market Structures
Four types:
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
Perfect competition: Many sellers, homogeneous product, no barriers to entry, none examples.
Monopolistic competition: Many sellers, differentiated product, no barriers to entry, Most retails & restaurants examples.
Oligopoly: Few sellers, Homogeneous or differential product, May be considerable barriers to entry, most manufacturing sectors examples.
Monopoly: One seller, No close substitutes product, Yes barriers to entry, Some public utilities examples.
Standing Out as a Coffee Shop
Question: How do you make your coffee shop stand out from competitors?
Monopolistic Competition: Short Run Equilibrium (Profit)
Price greater than average total cost.
Marginal revenue = marginal cost.
Economic profit.
Monopolistic Competition: Short Run Equilibrium (Loss)
Price less than average total cost.
Marginal revenue = marginal cost.
Economic loss.
Monopolistic Competition: Long Run Equilibrium (Zero Profit)
Price = Average total cost.
Zero economic profit.
Monopolistic Competition and Perfect Competition (Long Run)
Monopolistic Competition
Markup
Excess capacity
Perfect competition
Efficient scale
Monopolistic Competition: Firms Compete On
Price
Product differentiation leads to a downward-sloping demand curve.
Monopolistic Competition: Product Differentiation
Key feature.
Product Development
Marketing and Advertising
Brand Names
Jamie Oliver’s Restaurant Group Collapse
Changing consumer tastes are a major factor.
Constant evolution is necessary.
Classic PR blunders, including overexposure, a disconnect between actions and personal brand.
Borders Collapse
Lack of expertise in publishing, editing, online selling, or electronic books.
Failure to respond to change.
Oligopoly
Market Structures
Four types:
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
Perfect competition: Many sellers, homogeneous product, no barriers to entry, none examples.
Monopolistic competition: Many sellers, differentiated product, no barriers to entry, Most retails & restaurants examples.
Oligopoly: Few sellers, Homogeneous or Differential product, May be considerable barriers to entry, Most manufacturing sectors examples.
Monopoly: One seller, No close substitutes product, Yes barriers to entry, Some public utilities examples.
Oligopoly
Small number of firms.
Each firm has a large market share (market concentration).
Oligopoly – Market Share
Market Shares in Grocery Retailing
Woolworths 39.0%
Coles 33.5%
ALDI 10.3%
IGA 9.5%
Others 7.7%
Oligopoly in Australian Manufacturing
Oligopoly
Small number of firms.
Each firm has a large market share (market concentration).
The firms are interdependent
The profit earned by each firm depends on the firm’s own actions and on the actions of the other firms.
before making a decision, each firm must consider how the other firms will react to its decision and influence its profit.
Oligopoly
Small number of firms.
Each firm has a large market share (market concentration).
The firms are interdependent
The firms have an incentive to collude
Maybe even form into a cartel - A cartel is a group of firms acting together to limit output, raise price, and increase economic profit.
Coles and Woolworths Alleged Dodgy Discounts
Coles and Woolworths are alleged to have hiked the prices of products before dropping the prices a little and slapping a discount sticker on them and calling them sales, according to the Australian Competition and Consumer Commission (ACCC).
For example, insect repellent was originally prices at 9 before rising to 13.50 and then discounted by 1.
That means the discount was 39 per cent higher than the original.
ACCC Finds Australia's Supermarkets Are Among The World's Most Profitable
The interim report from the Australian Competition and Consumer Commission (ACCC)’s inquiry, released in September, found the supermarket industry was highly concentrated, and reported many suppliers had raised concerns about “being exploited”.
ACCC recommendation: Making it easier for smaller supermarket competitors to enter and expand in the market.
From Collusion to Competition
The Organization of the Petroleum Exporting Countries (OPEC) = 13 member countries
Competition from outside the cartel lowers prices and raises the risk of a cartel member making a quick dash for more revenue (either per unit or overall).
The United States has been increasing its production of shale oil since late 2014, which led to a collapse in the price of oil from above the 100 per barrel level that OPEC to around 45 per barrel (Jan 2015) (Next Slide).
….. and then back to collusion Non-Opec countries agree to cut oil output (Time to collude)
It is the first time OPEC has convinced non-OPEC producers to join in output cuts since 2001.
Oligopoly: Illustration from Collusion to Cheating
Suppose there are two firms (A & B).
If firms A & B collude (which is illegal in Australia) and each produce 4 units at price 70, they can maximise profit.
Joint profit max output will be 8 units.
Firm A: output = 4; profit = 180
TR = 70 \times 4 = 280
TC = 25 \times 4 = 100
Firm B: output = 4; profit = 180
TR = 70 \times 4 = 280
TC = 25 \times 4 = 100
Oligopoly: Illustration from Collusion to Cheating
We can decompose the market demand curve and show each firm’s price and output.
Firm A
Firm B
Oligopoly: Illustration from Collusion to Cheating
Suppose Firm A cheats and sells at a lower price (p=60) and increases output from 4 to 6 units; and B, not aware of, sticks to the agreement of 4 output and p=70.
Firm A
Firm B
Firm A: output = 6; profit = 210
TR = 60 \times 6 = 360
TC = 25 \times 6 = 150
Firm B: output = 4; profit = 40
TR = 70 \times 2 = 140
TC = 25 \times 4 = 100
Oligopoly: Illustration from Collusion to Cheating
Suppose Firm B also cheats and increases its output and lowers price.
Both firms will keep cheating until the joint-max output of 16 units is reached.
Firm A: output = 8; profit = 0
TR = 25 \times 8 = 200
TC = 25 \times 8 = 200
Firm B: output = 8; profit = 0
TR = 25 \times 8 = 200
TC = 25 \times 8 = 200
New market output = 16 units at P=25 from Dd curve)
Oligopoly Dilemma
Collusion and cheating creates a dilemma for an oligopolist firm.
MR = MC condition is not the only factor.
The behaviour of rivals need to be factored in.
Firms are interdependent of what their rivals could do.
We can speculate what a firm will do by using Game theory.
Game Theory
Nash equilibrium is an equilibrium in which each player takes the best possible action given the action of the other player.
Game theory — a tool used to analyse strategic behaviour that recognises mutual interdependence and takes account of the expected behaviour of others.
Two Strategies
Compete - Charge a low price.
Co-operate - Charge a high price (i.e. price fixing).
Game Theory
The outcome: BP will choose low and Caltex will choose low.
This is the Nash equilibrium.
The equilibrium of a game when each player takes the best possible action given the action of the other player.
Game Theory of Panic-Buying: What Would You Do?
Cooperation (Normal): emphasise the feelings of kinship between shoppers
Competition (Panic): individuals are simply unconcerned with others and take what they want to benefit themselves.
The Incredible Story of how De Beers created and lost the most powerful monopoly ever
In 1870, huge diamond mines were discovered near the Orange River, in South Africa. British financiers soon realised that their investment was endangered; diamonds had little intrinsic value — and their price depended on scarcity.
In 1880, Cecil Rhodes (English-born businessman) bought the claims of fellow rival Barney Barnato to create the De Beers Mining Company.
To control supply and demand (and prices), Rhodes created distribution arms through ‘The Diamond Syndicate’ including 'The Diamond Trading Company' in London and 'The Syndicate' in Israel.
He bought up small mining groups and formed them into large ones (merger) and eventually became the sole-owner of virtually all South African diamond mines.
De Beers
In 1947, the tag line 'A diamond is forever‘ was coined up. An advertising gimmick.
Numerous 'revolts' against the De Beers cartel had occurred in places like Zaire and Israel over the years, which were mostly quashed by De Beers releasing stockpiles of diamonds similar to that county's product.
Countries with enormous stockpiles of their own, like Russia, Canada and Australia, refused to cooperate with the single channel system.
In 2011, a 55 square metre De Beers Diamond Jewellers store opened at the Times Square Mall in Dalian, China. According to the company, this opening follows the success of the two other De Beers stores in the country.
This forced De Beers to switch up the company's strategy. From rough-diamond supplying and controlling the entire industry, to promoting its own brand of diamonds and retail stores.
Review of Today’s Lecture
Monopolistic Competition
Monopolistic Competition equilibrium in short run and long run
Product differentiation
Oligopoly
Game theory