Monopolistic Competition and OligopolyChapter OutlineMonopolistic Competition and OligopolyThe Makings of Monopolistic CompetitionA Monopolistically Competitive Firm in the Short and Long RunSlide 6Monopolistic Competition and Economic EfficiencyComparison of Monopolistically Competitive Equilibrium and Perfectly Competitive EquilibriumMonopolistic Competition in the Markets for Cola and CoffeeA C T I V E L E A R N I N G 1 AdvertisingAdvertisingThe Critique of AdvertisingThe Defense of AdvertisingAdvertising as a Signal of QualityBrand NamesThe Critique of Brand NamesThe Defense of Brand NamesComparing Perfect & Monop. CompetitionComparing Monopoly & Monop. CompetitionOligopolyEquilibrium in an Oligopolistic MarketThe Cournot ModelSlide 23Slide 24Linear Demand Curve – An ExampleSlide 26Slide 27The Stackelberg Model - First Mover AdvantageSlide 29The Bertrand Model – Price Competition with Homogeneous ProductsSlide 31Price Competition with Different ProductsSlide 33A Pricing Problem for Procter & GambleCompetition versus Collusion: The Prisoners’ DilemmaSlide 36Procter & Gamble in a Prisoners’ DilemmaMonopolistic Competition and OligopolyChapter 12Chapter Outline12.1 Monopolistic Competition12.2 Oligopoly12.3 Price Competition12.4 Competition versus Collusion: The Prisoners’ Dilemma12.5 Implications of the Prisoners’ Dilemma for Oligopolistic Pricing12.6 CartelsMonopolistic Competition and Oligopolymonopolistic competition Market in which firms can enter freely, each producing its own brand or version of a differentiated product.oligopoly Market in which only a few firms compete with one another, and entry by new firms is impededcartel Market in which some or all firms explicitly collude, coordinating prices and output levels to maximize joint profits.A monopolistically competitive market has two key characteristics:1. Firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes. In other words, the cross-price elasticities of demand are large but not infinite.2. There is free entry and exit: it is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their products become unprofitable.The Makings of Monopolistic CompetitionBecause the firm is the only producer of its brand, it faces a downward-sloping demand curve. P > MC and the firm has monopoly power. In the short run, P > AC as well, and the firm earns profits shown by the yellow-shaded rectangle.A Monopolistically Competitive Firm in the Short and Long RunIn the long run, profits attract new firms with competing brands. The firm’s market share falls, and its demand curve shifts downward. In long-run equilibrium, described in part (b), P=AC, so the firm earns zero profit even though it has monopoly power.A Monopolistically Competitive Firm in the Short and Long RunComparison of Monopolistically Competitive Equilibrium and Perfectly Competitive EquilibriumMonopolistic Competition and Economic EfficiencyUnder perfect competition, P = MC.The demand curve facing the firm is horizontal, so the zero-profit point occurs at the point of minimum AC.Under monopolistic competition, P>MC. Thus there is a deadweight loss, as shown by the yellow-shaded area. The demand curve is downward-sloping, so the zero-profit point is to the left of the point of minimum average cost.Any gains of monopolistic competition to consumers?Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive EquilibriumElasticities of Demand for Brands of Colas and CoffeeBrand Elasticity of Demand ColasRoyal Crown –2.4Coke –5.2 to –5.7Ground coffeeFolgers –6.4Maxwell House –8.2Chock Full o’Nuts –3.6With the exception of Royal Crown and Chock Full o’ Nuts, all the colas and coffees are quite price elastic. With elasticities on the order of −4 to −8, each brand has only limited monopoly power. This is typical of monopolistic competition.Monopolistic Competition in the Markets for Cola and Coffee1. So far, we have studied three market structures: perfect competition, monopoly, and monopolistic competition. In each of these, would you expect to see firms spending money to advertise their products? Why or why not? 2. Is advertising good or bad from society’s viewpoint? Try to think of at least one “pro” and “con.” A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11 AdvertisingAdvertisingAdvertisingIn monopolistically competitive industries, product differentiation and markup pricing lead naturally to the use of advertising. In general, the more differentiated the products, the more advertising firms buy. Economists disagree about the social value of advertising.The Critique of AdvertisingCritics of advertising believe:Society is wasting the resources it devotes to advertising.Firms advertise to manipulate people’s tastes.Advertising impedes competition – it creates the perception that products are more differentiated than they really are, allowing higher markups.The Defense of AdvertisingDefenders of advertising believe:It provides useful information to buyers.Informed buyers can more easily find and exploit price differences.Thus, advertising promotes competition and reduces market power.Results of a prominent study: Eyeglasses were more expensive in states that prohibited advertising by eyeglass makers than in states that did not restrict such advertising.Advertising as a Signal of QualityA firm’s willingness to spend huge amounts on advertising may signal the quality of its product to consumers, regardless of the content of ads. Ads may convince buyers to try a product once, but the product must be of high quality for people to become repeat buyers. The most expensive ads are not worthwhile unless they lead to repeat buyers. When consumers see expensive ads, they think the product must be good if the companyis willing to spend so much on advertising.Brand NamesIn many markets, brand name products coexist with generic ones. Firms with brand names usually spend more on advertising, charge higher prices for the products. As with advertising, there is disagreement about the economics of brand names…The Critique of Brand NamesCritics of brand names believe:Brand names cause consumers to perceive differences that do not really exist.Consumers’ willingness to