Monopolistic Competition And OligopolyThe Concept of Imperfect CompetitionMonopolistic CompetitionMany Buyers and SellersSellers Offer a Differentiated ProductSlide 6Easy Entry and ExitMonopolistic Competition in the Short-RunFigure 1: A Monopolistically Competitive Firm in the Short RunThe Long-RunFigure 2: A Monopolistically Competitive Firm in the Long RunExcess Capacity Under Monopolistic CompetitionNonprice CompetitionOligopolyNumber of FirmsMarket DominationEconomies of Scale: Natural OligopoliesBarriers to entryOligopoly vs. Other Market StructuresThe Game Theory ApproachThe Prisoner’s DilemmaFigure 3: The Prisoner’s DilemmaSlide 23Simple Oligopoly GamesFigure 4: A Duopoly GameOligopoly Games in the Real WorldSlide 27Cooperative Behavior in OligopolyExplicit CollusionTacit CollusionSlide 31The Limits to CollusionThe Incentive to CheatWhen is Cheating Likely?Figure 5a: Advertising in Monopolistic CompetitionFigure 5b: Advertising in Monopolistic CompetitionUsing the Theory: Advertising in Monopolistic Competition and OligopolyAdvertising and Collusion in OligopolyFigure 6: An Advertising GameThe Four Market Structures: A PostscriptHall & Leiberman; Economics: Principles And Applications, 2004 1Monopolistic Competition And Oligopoly•On any given day, you are probably exposed to hundreds of advertisements•In perfect competition and monopoly firms do little, if any, advertising•Where, then, is all the advertising coming from?Hall & Leiberman; Economics: Principles And Applications, 2004 2The Concept of Imperfect Competition•Refers to market structures between perfect competition and monopoly•Types of imperfectly competitive markets–Monopolistic competition –OligopolyHall & Leiberman; Economics: Principles And Applications, 2004 3Monopolistic Competition•Hybrid of perfect competition and monopoly, sharing some of features of each–A monopolistically competitive market has three fundamental characteristics•Many buyers and sellers•Sellers offer a differentiated product•Sellers can easily enter or exit the marketHall & Leiberman; Economics: Principles And Applications, 2004 4Many Buyers and Sellers•Under monopolistic competition, an individual buyer is unable to influence price he pays•But an individual seller, in spite of having many competitors, decides what price to chargeHall & Leiberman; Economics: Principles And Applications, 2004 5Sellers Offer a Differentiated Product•Each seller produces a somewhat different product from the others•Faces a downward-sloping demand curve –In this sense is more like a monopolist than a perfect competitor–When it raises its price a modest amount, quantity demanded will decline (but not all the way to zero)Hall & Leiberman; Economics: Principles And Applications, 2004 6Sellers Offer a Differentiated Product•What makes a product differentiated?•Product differentiation is a subjective matter•Thus, whenever a firm (that is not a monopoly) faces a downward-sloping demand curve, we know buyers perceive its product as differentiatedHall & Leiberman; Economics: Principles And Applications, 2004 7Easy Entry and Exit•Same as in perfect competition–Ensures firms earn zero economic profit in long-run•In monopolistic competition, however, assumption about easy entry goes further–No barrier stops any firm from copying the successful business of other firmsHall & Leiberman; Economics: Principles And Applications, 2004 8Monopolistic Competition in the Short-Run•Individual monopolistic competitor behaves very much like a monopoly•Key difference is this–When a monopolistic competitor raises its price, its customers have one additional option – to buy from another sellerHall & Leiberman; Economics: Principles And Applications, 2004 9Figure 1: A Monopolistically Competitive Firm in the Short RunMR1$7030250d1AMCATCDollarsHomes Serviced per Month2. and charges $70 per home.4. Kafka's monthly profit–$10,000–is the area of the shaded rectangle.1. Kafka services 250 homes per month, where MC and MR intersect . . .3. ATC at 250 units is less than price, so profit per unit is positive.Hall & Leiberman; Economics: Principles And Applications, 2004 10The Long-Run•No barriers to entry and exit—the firm will not enjoy its profit for long•Under monopolistic competition, firms can earn positive or negative economic profit in short-run•But in long-run, free entry and exit will ensure that each firm earns zero economic profit just as under perfect competitionHall & Leiberman; Economics: Principles And Applications, 2004 11Figure 2: A Monopolistically Competitive Firm in the Long Rund2MR2EMC$40100 250DollarsHomes Serviced per MonthATCMR1In the long run, profit attracts entry, which shifts the firm's demand curve leftward.The typical firm produces where its new MR crosses MC.d1Entry continues until P = ATC at the best output level, and economic profit is zero.Hall & Leiberman; Economics: Principles And Applications, 2004 12Excess Capacity Under Monopolistic Competition•In long-run, a monopolistic competitor will operate with excess capacity•Excess capacity suggests that monopolistic competition is costly to consumers•Does that mean consumers prefer perfect competition to monopolistic competition?Hall & Leiberman; Economics: Principles And Applications, 2004 13Nonprice Competition•Any action a firm takes to increase demand for its output—other than cutting its price—is called nonprice competition•Nonprice competition is another reason why monopolistic competitors earn zero economic profit in long-run•All this nonprice competition is costlyHall & Leiberman; Economics: Principles And Applications, 2004 14Oligopoly•An oligopoly is a market dominated by a small number of strategically interdependent firms•In such a market, each firm recognizes its strategic interdependence with othersHall & Leiberman; Economics: Principles And Applications, 2004 15Number of Firms•Oligopoly requires that a few firms dominate the market•No absolute number at which oligopoly ends and monopolistic competition beginsHall & Leiberman; Economics: Principles And Applications, 2004 16Market Domination•Strategic interdependence requires that a few firms dominate the market•As combined market share shrinks, strategic interdependence becomes weaker•Oligopoly is a matter of degree–Not an absolute classificationHall & Leiberman; Economics: Principles And Applications, 2004
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