Microeconomics CH 11 Monopolistic Competition and Oligopoly Monopolistic competition market structure in which There are a large number of firms The products produced by the different firms are differentiated Entry and exit occur easily Product differentiation implies that the products are different enough that the producing firms exercise a mini monopoly over their product Firms compete more on product differentiation than on price Entering firms produce close substitutes not an identical or standardized product Nonprice Competition The firm attempts to establish its product as a different product from that offered by its rivals Differentiation means that in the consumer s mind the product is not the same Marketing is often the key to successful differentiation Firms may differentiate products by perceived quality reliability color style safety features packaging purchase terms warranties and guarantees location availability hours of operation or any other features Brand names may signal information regarding the product reducing consumer risk Advertising Prices and Profits Product differentiation reduces the price elasticity of demand which appears as a steeper demand curve Successful product differentiation enables the firm to charge a higher price Brand Name Brand name is valuable to a firm it makes the demand less elastic and can enable the firm to earn higher profits Once consumer has had a positive experience with a good the price elasticity of demand for that good typically decreases consumer becomes loyal to the product Oligopoly is a market structure characterized by Few firms Either standardized or differentiated products Difficult entry Key characteristic of oligopolies each firm can affect the market making each firm s choices dependent on the choices of the other firms They are interdependent Interdependence The importance of interdependence is that it leads to strategic behavior Strategic behavior behavior that occurs when what is best for A depends upon what B does and what is best for B depends upon what A does Oligopolistic behavior includes both ruthless competition and cooperation Game Theory Dominant Strategy Game theory provides a description of oligopolistic behavior as a series of strategic moves and countermoves strategic behavior has been analyzed using game theory mathematical techniques Dominant strategy strategy that produces better results no matter what strategy other firms follow oligopoly firms try to achieve this The interdependence of oligopolies decisions can often lead to the prisoners dilemma Nash Equilibrium Nash Equilibrium occurs when a unilateral move by a participant does not make the participant better off Example video http www youtube com watch v 2d dtTZQyUM Cooperation and Cartels If the firms in an oligopoly cooperate they may earn more profits than if they act independently Collusion leads to secret cooperative agreements illegal in the U S although it is legal and acceptable in many other countries Price Leadership Cartels may form in which firms simply do whatever a single leading firm in the industry does this avoids strategic behavior and requires no illegal collusion Cartel is an organization of independent firms whose purpose is to control and limit production and maintain or increase prices and profits cartels are illegal in US Conditions necessary for a cartel to be stable maintainable There are few firms in the industry There are significant barriers to entry An identical product is produced There are few opportunities to keep actions secret There are no legal barriers to sharing agreements OPEC Organization of Petroleum Exporting Countries o Controls prices by setting production quotas for member countries o Such cartels are difficult to sustain because members have large incentives to cheat exceeding their quotas Facilitating practices actions by oligopolistic firms that can contribute to cooperation and collusion even though the firms do not formally agree to cooperate Cost plus or mark up pricing a pricing policy where a firm computes its average costs of producing a product and sets the price at some percentage above this cost
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