Oligopoly and Monopolistic Competition 14.1,14.2,14.3,14.5

14.1 Two More Market Structures

--Coffee and tasty foods are typical examples of differentiated products, which are goods that are similar but are not perfect substitutes. --They contrast with homogeneous products, which are those goods that are identical and are therefore perfect substitutes. --A useful classification of market structures must therefore distinguish industries along two dimensions: --The number of firms supplying a given product --The degree of product differentiation --Our first new market structure is oligopoly, which applies when there are only a few suppliers of a product. --Because in an oligopoly only a few firms are operating, each firm's profits and profit-maximizing choices depend on other firms' actions --Our second new market structure is monopolistic competition --All firms in a monopolistically competitive industry face a downward-sloping demand curve, so they have market power and choose their own price, just as monopolists do. These characteristics account for the first part of the name. What's competitive about such markets is that there are no restrictions on entry—any number of firms can enter the industry at any time --This means that firms in a monopolistically competitive industry, despite having pricing power, make zero economic profits in the long run. --similar to a perfectly competitive industry, monopolistic competition features many competing firms, but unlike perfect competition, the sellers produce and sell differentiated products. --

Oligopoly and Monopolistic Competition intro

--Does simply counting the number of firms in an industry tell us whether the market is competitive? If so, then how many firms do we need to make a market competitive? --In fact, fall between the two extremes of perfect competition and monopoly: oligopoly and monopolistic competition --Key Ideas --Two market structures that lie between perfect competition and monopoly are oligopoly and monopolistic competition. --In both of these markets, the seller must recognize actions of competitors. --In oligopolies, economic profits in the long run can be positive. --In monopolistically competitive markets, entry and exit drive economic profits to zero in the long run. --Several important variables—such as the number of firms in the industry, the degree of product differentiation, entry barriers, and the presence or absence of collusion—determine the competitiveness of a market.

14.3 Monopolistic Competition

--Most importantly, in the short run the mechanics of monopolistic competition are identical to those for the monopolist's problem, whereas in the long run the equilibrium mirrors perfect competition. --s a monopolistic competitor, Dairy Queen must figure out the quantity and price that maximizes its profits. The optimal quantity is found by setting marginal revenue equal to marginal cost, that is, MC=MR. Then just go up to the demand curve to find price --Monopolist and monopolistic competitor: Set P∗>MR=MC Perfect competitor: Set P∗=MR=MC --is identical across the three market structures of perfect competition, monopoly, and monopolistic competition: expand production until MC=MR --The major difference arises with the firm in a perfectly competitive industry: it faces a perfectly elastic demand curve for its product, which leads to P=MR For the monopolist and monopolistic competitor, however, we have P>MRP>MR because they face a downward-sloping demand curve. --Computing economic profits for the monopolistically competitive firm works exactly the same way as computing economic profits for the other three market structures, that is, Profits=Total revenue−Total cost --If total revenues cover variable costs, then continue to produce in the short run. If total revenues do not cover variable costs, then shutdown is optimal, as you will lose less money by shutting down and paying fixed costs than you would by operating. --Long-Run Equilibrium in a Monopolistically Competitive Industry --We know that when there are more substitutes for a good, a firm's residual demand curve shifts to the left and becomes more elastic (less steep) --The key to understanding what happens in monopolistically competitive markets is to recognize what happens to the demand curves of the market's existing firm(s) when another firm enters. --As the exhibit shows, Dairy Queen is still earning economic profits. We should therefore expect more firms to enter. Each firm that enters will further shift leftward Dairy Queen's residual demand curve as well as make it more elastic. When does entry stop? Similar to a perfectly competitive industry, entry stops when there are no longer economic profits. --In monopolistic competition, market changes occur because the residual demand curve becomes flatter and shifts leftward with entry. --Because entry pushes economic profits to zero in the long run, monopolistically competitive firms have an incentive to continually try to distinguish themselves from rivals—in this way, such markets are perpetually in motion --Firm exit will cause the demand curve facing existing individual sellers to shift rightward and steepen (become less elastic).

14.5 Summing Up: Four Market Structures

--We now have studied the four major market types. In Chapters 4-7, we focused on perfect competition. In Chapter 12, we studied monopolists. Between the two extreme market structures—perfect competition and monopoly—are monopolistic competition and oligopoly. --As we just learned, monopolistic competition and oligopoly share many features with monopolies, including the ability to set prices. --The primary difference across these three market structures is the number of competitors, or the number of sellers. --A monopoly has only one seller --monopolistic competition and oligopoly are market structures with more than one seller, because of this fact, they have to concern themselves with the actions of other firms. --How many firms are necessary to make a market competitive?In many industries and in the lab, approximately three or four.

14.2 Oligopoly

0 In this chapter, we discuss two models to help us understand oligopoly: --Oligopoly model with homogeneous (identical) products --Oligopoly model with differentiated products --The first model, oligopoly with identical products, is similar to the monopoly model, but one key difference is that the oligopolist must recognize the behavior of its competitors, whereas the monopolist does not. --The second model, oligopoly with differentiated products, is linked to the monopolistic competition market structure with one major exception: entry is impeded in the oligopoly, whereas there is free entry in the monopolistically competitive market. --Due to cost advantages associated with the economies of scale of oligopoly or other barriers to entry, entry and exit will not necessarily push the market to zero economic profits in the long run (as is the case with perfect competition and monopolistic competition). --Because of relatively few competitors, the sellers that do occupy the market interact strategically. --One of the simplest cases of oligopoly is an industry with only two competing firms—a duopoly --For simplicity, let's say that the market has a total demand of 1,000 landscaping jobs per week, provided that the price is $50 or below. At any price above $50, the market demand is zero --What is directly relevant for a firm's profit-maximizing decisions is not the market demand curve but its residual demand curve, which is the demand that is not met by other firms --In particular, in this example it is given as 1,000, if your price is less than Rose Petal's, or PDW<PRP; 1,000/21,000/2, if your price is equal to Rose Petal's, or PDW=PRP; 0, if your price is more than Rose Petal's, or PDW>PRP. --Contrasted with the market demand curve, which depends on the "market price"—the minimum of the prices charged in the market—the residual demand curve depends on the prices charged by both you and Rose Petal. --How should you start? A first consideration is determining costs. Recall that the marginal cost is assumed to be $30 per job for both you and Rose Petal. -When does all of this price-cutting end? In other words, what is the Nash equilibrium? --we reach the unique Nash equilibrium: both firms charge a price equal to marginal cost, or $30 per landscaping job. That is, PDW=PRP=MC=$30 --they both earn zero economic profits. --If you cut the price further, you will not cover your marginal cost(PDW<MC=$30), so this is not a good strategy either --Economists refer to a market in which multiple varieties of a common product type are available as a differentiated product market. --When there are a few firms selling products that aren't identical, the key is to explicitly account for consumers' willingness to substitute among the products. --Therefore, this is not the "all-or-nothing" demand a firm faces with different prices for homogeneous products. --this argument shows that in an oligopoly with differentiated products, the equilibrium cannot have price equal to marginal cost and zero profits. --The less substitutable the two products are—meaning that there are more diehard consumers committed to each product—the further away we will be from the situation with homogeneous products, and the higher the prices will be. --In summary, we have seen that with homogeneous products, two firms competing head-to-head are sufficient to bring the price down to marginal cost. This is no longer true with differentiated products. --In oligopoly with differentiated products, price will typically be lower with three firms competing compared to two firms competing --As the number of firms in an oligopolistic market increases further, prices tend to decline toward marginal cost. --It's not in the interest of one company to collude if the other is colluding. --Collusion occurs when rival firms conspire among themselves to set prices or to control production quantities rather than let the free market determine them --How should you set prices jointly? One model of how an oligopoly might behave is for all the firms to coordinate and collectively act as a monopolist and then split the monopoly profits among themselves --Accordingly, collusion is much more profitable than competition for both of you. (50 dollars for 1000 jobs landscapping than competeing and going to 30 dollars per job) --Is it possible to sustain collusion if firms recognize that they will be playing this game over and over rather than just once? The answer is yes. There are two important considerations that determine how successful a collusive arrangement is: Detection and punishment of cheaters The long-term value of the market --f another player can cheat without being detected—such as giving customers a secret price discount—then it is difficult to maintain collusive agreements on keeping prices high --ut should Rose Petal cut its price, as soon as you find out about it, you price at marginal cost, or $30 per job forever, thus denying Rose Petal the high profits that it would have enjoyed with the collusive agreement. This type of punishment strategy is called a grim strategy. --A colluder who values future monopoly profits more than current cheating profits will abide by the collusive agreement. In this view, impatient firms, for example those in danger of bankruptcy and therefore in desperate need of profits today, are more likely to cheat on the collusive agreement. In addition, if the government bans a product, then firms selling that product will know that on the last day of legal sales, no individual firm has an incentive to continue playing a cooperative strategy, so all firms cut prices on the last day.