OutlineI. Introduction A. Where Does Monopolistic Competition “fit in”? B. Assumptions of Monopolistic CompetitionII. Monopolistic Competition A. Short Run B. Long Run
Outline (Cont.)III. Long Run Conditions A. Excess Capacity B. Product Differentiation C. Allocative and Productive EfficiencyIV. Oligopoly A. Where Oligopoly “fits in” B. Assumptions C. Concentration Ratios
Outline (Cont.)V. Models of Oligopoly A. Cartel Theory B. Game Theory
Where Does Monopolistic Competition “fit in?”Perfect Competition Monopoly
Where Does Monopolistic Competition “fit in?”Perfect Competition Monopoly Monopolistic Competition
Assumptions of Monopolistic Competition• Many buyers and sellers (as opposed to monopoly)• Firms produces a similar, yet unique product (gives us downward sloping demand)• Ease of entry and exit
Monopolistic Competition in the Short Run• Looks and Acts Like Monopoly • Faces Downward Sloping Demand and MR • Produces where MR=MC and may make a profit.
Monopolistic Competition in the Short Run P$10 MC 8 ATC p* AVC 6 atc* 4 2 MR D 0 1 2 3 4 5 Q
Monopolistic Competition in the Long Run• Firm Demand Shifts Back and Gets More Elastic. • Demand Shifts Back Because More Firms Enter the Industry, So There is Less Demand Per Firm. • Demand Gets More Elastic Because More Firms Means More Substitutes and More Substitutes Means More Elastic
Monopolistic Competition in the Long Run• Like Perfect Competition, Firms Will Continue to Enter Until There are No More Profits to Attract Them.
Monopolistic Competition in the Long Run P$10 MC 8 ATC AVC 6p*= atc* 4 2 MR D 0 1 2 3 4 5 Q
Long Run Conditions of Monopolistic Competition• Excess Capacity• Product Differentiation• Efficiency
Excess Capacity• Excess Capacity is the Difference Between The Long Run Perfectly Competitive Quantity Produced and the Long Run Monopolistically Competitive Quantity Produced.• Generally Speaking, There Will be Excess Capacity in the Long Run of Monop. Competition.
Excess CapacityP MC ATC AVCP* D MR0 Q Q Q Excess Capacity
Product Differentiation• The More That a Firm Can Differentiate Their Product, The More Inelastic The Demand Becomes.• Thus, Profits Can Be Sustained.• This is the Role of Advertising.
Efficiency• Productive Efficiency – Generally, A Monopolistically Competitive Firm is not Productively Efficient, since it is not producing at the bottom of it’s ATC curve• Allocative Efficiency – Generally, A Monopolistically Competitive Firm is not Allocatively Efficient, since there is excess capacity.
Oligopoly• For a Market to be Described as Oligopolistic, it must satisfy the following conditions: – Few Sellers, Many Buyers (more like Monopoly). – The Firm’s products may be identical or unique – The are Barriers to Entry (like monopoly)
Where Does Oligopoly “fit in?”Perfect Competition Monopoly Monopolistic Oligopoly Competition
Concentration Ratios• One Way to Determine Whether a Market is Oligopolistic is to look at a Concentration Ratio• A Concentration Ratio Let’s Us Know if the Whole Industry’s Sales are Dominated by the Sales of a Few Firms.
The X-Firm Concentration Ratio• The X-Firm Concentration Ratio is the Percentage of Industry Sales Accounted for by the Sales of the Top X Firms in the Industry:• Sales of the Top X Firms Total Industry Sales
Models of Oligopoly• Cartel Theory: The Oligopolists Get Together (Since There are So Few of Them) and Act As If They Were One Monopolist and Collectively Produce the Monopolistic Quantity - Thus Maximizing Profit• Example: OPEC
Problems With Cartels• Generally, They Are Not Legal (Price Fixing)• They Are Difficult to Organize and Monitor• Can’t Force New Firms to Join• Cheating
The Incentive to Cheat On A Cartel• If the Cartel Maintains the Monopoly Price, The Individual Member of the Cartel Can Act Like a Price Taker (They Can Sell All They Want at the Market Price)• As a Price Taker, They Maximize Profit Where MC=MR.
The Incentive to Cheat On A Cartel (Cont.)• This Quantity is Greater Than the Cartel Wants the Individual Firm to Produce.• All Firms in the Cartel Do This and the Cartel Falls Apart
The Incentive to Cheat On A Cartel$ $ MR MC MC ATC P MR D Q Market Q Q Firm Qcheater
Game Theory• Game Theory is a Technique That Allows Us to Examine The Strategies of Oligopolists• This Technique Allows Us to Determine the Best Strategy for a Oligopolist if the Other Oligopolists are Aware of the All of Avaliable Strategies
Example - The Prisoner’s DilemmaConsider the Following Story:• Bill and Jill Have Cheated on an Exam• They are Both Caught• Bill in Prof. Platt’s Office and Jill is Prof. Lage’s Office• Each Are Told That Their Punishment Will Be Somewhat Lighter if They Confess
Example - The Prisoner’s Dilemma (Cont.)• They Both Know That if They BOTH Admit Nothing, it Will Be Tough to Prove That They Cheated• They Can’t Communicate With Each Other• What Do They Do?
Example - The Prisoner’s Dilemma Jill is Silent Jill ConfessesBill is They Fail The Class Jill Fails,Silent and Their Transcript Bill is Expelled is Noted They Are BothBill Bill Fails, Suspended For a Year,Confesses Jill is Expelled Fail the Class and Transcipts are Noted.
How Does The Prisoner’s Dilemma Apply to Oligopoly?• A Cartel Can only Hold Together if Everyone Sticks to Producing the Monopoly Quantity• But a Cheater Benefits More Than the Others - Much Like Confession By Bill or Jill Alone, Benefits One More Than the Other.• But if They All Know This -- They All Cheat and the Cartel Falls Apart.