10 monopolistic competition and oligopoly

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10 monopolistic competition and oligopoly

  1. 1. Chapter 10Monopolistic Competition and Oligopoly • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing 1
  2. 2. In this chapter, you will learn to solve these economic puzzles:Are Howwill Ivan’s Oysterand does the NCAA Cheerios, Rice Krispies, Why other brands sold by firms in the Why doFour basketball Final OPEC economic and other Bar make zero industry breakfast cereal usedown? tournament cartels tend to long-run? profit in the break produced under monopolistic competitioncompetition imperfect or oligopoly? 2
  3. 3. What isImperfect Competition?A market structure between the extremes of perfect competition and monopoly 3
  4. 4. What is Monopolistic Competition?• many small sellers• differentiated product• easy entry and exit 4
  5. 5. What isProduct Differentiation? The process of creating real or apparent differences between goods and services 5
  6. 6. What does Many Small Sellers mean?Each firm is so small relative to the total market that each firm’s pricing decisions have a negligible effect on the market price 6
  7. 7. What isNonprice Competition?A firm competes using advertising, packaging, product development, better service, rather than lower prices 7
  8. 8. How easy is entry and exit in Monopolistic Competition?Not as easy as in Perfect Competition because of product differentiation 8
  9. 9. Why is a Monopolistic Competitive firm a price maker? Product differentiation gives the firm some control over its price 9
  10. 10. What does the demandcurve for MonopolisticCompetition look like?It is less elastic (steeper) than for a perfectly competitive firm and more elastic (flatter) than for a monopolist 10
  11. 11. What are examples ofMonopolistic Competition? • grocery stores • hair salons • gas stations • video rental stores • restaurants 11
  12. 12. How effective is Advertising?Somewhat effective in the short-run but less effective in the long-run 12
  13. 13. What effect doesAdvertising have on Average Costs?It raises the long-run average cost curve 13
  14. 14. P The effect of Advertising$4.00 With advertising$3.50 Cost per unit$3.00 LRAC2$2.50$2.00$1.50$1.00 LRAC1 Without advertising $.50 2 4 6 8 10 12 14 16 18 Q 14
  15. 15. How does a firm decide what price tocharge and how many units to produce? MR = MC 15
  16. 16. P$50 MR=MC$40 MC$30$25$20 ATC$15 Profit$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 16
  17. 17. Why is a Normal Profitmade in the Long-run? The combination of the leftward shift in the firm’s demand curve and the upward shift in the LRAC curve 17
  18. 18. P Normal Profit$40$35 MC$30$25$20 LRAC$15$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 18
  19. 19. How efficient isMonopolistic Competition? Less resources are used and a higher price is charged than would be the case under Perfect Competition 19
  20. 20. P Monopolistic Competition$40$35 Minimum MC$30 LRAC$25$20 ATC$15$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 20
  21. 21. P Perfect Competition$40 Price & Cost per unit Minimum MC LRAC$35 LRAC$30 MR$25$20$15$10 $5 1 2 3 4 5 6 7 8 9 Q 21
  22. 22. What is Oligopoly?• few sellers• either homogeneous or a differential product• difficult market entry 22
  23. 23. How few are a few Sellers?When the firms are so large relative to the total market that they can affect the market price 23
  24. 24. What is a significant Barrier to Entry? Economies of scale 24
  25. 25. What isNonprice Competition?Competition in ways other than pricing policies 25
  26. 26. What is thedistinguishing feature of Oligopoly?Mutual interdependence 26
  27. 27. What is Mutual Interdependence?A condition in which an action by one firm may cause a reaction on the part of other firms 27
  28. 28. What does MutualInterdependence do to the Demand Curve?A kinked demand curve is a possible result of this characteristic 28
  29. 29. What does a KinkedDemand Curve show?It shows that rivals will match a firm’s price decrease, but ignore a price increase 29
  30. 30. P Oligopolist’s Kinked Demand Curve$400$350 Rivals ignore price changes$300$250$200$150$100 Rivals match price changes $50 5 10 15 20 25 30 35 40 45 Q 30
  31. 31. How do Oligopolists determine price?They play the game “follow the leader” that economists call price leadership 31
  32. 32. What is Price Leadership?A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow 32
  33. 33. What is a Cartel?A group of firms formally agreeing to control the price and output of a product 33
  34. 34. What are examples of Cartels?• Organization of Petroleum Exporting Countries (OPEC)• International Telephone Cartel (CCITT)• International Airline Cartel (IATA) 34
  35. 35. What is the majorweakness of a Cartel?Member firms cheating 35
  36. 36. P Why a Cartel Member Has an Incentive to Cheat$40 Price & Cost per unit$35 MC LRAC$30 MR2$25$20 MR1$15$10 $5 1 2 3 4 5 6 7 8 9 Q 36
  37. 37. Key Concepts 37
  38. 38. Key Concepts• What is Imperfect Competition?• What is Monopolistic Competition?• What is Product Differentiation?• What is Nonprice Competition?• Why is a Monopolistic Competitive firm a price• How does a firm decide what price to charge an• Why is a Normal Profit made in the Long-run? 38
  39. 39. Key Concepts cont.• How efficient is Monopolistic Competition?• What is Oligopoly?• What is Nonprice Competition?• What is the distinguishing feature of Oligopoly?• What does a Kinked Demand Curve show?• How do Oligopolists determine price?• What is a Cartel? 39
  40. 40. Summary 40
  41. 41. Imperfect competition is themarket structure between theextremes of perfect competition andmonopoly Monopolistic competitionand oligopoly belong to theimperfect competition category. 41
  42. 42. Monopolistic competition is amarket structure characterized by (1)many small sellers, (2) a differentiatedproduct, and (3) easy market entry andexit. Given these characteristics, firmsin monopolistic competition have anegligible effect on the market price. 42
  43. 43. Product differentiation is a keycharacteristic of monopolisticcompetition. It is the process ofcreating real or apparent differencesbetween products. 43
  44. 44. Nonprice competition includesadvertising, packaging, productdevelopment, better quality, andbetter service. Under imperfectcompetition, firms may competeusing nonprice competition, ratherthan price competition. 44
  45. 45. Short-run equilibrium for amonopolistic competitor can yieldeconomic losses, zero economicprofits, or economic profits. In thelong run, monopolistic competitorsmake zero economic profits. 45
  46. 46. P$50 MR=MC$40 MC$30$25$20 ATC$15 Profit$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 46
  47. 47. Comparing monopolisticcompetition with perfect competition,we find that the monopolisticcompetitive firm does not achieveallocative efficiency,charges a higherprice, restricts output, and does notproduce where average costs are at aminimum. 47
  48. 48. P Monopolistic Competition$40$35 Minimum MC$30 LRAC$25$20 ATC$15$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 48
  49. 49. P Perfect Competition$40 Price & Cost per unit Minimum MC LRAC$35 LRAC$30$25 MR$20$15$10 $5 1 2 3 4 5 6 7 8 9 Q 49
  50. 50. Oligopoly is a market structurecharacterized by (1) few sellers, (2) ahomogeneous or differentiatedproduct, and (3) difficult market entry.Oligopolies are mutuallyinterdependent because an action byone firm may cause a reaction on thepart of other firms. 50
  51. 51. The nonprice competition modelis a theory that might explainoligopolistic behavior. Under thistheory, firms use advertising andproduct differentiation, rather thanprice reductions, to compete. 51
  52. 52. The kinked demand curve is amodel that explains why prices maybe rigid in an oligopoly. The kink isestablished because an oligopolistassumes that rivals will match a pricedecrease, but ignore a price increase. 52
  53. 53. P Oligopolist’s Kinked Demand Curve$400$350 Rivals ignore price changes$300$250$200$150$100 Rivals match price changes $50 5 10 15 20 25 30 35 40 45 Q 53
  54. 54. Price leadership is another theoryof pricing behavior under oligopoly.When a dominant firm in an industryraises or lowers price, other firmsfollow suit. 54
  55. 55. A cartel is a formal agreementamong firms to set prices and outputquotas. The goal is to maximizeprofits, but firms have an incentiveto cheat, which is a constant threatto a cartel. 55
  56. 56. P Why a Cartel Member Has an Incentive to Cheat$40 Price & Cost per unit$35 MC LRAC$30 MR2$25$20 MR1$15$10 $5 1 2 3 4 5 6 7 8 9 Q 56
  57. 57. Comparing oligopoly withperfect competition, we find that theoligopolist allocates resourcesinefficiently, charges a higher price,and restricts output so that pricemay exceed average cost. 57
  58. 58. Chapter 10 Quiz ©2000 South-Western College Publishing 58
  59. 59. 1. An industry with many small sellers, a differentiated product, and easy entry would best be described as which of the following? a. Oligopoly. b. Monopolistic competition. c. Perfect competition. d. Monopoly.B. An oligopoly has only a few sellers. A monopoly only has one, and perfect competition has homogeneous products. 59
  60. 60. 2. Which of the following industries is the best example of monopolistic competition? a. Wheat. b. Restaurant. c. Automobile. d. Water service.B. Wheat would be in a perfectly competitive market. Automobiles would be an oligopoly. And the water service is an example of a regulated monopoly. 60
  61. 61. 3. Which of the following is not a characteristic of monopolistic competition? a. A large number of small firms. b. A differentiated product. c. Easy market entry. d. A homogeneous product. D. A characteristic of monopolistic competition is differentiated products. 61
  62. 62. 4. A monopolistically competitive firm willa. maximize profits by producing where MR = MC.b. probably not earn an economic profit in the long run.c. shut down if price is less than average variable cost.d. do all of the above. D. Both a monopolistically competitive firm and a perfectly competitive firm share these characteristics. 62
  63. 63. 5. The theory of monopolistic competition predicts that in long-run equilibrium a monopolistically competitive firm will a. produce the output level at which price equals long-run marginal cost. b. operate at minimum long-run average cost. c. overutilize its insufficient capacity. d. produce the output level at which price equals long-run average cost. D 63
  64. 64. P Monopolistic Competition$40$35 Minimum MC$30 LRAC$25$20 ATC$15$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 64
  65. 65. 6. A monopolistically competitive firm is inefficient because the firm a. earns positive economic profit in the long run. b. is producing at an output where marginal cost equals price. c. in not maximizing its profit. d. produces an output where average total cost is not minimum. D. 65
  66. 66. P Monopolistic Competition$40$35 Minimum MC$30 LRAC$25$20 ATC$15$10 AVC $5 MR D 1 2 3 4 5 6 7 8 9 Q 66
  67. 67. 7. A monopolistically competitive firm in the long run earns the same economic profit as a a. perfectly competitive firm. b. monopolist. c. cartel. d. none of the above. A. In the long-run, a normal profit is made because of the ease of entry and exit. Once economic profits are made, more firms will enter the industry, driving price down. When losses are made, firms leave the industry, driving price up, restoring profits. 67
  68. 68. 8. One possible effect of advertising on a firm’s long-run average cost curve is to a. raise the curve. b. lower the curve. c. shift the curve rightward. d. shift the curve leftward. A. The ATC curve is raised because of the added expense of the advertising. 68
  69. 69. 9. Monopolistic competition is an inefficient market structure because a. firms earn zero profit in the long-run. b. marginal cost is less than price in the long- run. c. a wider variety of products is available compared to perfect competition. d. all of the above. B. In the long-run, marginal cost is less than price because of the downward sloping demand curve and a marginal revenue curve that is more steeply sloped beneath the demand curve. 69
  70. 70. 10. The “Big Three” U.S. automobile industry is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly.D. An oligopoly is a market form with only a few sellers. 70
  71. 71. 11. The cigarette industry in the United States is described as a (an) a. monopoly. b. perfect competition. c. monopolistic competition. d. oligopoly.D. The cigarette industry has only a few sellers. 71
  72. 72. 12. A characteristic of an oligopoly is a. mutual interdependence in pricing decisions. b. easy market entry. c. both (a) and (b). d. neither (a) nor (b).A. The distinguishing feature of an oligopoly is mutual interdependence. No one firm will make a decision without first considering the reaction of its competitors to its policy change. 72
  73. 73. 13. The kinked demand curve theory attempts to explain why an oligopolistic firm a. has relatively large advertising expenditures. b. fails to invest in research and development (R and D). c. infrequently changes its price. d. engages in excessive brand proliferation.C. Everything else being equal, if firm A raises its price, other firms will not raise theirs, and A will experience a big decline in sales. If A lowers its price, other firms will follow suit and A will not gain many sales. 73
  74. 74. 14. According to the kinked demand theory, when one firm raises its price, other firms will a. also raise their price. b. refuse to follow. c. increase their advertising expenditures. d. exit the industry.B. They will refuse to follow firm A because they can gain more by charging a lower price, their sales will increase because fewer people will buy from firm A. 74
  75. 75. 15. Which of the following is evidence that OPEC is a cartel? a. Agreement on price and output quotas by oil ministries. b. Ability to raise prices regardless of demand. c. Mutual interdependence in pricing and output decisions. d. Ability to completely control entry.A. A cartel is characterized by collusion, the coming together and agreeing to certain policies, for example, the level of prices. 75
  76. 76. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 76
  77. 77. END 77

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