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monopolostic competition and oligopoly

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• Product differentiation—the heart of the space between monopoly and competition An old “ice cream on the beach” analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B . Tell the students that the line represents a beach (a long beach) along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get the most customers because the cost of an ice cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation—technically, there is minimum differentiation . Now suppose a third and fourth ice-cream vendor come along. Where to they locate? At the ends of the beach at A and B . They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
• The demand for a firm’s differentiated product in monopolistic competition Remind the students about the ceteris paribus condition that defines a demand curve. Along the demand curve for Nike tennis shoes, the prices of Adidas, Fila, Head, K Swiss, Prince, Reebok, and Wilson tennis shoes are constant. Some people prefer Nike to the other brands and will pay a bit more for Nike. Other people prefer some other brand and will buy Nike only if its price is low enough. Buyers have brand preferences, but they will switch brands if price differences are large enough. So the higher the price of a Nike shoe, the prices of the other brands remaining the same, the smaller is the quantity of Nike shoes demanded.
• Understanding real world markets. Students have no difficulty seeing oligopoly in the world around them. Again, emphasize that the work they’ve just done understanding the models of perfect competition and monopoly are not wasted because the real-world situation of oligopoly can be better understood by building on some of the features of competition and monopoly. Again, some of what they learned in each of the two previous chapters survives and operates in oligopoly. Traditional oligopoly models. Many instructors today want to skip the traditional models of oligopoly. Others want to teach only these models and skip the game theory approach. Your choice! This chapter is written in self-contained sections so that you can skip either approach.
• ### Economics slides

1. 1. Imperfect competition All the assumptions of perfect competition are not met Increase in market power Perfect Monopolistic Oligopoly Purecompetition competition monopoly Many small Firms with Few but One firm and similar brands powerful firms firms 1
2. 2. Monopoly and How It Arises– A monopoly is a market: That produces a good or service for which no close substitute exists In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. 2
3. 3. What Is Monopolistic Competition?– Monopolistic competition is a market structure in which A large number of firms compete. Each firm produces a differentiated product. Firms compete on product quality, price, and marketing. Firms are free to enter and exit the industry. 3
4. 4. Monopolistic CompetitionLarge Number of Firms–The presence of a large number of firms in the market implies: Each firm has only a small market share and therefore has limited marketpower to influence the price of its product Each firm is sensitive to the average market price, but no firm pays attentionto the actions of others. So no one firm’s actions directly affect the actions ofothers. Collusion, or conspiring to fix prices, is impossible. 4
5. 5. What Is Monopolistic Competition?Product Differentiation – A firm in monopolistic competition practices product differentiation if the firm makes a product that is slightly different from the products of competing firms. 5
6. 6. What Is Monopolistic Competition?Competing on Quality, Price, and Marketing – Product differentiation enables firms to compete in three areas: quality, price, and marketing.  Quality includes design, reliability, and service.  Because firms produce differentiated products, the demand for each firm’s product is downward sloping. But there is a tradeoff between price and quality.  Because products are differentiated, a firm must market its product.  Marketing takes the two main forms: advertising and packaging. 6
7. 7. Monopolistic CompetitionEntry and Exit – There are no barriers to entry in monopolistic competition, so firms cannot make an economic profit in the long run.Examples of Monopolistic Competition – Producers of audio and video equipment, clothing, jewelry, computers, and sporting goods operate in monopolistic competition. 7
8. 8. Price and Output in Monopolistic CompetitionThe Firm’s Short-Run Output and Price Decision – A firm that has decided the quality of its product and its marketing program produces the profit-maximizing quantity at which its marginal revenue equals its marginal cost (MR = MC). – Price is determined from the demand curve for the firm’s product and is the highest price that the firm can charge for the profit- maximizing quantity. – Figure 12.1 shows a firm’s economic profit in the short run. 8
9. 9. Price and Output in Monopolistic Competition– The firm in monopolistic competition operates like a single-price monopoly.– The firm produces the quantity at which MR equals MC and sells that quantity for the highest possible price.– It earns an economic profit (as in this example) when P > ATC. 9
10. 10. Price and Output in Monopolistic CompetitionProfit Maximizing or Loss Minimizing – A firm might incur an economic loss in the short run. – Here is an example. – At the profit-maximizing quantity, If P < ATC and the firm incurs an economic loss. 10
11. 11. Price and Output in Monopolistic CompetitionMonopolistic Competition and Perfect Competition – Two key differences between monopolistic competition and perfect competition are:  Excess capacity  Markup – A firm has excess capacity if it produces less than the quantity at which ATC is a minimum. – A firm’s markup is the amount by which its price exceeds its marginal cost. 11
12. 12. Price and Output in Monopolistic Competition– Firms in monopolistic competition operate with excess capacity in long-run equilibrium.– Firms produce less than the efficient scale—the quantity at which ATC is a minimum.– The downward-sloping demand curve for their products drives this result. 12
13. 13. Price and Output in Monopolistic CompetitionIs Monopolistic Competition Efficient? – Price equals marginal social benefit. – The firm’s marginal cost equals marginal social cost. – Price exceeds marginal cost, so marginal social benefit exceeds marginal social cost. –So the firm in monopolistic competition in the long run produces less than the efficient quantity. 13
14. 14. Product Development and MarketingInnovation and Product Development – We’ve looked at a firm’s profit-maximizing output decision in the short run and in the long run, for a given product and with given marketing effort. –To keep making an economic profit, a firm in monopolistic competition must be in a state of continuous product development. – New product development allows a firm to gain a competitive edge, if only temporarily, before competitors imitate the innovation. 14
15. 15. Product Development and Marketing– Innovation is costly, but it increases total revenue.– Firms pursue product development until the marginal revenue from innovation equals the marginal cost of innovation.–MR=MC innovation 15
16. 16. Product Development and MarketingBrand Names – Why do firms spend millions of dollars to establish a brand name or image? – Again, the answer is to provide information about quality and consistency. – You’re more likely to overnight at a Holiday Inn than at Joe’s Motel because Holiday Inn has incurred the cost of establishing a brand name and you know what to expect if you stay there. 16
17. 17. Product Development and MarketingEfficiency of Advertising and Brand Names – To the extent that advertising and selling costs provide consumers with information and services that they value more highly than their cost, these activities are efficient. 17
18. 18. In some markets, there are only a few firms which compete.For example, computer chips are made by Intel and Advanced MicroDevices and each firm must pay close attention to what the other firm isdoing.When a market has only a small number of firms, do they operate in thesocial interest, like firms in perfect competition? Or do they restrict outputto increase profit, like a monopoly?………………………….Room for the oligopoly 18
19. 19. What Is Oligopoly?– Oligopoly is a market structure in which Natural or legal barriers prevent the entry of new firms. A small number of firms compete. 19
20. 20. What Is Oligopoly?– In part (b), there is a natural oligopoly market with three firms.– A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms. 20
21. 21. What Is Oligopoly?Small Number of Firms – Because an oligopoly market has a small number of firms, the firms are interdependent and face a temptation to cooperate. – Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions. – Cartel: A cartel and is an illegal group of firms acting together to limit output, raise price, and increase profit. – Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break down. – Think OPEC. 21