MANAGERIAL MANAGERIAL ECONOMICS 11ECONOMICS 11thth Edition Edition

ByBy

Mark HirscheyMark Hirschey

Monopolistic Competition Monopolistic Competition and Oligopolyand Oligopoly

Chapter 13Chapter 13

Chapter 13Chapter 13OVERVIEWOVERVIEW

Contrast Between Monopolistic Competition and Oligopoly

Monopolistic Competition Monopolistic Competition Process Oligopoly Cartels and Collusion Oligopoly Output-Setting Models Oligopoly Price-Setting Models Market Structure Measurement Census Measures of Market Concentration

Chapter 13Chapter 13KEY CONCEPTSKEY CONCEPTS

monopolistic competition oligopoly high-price/low-output

equilibrium low-price/high-output

equilibrium cartel collusion Cournot model output-reaction curve Stackelberg model first-mover advantage price signaling price leadership

barometric price leadership

Bertrand model price-reaction curve contestable markets

theory Sweezy model kinked demand curve oligopoly theory economic census North American Industry

Classification System (NAICS)

concentration ratios Herfindahl-Hirschmann

Index (HHI)

Contrast Between Monopolistic Competition and Oligopoly

Monopolistic Competition Large number of sellers that offer differentiated

products. Normal profit opportunity in long-run equilibrium.

Oligopoly Few sellers. Economic profits are possible in long-run

equilibrium. Dynamic Nature of Competition

Timely market structure information is required for managerial investment decisions

Monopolistic Competition

Monopolistic Competition Characteristics

Many buyers and sellers. Product heterogeneity. Free entry and exit. Perfect information. Opportunity for normal profits in

long-run equilibrium.

Monopolistic Competition Price/Output Decisions

Set Mπ = MR - MC = 0 to maximize profits.

MR=MC at optimal output. No durable economic profits because

P=AR=AC.

Monopolistic Competition Process

Short-run Monopoly Equilibrium Monopolistically competitive firms take full

advantage of short-run monopoly. Long-run High-price/Low-output Equilibrium

With differentiated products, P=AC at a point above minimum LRAC.

P > MR = MC. Long-run Low-price/High-output Equilibrium

With homogenous products, P=AC at minimum LRAC.

This is a competitive market equilibrium with homogeneous production.

Oligopoly Oligopoly Market Characteristics

Few sellers. Homogenous or unique products. Blockaded entry and exit. Imperfect dissemination of information. Opportunity for above-normal (economic) profits in

long-run equilibrium. Examples of Oligopoly

National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc.

Local retail markets for gasoline, food, specialized services, etc.

Cartels and Collusion

Overt and Covert Agreements Cartels operate under formal agreements.

Powerful cartels function as a monopoly. Collusion exists when firms reach secret,

covert agreements. Enforcement Problem

Cartels are typically rather short-lived because coordination problems often lead to cheating.

Cartel subversion can be extremely profitable. Detecting the source of secret price

concessions can be extremely difficult.

Oligopoly Output-Setting Models

Cournot Oligopoly Cournot equilibrium output is found

by simultaneously solving output-reaction curves for both competitors.

Cournot equilibrium output exceeds monopoly output but is less than competitive output.

Stackelberg Oligopoly

Stackelberg model posits a first-mover advantage.

Price wars severely undermine profitability for both leading and following firms.

Price signaling can reduce uncertainty in oligopoly markets.

Price leadership occurs when firms follow the industry leader’s pricing policy.

Oligopoly Price-Setting Models

Bertrand Oligopoly: Identical Products The Bertrand model focuses upon the price

reactions. The Bertrand model predicts a competitive

market price/output solution in oligopoly markets with identical products.

Bertrand Oligopoly: Differentiated Products The Bertrand model demonstrates how price-

setting oligopolists profit with differentiated products.

Sweezy Oligopoly

Sweezy model predicts “sticky” prices. Sweezy model explains why prices in

oligopoly markets sometimes fail to respond to marginal cost change.

Oligopoly Model Comparison

Cournot model does not incorporate output reactions.

Bertrand model does not incorporate price reactions.

Stackelberg model explains first-mover advantages, but does not explain countermoves.

Sweezy model is incomplete. Modeling behavior in oligopoly markets is

difficult.

Market Structure Measurement

Economic Markets An economic market consists of all individuals and

firms willing and able to buy or sell. When cross-price elasticities are large and

positive, goods are competing products. Economic Census

The economic census provides a comprehensive statistical profile of the economy.

Industry statistics are classified using the North American Industry Classification System (NAICS).

Census Measures of Market Concentration

Concentration Ratios Group market share data are called concentration ratios. CRi = ∑ Xi, where Xi is market share of the ith leading firm.

CRi = 100 for monopoly. CRi ≈ 0 for a perfectly competitive industry.

Herfindahl-Hirschmann Index Calculated in percentage terms, the HHI is the sum of

squared market shares for all competitors. HHI = ∑ Xi

2, where Xi2 is squared market share of the ith

firm. HHI = 10,000 for monopoly. HHI ≈ 0 for a perfectly competitive industry.

Limitations of Census Information Slow reports hinder usefulness. National statistics obscure local markets.