Monopoly and-Oligopoly

8/7/2019 Monopoly and-Oligopoly

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Monopolistic Competition &

OligopolyBetween Perfect Competition &

Monopoly


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What is Monopolistic Competition?

A market structure in which many firmssell products that are similar but notidentical.

Firms have some degree of market powerbut not monopoly power.


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Monopolistic Competition- Characteristics

Many sellers and buyers

Differentiated product

Free entry and exit for firms

Limited monopoly power Downward-sloping demand curve

Increase in market share by competitorscauses decrease in demand for the firmsproduct

Eg. Restaurants, soaps, toothpastes, books,biscuits


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Monopolistic Competition

Short-Run EquilibriumEquilibrium occurs where

MR=MC

Shaded area is the profitearned


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Monopolistic Competition

Long-Run Equilibrium

Profit = 0


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Monopolistic Competition Vs Perfect

Competition

I EXCESS CAPACITY

Long-run Equilibrium quantityminimises average total cost inperfect competition. Firm operates atefficient scale

Long-run Equilibrium quantity at lessthan minimum average total cost inmonopolistic competition. Firmoperates at less than efficient scale.

Firm restricts production to keepprices relatively higher, has excesscapacity


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Monopolistic Competition Vs Perfect

Competition

II RELATIONSHIP BETWEEN PRICE AND MARGINAL COST For a firm in perfect competition price equals marginal cost,

for a monopolistically competitive firm price exceeds marginalcost

This is because firm has some market power due to adifferentiated product


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Externalities created byMonopolistic Competition

Entry of a new firm in a monopolistic market hastwo externalities associated:

The product-variety externality: Consumers get

positive externality through the introduction ofa new product in terms of a wider choice.

The business-stealing externality:

Existing firms may face a negative externalityasthey can lose market power and profits from theentry of a new competitor


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The Advertising Debate

Critique of advertising- Manipulates peoples tastes

- Psychological not informational

- Tries to convince consumers that productsare more different than they truly are

Defence of advertising

- Advertising provides information tocustomers

- Fosters competition

- Advertising as a signal of quality


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What is Oligopoly?

A market structure with few sellers offeringa similar/identical or somewhatdifferentiated product.


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Oligopoly

Few sellers and many buyers

Product may be homogeneous ordifferentiated

Barriers to entry

Eg. Crude oil, petrol, steel


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Characteristics of Oligopoly

The key feature of an oligopoly is that firms act

strategically.

Firms in an oligopoly are interdependent. Theactions of one firm affect the profits of the other

firms. There is tension between co-operation and self-

interest

Oligopolists are best-off operating like amonopolist, offering a small quantity andcharging a price that is higher than marginal cost


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Characteristics of Oligopoly

Each oligopolist cares about own profit, there

are powerful incentives that hinder the group offirms from maintaining the monopoly outcome

Each oligopolist is tempted to increaseproduction and capture larger market share


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Game Theory

Game theory provides an analytical guideor tool for making decisions in strategicsituations involving interdependence

By strategic we mean a situation inwhich each person when deciding whatactions to take must consider how others

might respond to that action


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Nash Equilibrium

A Nash equilibrium, named after JohnNash, Nobel prize winner and star of themovie A Beautiful Mind, is the equilibrium

that is the dominant (or best) strategy foreach player in the game, given the actionstaken by any other player.


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What is A Dominant Strategy?

A strategy that is best for a player in agame regardless of the strategies chosenby the other player.


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Nash Equilibrium

Occurs when each player's strategy isoptimal, given the strategies of the otherplayers.

A player's best response (or best strategy) isthe strategy that maximizes that player'spayoff or benefit, given the strategies of other

players.A Nash equilibrium is a situation in which

each player makes his or her best response.


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Prisoner's Dilemma

Famous example of game theory.

Strategies must be undertaken without thefull knowledge of what other players will do.

Players adopt dominant strategies, but theydon't necessarily lead to the best outcome.


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Prisoners Dilemma


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Bonnies Decision Tree

Dominant Strategy for Bonnie is to confess whatever Clyde does

Similarly dominant strategy for Clyde would also be to confess

Rational decision-makers should always take the action

associated with a dominant strategy


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Getting into Clydes Head

If Bonnie does not confess (bless herheart), Clyde receives a lighter sentenceby confessing (sorry Bonnie, I promise Illvisit you often)

If Bonnie confesses (Bonnie never reallyloved me), Clyde still receives a lightersentence by confessing (sorry bonnie,what did you expect me to do?)

No matter what Bonnie does Clyde gets alighter sentence by confessing


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The Prisoner's dilemma has one Nash equilibrium:

when both players confess. However, "bothconfess" is inferior to "both co-operate", in thesense that the total jail time served by the twoprisoners is greater if both confess. The strategy"both cooperate" is unstable, as a player coulddo better by confessing while their opponent stillcooperates. Thus, "both cooperate" is not an

equilibrium. "sometimes rational decisions aren'tsensible!"


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Example 1: Price CompetitionBetween Firms

Two identical firms competing in prices.

If both set high prices they share the market andthe price is high, so both make large profits.

But given that the other firm prices high, eitherfirm can make an even larger profit by pricinglow (undercutting) and capturing the wholemarket.

Both firms have a dominant strategy of pricinglow, and the Nash Equilibrium is for both to pricelow and both make low profits.


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Example 2: Flat Cleaning

Two flatmates share a flat and neither likescleaning.

Both prefer the outcome where both put effort

into cleaning to the outcome where no one doescleaning, but each prefers that the other did thecleaning while she herself did not.

Not cleaning is a dominant strategy for both andthe worst outcome arises: no one does anycleaning.


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The Point of the PrisonersDilemma Game

The players could achieve a goodoutcome for both if they cooperated.

But, if each acts in their own self-interestthen the worst outcome is the Nashequilibrium.


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Economic Applications of GameTheory

Cheating on a cartel

Trade wars between countries

Advertising Games without dominant strategies


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Collusions and Cartels

Collusion: An agreement among firms in amarket about quantities to produce orprices to charge

Cartel: A group of firms acting in unison

Eg. The OPEC oil cartel


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Cheating on a Cartel

Cartel members' possible strategies rangefrom abiding by their agreement tocheating.

Cartel members can charge the monopolyprice or a lower price.

Cheating firms can increase profits.

The best strategy is charging the low price.


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Cheating on a Cartel

PepsiCo

Cheat on Cartel

(Charge Low Price)

Dont Cheat

(Charge Monopoly Price)

Coca

Cola

Cheat onCartel

$3 million eachCoke earns $8 millionPepsi earns $2 million

Dont CheatCoke earns $2 millionPepsi earns $8 million

$6 million each


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Trade Wars Between Countries

Free trade benefits both trading countries.

Tariffs can benefit one trading country.

Imposing tariffs can be a dominant strategyand establish a Nash equilibrium eventhough it may be inefficient.


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Trade War Payoffs

Japan

Tariff No Tariff

UnitedTariff $5 each

$9 for U.S.$4 for Japan

StatesNo Tariff

$4 for U.S.$9 for Japan $8 each


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Decision Tree for the UnitedStates


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The Kinked Demand Curve- PriceRigidity in Oligopoly

The kinked demand curve is anoligopoly model of that assumes

the worst about how other firmswill respond to price changes.


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The Kinked Demand Curve

Increase price: the other firms

will not change their prices andquantity will decrease by a largeamount (elastic)

After the initial price of $6, the firmhas two options:

Decrease price: the other firms

will decrease their prices, soquantity will increase only by asmall amount (inelastic)


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Monopoly and-Oligopoly