Chapter 13 Lecture and Book notes
Chapter 13 Lecture and Book notes ECON 1010
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This 7 page Class Notes was uploaded by Danyn Notetaker on Monday April 25, 2016. The Class Notes belongs to ECON 1010 at Tulane University taught by Armine Shahoyan in Summer 2015. Since its upload, it has received 10 views. For similar materials see Microeconomics in Economcs at Tulane University.
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Date Created: 04/25/16
Monopolistic Competition: Characteristics and Occurrences - Monopolistic Competition refers to a market situation in which a relatively large number of sellers offer similar products • Each ﬁrm has a small % of the total market • Collusion is nearly impossible with so many ﬁrms Firms act independently; the actions of one ﬁrm is ignored by other ﬁrms in the industry - • Product differentiation and other types of non-price competition give the individual ﬁrm some degree of monopoly that the purely competitive ﬁrm does not possess • Product differentiation may be physical • Services and conditions accompanying the scale of production are important aspects of product differentiation • Location is another type of differentiation • Brand names and packaging lead to perceived differences • Product differentiation allows produces to have some control over the prices of their products - Similar to pure competition, under monopolistic competition ﬁrms can enter and exit these industries relatively easy - Firms often heavily advertise their goods to communicate product difference, and non-price completion is signiﬁcant - Monopolistically competitively industries • Concentration rialtos are one way to measure market dominance - Some markets are local rather than national, and dew ﬁrms may dominate within the regional market - If the 4-ﬁrm-concentration ratio is less than 40%, its likely to be monopolistically competitive The Herﬁndahl index is another way to measure market dominance • Price and Output in Monopolistic Competition - The ﬁrms demand curve is highly, but not perfectly, elastic. It is more elastic that the monopoly’s demand curve because the seller has many rivals producing close substitutes. It is less elastic than pure competition because the seller’s product is differentiated from its rivals, so the ﬁrm has control over price - In the SR situation, the ﬁrm will maximize proﬁts or minimize losses by producing where MC=MR, as was true in pure competition • Firms can enter the industry easily and will if the existing ﬁrms are making an economic proﬁt - As ﬁrms enter, this decreases the demand curve facing an individual ﬁrm as buyers shift until the ﬁrm breaks even - If the demand shifts below the breakeven point, some ﬁrms will leave in the LR • If ﬁrms were making a loss in the SR, some ﬁrms will leave - This raises demand curve facing the remaining ﬁrm as there are fewer substitutes for buyers, losses will diminish until breakeven point is reached • Complicating factors are involved with this analysis - Some ﬁrms may achieve a measure of differentiation that is not easily duplicated bu rivals and can realize an economic proﬁt in the LR - There is some restriction to entry, such as ﬁnical barriers that exist for small businesses, so economic proﬁt in the LR is a reasonable reﬂection of the real world Monopolistic Competition and Economic Efﬁciency - Review the deﬁnitions of allocative and proactive efﬁciency • Allocative efﬁciency occurs when price=MC, where the right amount of resources are allocated to the product • Productive efﬁciency occurs where price=minimum ATC, where production occurs using the least-cost combination of resources - Productive and allocative efﬁciency are not achieved • P3 is higher than the min ATC (A4) at an output of Q3, implying that productive efﬁciency is not achieved P3 is greater than the MC at Q3, failing to achieve allocative efﬁciency • - Allocative efﬁciency output is at point where C where demand intersect the MC curve - Producing output at Q3 creates deadweight loss equivalent to ACD - Excess capacity will tend to be a feature of monopolistically competitive ﬁrms • If each ﬁrm could proﬁtably produce at B (min ATC) there would be a lower price • Fewer ﬁrms would be required to produce total output Product Variety - A monopolistically competitive producer may be able to postpone the LR outcome of just normal proﬁts through product development, improvement, and advertising - Compared to pure competition, this suggests possible advantage to the consumer • Developing/improving a precept can provide the consumer with diversity of choices Product differentiation is at the heart of the tradeoff between consumer choice and • productive efﬁciency - The greater number of choices, the greater the excess product problem - AC may be higher than under pure competition, due to advertising and other costs - Monopolistically competitive ﬁrm juggles three factors — product attributes, product price, and advertising — in seeking proﬁt maximization • The is complex situation is not easily expressed - Each possible combination of price, product, and advertising poses a different demand and cost situation for the ﬁrm • In practice, the optimal combination cannot be readily forecast but must be found by trial and error Oligopoly: Characteristics and Occurrence - Oligopoly exists where a few large ﬁrms producing a homogeneous/differentiated product dominate a market • There are few enough ﬁrms in the industry that ﬁrms are mutually independent each must consider its rivals reactions in response to its decision about prices, outputs, and advertising • Some Oligopolistic industries produce standardized products, where as others produce differentiated products - Barriers to entry: Economies of scale may exist due to technology and market share • • Capital investment requirement may be very large • Others may exist, such patents, control of raw resources, preemptive and retialory pricing, and brand loyalty • Although some ﬁrms have become dominate as a result of internal growth, others have gained this dominance through mergers - Measuring industry concentration: • Concentration ratios are one way to measure market dominance. If greater than 40% then it is an oligopoly - Some markets are local rather than national, and a few ﬁrms may dominate within the regional market - Inter-industry competition sometimes exists so dominance in one industry may not mean that competition from substitute is lacking - World trade has increased competition, despite high domestic concentration ratios in some industries - Concentration rations fail to measure accurately the distribution of power among the leading ﬁrms • The Herﬁnadl index is another way to measure market dominance - Measures the sum of the squared market shares of each ﬁrm in the industry, so that much larger weight is given to ﬁrms with high market shares High index indicates a high degree of concentration in one or two ﬁrms, low number • means that top 4 ﬁrms have equal shares Oligopoly Behavior: A Game Theory Overview - Oligopoly behavior is similar to a game of strategy, like poker, chess, or bridge - Mutual interdependence is demonstrated by the following • 2 competitors • 2 price strategies • Each strategy has a payoff matrix Greatest combined proﬁt (numbers in boxes) • Independent actions • • stimulate a response • RareAir’s best strategy is to have a low price strategy if Uptown follows a high price strategy • Independently lowered prices in expectation of greater proﬁt leads to worst combined outcome • Eventually low outcomes make ﬁrms return to higher prices • Proﬁt each company earns will depend on the strategy it chooses and of rival • Blue is RareAir Yellow Uptown Cells A,B,C,D are 4 possible combinations of the ﬁnal proﬁts • • with lower price quantity sold will be up so will proﬁt • second company has no choice but to match price of rival so both are coming to Cell D • To move move up in proﬁt companies but collude and set common price - Another conclusion is that oligopoly can lead to collusive behavior - If collusion does exist, there is much incentive on both parties to cheat/secretly break the agreement • Prisoners dilema Three Oligopoly Models are used to Explain Price Outbreaks - A kinked-demand model assumes a non-collusive oligopoly The individual forms believe that rivals will match any prices • • Say there are 3 oligopoly companies (graph only shows one company, but shows inﬂuence) and we are considering A. A sells Q0 at P0 and somehow its the best price. • Situation #1: Suppose Rivals B+C are watching price change for company A, in this case Company A demand is D1 and the MR curve is MR1 both curves are when company A cuts price two rivals will also cut prices too to prevent company a from gaining advantage over them. The result is company A will gain no sales from B+C • Situation #2: Company B+C are ignoring price change by Company A, in this case Company A’s demand curve is D2 and MR curve is MR2. Demand in situation #2 is more elastic than in situation 1 than 2 because if company A lowers its prices and rivals do not they will gain sales signiﬁcantly at the expense of their rivals. • In case if Company A will increase price and rivals will not change their own prices then company A will lose sales to B+C • Conclusion: Company A demand curve is more elastic when rivals ignore price change and less elastic when rivals match price change. Oligopolies always will match price change when it decreases but not when it increases. The demand curve for A will be dark green lines D2=D1 - Each ﬁrm views its demand as inelastic for price cuts, which means they will not want to lower prices since TR falls when demand is inelastic and prices are lowered - With regard to raising prices, there is no reason to believe that rivals will follow suit because they may increase their market shares by not raising prices - This analysis is one explanation of the fact that prices tend inﬂexible on oligopolistic industries - There are criticism of the kinder demand theory • There is no explanation to why P0 is the original price • In the real world oligopoly prices are often not rigid - Cartels and collusion agreements constitute another oligopoly model • Game theory suggests that collusion is beneﬁcial to the participant Collusion reduces uncertainty, increases proﬁts, may prohibit new entry • • A cartel may reduce the chance of a price war breaking outpouring general business recession - In the result of collusion several oligopolies are operating as one monopoly that is why this showers the proﬁt max of one monopoly - In result of collusion several oligopolies are operating as a monopoly, that is why this shows the proﬁt maximization of one monopoly • Kinked demand curve’s tendency prices may adversely affect proﬁts if general inﬂationary pressures increase costs • Mot maximize proﬁt, the ﬁrms collude and anew to a certain price • Cartels are illegal in the U.S., any collusion that exists is covert and secret • ‘Gentlemen's agreements,’ often made informally, are also illegal There are many obstacles to collusion • - Differing demand and cost conditions among ﬁrms - A large number of ﬁrms - Attraction of new potential entry of new ﬁrms - Incentive to cheat - Recession and declining demand - Antitrust lass that prohibit collusion - Price leadership is a type of gentlemen’s agreement that allows oligopolists to coordinate their prices legally; no formal arrangement or meeting • Several price leadership tactics are practice by the leading ﬁrm - Prices are changed only when cost and demand conditions have been altered signiﬁcantly and industry wide - Impending price adjustments are often communicated through publications, speeches, and so forth - New price may be below proﬁt-maximum level to discourage new entry • Price leadership in oligopoly occasionally breaks down and results in price war Oligopoly and Advertising - Product development and advertisement campaigns are more difﬁcult to combat and match than lower prices - Oligopolists have substantial ﬁnancial resources with which to support advertising and product development - Advertising can affect price, competition, and efﬁciency both positively and negatively • Advertisements reduces a buyers search time and minimizes the costs • Providing information competing goods, and diminishes monopoly power, resulting in greater economic efﬁciency • By facilitating the introduction of new products, advertising speeds up technological progress • If advertising is successful in boosting demand increased output may reduce LR TC, enabling ﬁrms to enjoy economies of scale • Not always positive - Much of advertising is designed to be manipulative rather than inform buyers - When advertising either leads to increased monopoly power, or is self-canceling, resulting in economic efﬁciency Economic Efﬁciency of Oligopoly is Hard to Evaluate - Allocative and productive efﬁciency are not realized because price will exceed MC and output will be less than minimum ATC output level - Economic efﬁciency may be lessened because • Foreign competition has made many oligopolistic industries may foster more rapid product development and greater improvement of production techniques than would be possible if they were completely competitive
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