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Chapter 13 Lecture and Book notes

by: Danyn Notetaker

Chapter 13 Lecture and Book notes ECON 1010

Marketplace > Tulane University > Economcs > ECON 1010 > Chapter 13 Lecture and Book notes
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Lecture material and material from the book
Armine Shahoyan
Class Notes
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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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