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Economics 2005 Chapter 10 Notes

by: Tim Reynolds

Economics 2005 Chapter 10 Notes ECON 2005

Tim Reynolds
Virginia Tech

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These notes for chapter 10 will be covered on Exam 3.
Principles of Economics
Steve Trost
Class Notes
monopolies, perfect competition, Economics, firms
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This 4 page Class Notes was uploaded by Tim Reynolds on Friday April 1, 2016. The Class Notes belongs to ECON 2005 at Virginia Polytechnic Institute and State University taught by Steve Trost in Spring 2016. Since its upload, it has received 25 views. For similar materials see Principles of Economics in Economcs at Virginia Polytechnic Institute and State University.

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Date Created: 04/01/16
Econ 2005 Chapter 10 Monopolistic Competition and Oligopoly Monopolistic competition and Oligopoly  Monopoly and perfect competition are two extreme models. We don’t see either very much in the real world.  Gives firms a little bit more control over their prices.  Oligopolies are the few large dominate firms (i.e. - automobiles, aluminum). Monopolistic Competition  Monopolistic competition: A common form of industry structure in the US, characterized by a large number of firms, none of which can influence market price by virtue of size alone.  While pure monopoly and perfect competition are rare, monopolistic competition is a very common form of organization for firms in the US. Monopolistic competition vs. Monopolies 1. Firms can’t influence market price by the virtue of size. 2. Good substitutes exist. 3. Unlimited entry and exit for firms. Econ 2005 Chapter 10 Cont’d/Exam 2 in-class review 3 features distinguish monopolistic comp from monopoly and oligopoly: 1. Firms cannot influence market rice by virtue of size. 2. Good substitutes exist. 3. There is unrestricted entry and exit. Monopolistic competition  Product differentiation: A strategy that firms use to achieve market power. Types of product differentiation: o Physical differences  Appearance, quality o Location  Spatial differentiation o Product image  Promotion, advertising, marketing, packaging o Service  Note: Whether differences actually exist is irrelevant, what is important is that consumers think differences exist. Case against Product differentiation - Critics of product differentiation and advertising argue that PD causes waste and inefficiency. Oligopoly - Oligopoly: A form of industry structure characterized by a few dominant and interdependent firms. Econ 2005 Chapter 10 Contd 2 Oligopoly Models- Because many different types of oligopolies exist, a number of different oligopoly models have been developed. - Collusion: The act of working with other producers in an effort to limit competition and increase joint profits. - Cartel: A group of firms that gets together and makes the joint price and output decisions to maximize joint profits. *The colluding oligopoly will face market demand and produce only up to the point at which the marginal revenue and marginal cost are equal. For collusion to work, all firms must restrict their quantity. Collusion - Because market output is restricted, each firm’s output must be restricted as well. The cartel, therefore, sets production quotas for each individual firm Why isn’t every industry a cartel? 1. Different costs and products make it hard to figure out how much each firm should produce – this makes is hard to distribute the profits evenly and make some firms mad (so that they drop out). 2. For a cartel to be successful, entry into the industry must be blocked – this is not always possible. 3. Cartels are inherently unstable because of cheaters and free riders. The instability is something that occurs with each and every cartel. The more firms in a cartel, the more unstable it is. *It is important to note that cartels are also illegal. The Price-Leadership model of oligopoly - Price leadership: A form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy. - The price-leadership: model assumes that the industry is made up of one dominant firm and a number of smaller competitive firms. Cournot model: - A model of a two-firm industry in which a series of output adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly. Bertrand Competition - Another model of oligopoly that has firms choosing prices. The two firms keep underbidding each other in an attempt to steal market share. This competition results in P=MC=AC (the PC price) as the firms push prices lower and lower. This model assumes homogenous products and ample capacity to produce the PC quantity. *You will not be tested on these models in detail, but you should understand the gist of them to understand how firms compete. Oligopoly - Perfectly contestable market: A market in which entry and exit are costless. - In contestable markets, even large oligopolistic firms end up behaving like perfectly competitive firms. Prices are pushed to long-run average cost by competition, and positive profits do not persist.


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