1. Imperfect competition
All the assumptions of perfect competition are not met
Increase in market power
Perfect Monopolistic Oligopoly Pure
competition competition monopoly
Many small Firms with Few but One firm
and similar brands powerful firms
firms 1
2. Monopoly and How It Arises
– A monopoly is a market:
That produces a good or service for which no close
substitute exists
In which there is one supplier that is protected from
competition by a barrier preventing the entry of new
firms.
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3. What Is Monopolistic Competition?
– Monopolistic competition is a market structure in which
A large number of firms compete.
Each firm produces a differentiated product.
Firms compete on product quality, price, and marketing.
Firms are free to enter and exit the industry.
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4. Monopolistic Competition
Large Number of Firms
–The presence of a large number of firms in the market implies:
Each firm has only a small market share and therefore has limited market
power to influence the price of its product
Each firm is sensitive to the average market price, but no firm pays attention
to the actions of others. So no one firm’s actions directly affect the actions of
others.
Collusion, or conspiring to fix prices, is impossible.
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5. What Is Monopolistic Competition?
Product Differentiation
– A firm in monopolistic competition practices product
differentiation if the firm makes a product that is slightly different
from the products of competing firms.
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6. What Is Monopolistic Competition?
Competing on Quality, Price, and Marketing
– Product differentiation enables firms to compete in three areas:
quality,
price,
and marketing.
Quality includes design, reliability, and service.
Because firms produce differentiated products, the demand for each
firm’s product is downward sloping.
But there is a tradeoff between price and quality.
Because products are differentiated, a firm must market its product.
Marketing takes the two main forms:
advertising and packaging. 6
7. Monopolistic Competition
Entry and Exit
– There are no barriers to entry in monopolistic competition, so firms cannot
make an economic profit in the long run.
Examples of Monopolistic Competition
– Producers of audio and video equipment, clothing, jewelry, computers, and
sporting goods operate in monopolistic competition.
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8. Price and Output in Monopolistic Competition
The Firm’s Short-Run Output and Price Decision
– A firm that has decided the quality of its product and its marketing
program produces the profit-maximizing quantity at which its
marginal revenue equals its marginal cost (MR = MC).
– Price is determined from the demand curve for the firm’s product
and is the highest price that the firm can charge for the profit-
maximizing quantity.
– Figure 12.1 shows a firm’s economic profit in the short run.
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9. Price and Output in Monopolistic Competition
– The firm in monopolistic
competition operates like
a single-price monopoly.
– The firm produces the quantity
at which MR equals MC and
sells that quantity for the
highest possible price.
– It earns an economic profit (as
in this example) when P > ATC.
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10. Price and Output in Monopolistic Competition
Profit Maximizing or Loss Minimizing
– A firm might incur an economic loss
in the short run.
– Here is an example.
– At the profit-maximizing quantity,
If P < ATC and the firm incurs an
economic loss.
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11. Price and Output in Monopolistic Competition
Monopolistic Competition and Perfect Competition
– Two key differences between monopolistic competition and perfect
competition are:
Excess capacity
Markup
– A firm has excess capacity if it produces less than the quantity at which
ATC is a minimum.
– A firm’s markup is the amount by which its price exceeds its marginal
cost.
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12. Price and Output in Monopolistic Competition
– Firms in monopolistic
competition operate with
excess capacity in long-run
equilibrium.
– Firms produce less than the
efficient scale—the quantity
at which ATC is a minimum.
– The downward-sloping
demand curve for their
products drives this result.
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13. Price and Output in Monopolistic Competition
Is Monopolistic Competition Efficient?
– Price equals marginal social benefit.
– The firm’s marginal cost equals marginal social cost.
– Price exceeds marginal cost, so marginal social benefit exceeds
marginal social cost.
–So the firm in monopolistic competition in the
long run produces less than the efficient
quantity.
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14. Product Development and Marketing
Innovation and Product Development
– We’ve looked at a firm’s profit-maximizing output decision in the
short run and in the long run, for a given product and with given
marketing effort.
–To keep making an economic profit, a firm in
monopolistic competition must be in a state of
continuous product development.
– New product development allows a firm to gain a competitive
edge, if only temporarily, before competitors imitate the
innovation.
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15. Product Development and Marketing
– Innovation is costly, but it increases total revenue.
– Firms pursue product development until the marginal revenue from
innovation equals the marginal cost of innovation.
–MR=MC innovation
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16. Product Development and Marketing
Brand Names
– Why do firms spend millions of dollars to establish a brand name
or image?
– Again, the answer is to provide information about quality and
consistency.
– You’re more likely to overnight at a Holiday Inn than at Joe’s Motel
because Holiday Inn has incurred the cost of establishing a brand
name and you know what to expect if you stay there.
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17. Product Development and Marketing
Efficiency of Advertising and Brand Names
– To the extent that advertising and selling costs provide consumers with
information and services that they value more highly than their cost, these
activities are efficient.
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18. In some markets, there are only a few firms which compete.
For example, computer chips are made by Intel and Advanced Micro
Devices and each firm must pay close attention to what the other firm is
doing.
When a market has only a small number of firms, do they operate in the
social interest, like firms in perfect competition? Or do they restrict output
to increase profit, like a monopoly?
………………………….Room for the oligopoly
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19. What Is Oligopoly?
– Oligopoly is a market structure in which
Natural or legal barriers prevent the entry of new
firms.
A small number of firms compete.
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20. What Is Oligopoly?
– In part (b), there is a
natural oligopoly market
with three firms.
– A legal oligopoly might
arise even where the
demand and costs leave
room for a larger number
of firms.
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21. What Is Oligopoly?
Small Number of Firms
– Because an oligopoly market has a small number of firms, the firms are
interdependent and face a temptation to cooperate.
– Interdependence: With a small number of firms, each firm’s profit depends
on every firm’s actions.
– Cartel: A cartel and is an illegal group of firms acting together to limit
output, raise price, and increase profit.
– Firms in oligopoly face the temptation to form a cartel, but aside from
being illegal, cartels often break down.
– Think OPEC.
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Notes de l'éditeur
Product differentiation—the heart of the space between monopoly and competition An old “ice cream on the beach” analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B . Tell the students that the line represents a beach (a long beach) along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get the most customers because the cost of an ice cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation—technically, there is minimum differentiation . Now suppose a third and fourth ice-cream vendor come along. Where to they locate? At the ends of the beach at A and B . They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
The demand for a firm’s differentiated product in monopolistic competition Remind the students about the ceteris paribus condition that defines a demand curve. Along the demand curve for Nike tennis shoes, the prices of Adidas, Fila, Head, K Swiss, Prince, Reebok, and Wilson tennis shoes are constant. Some people prefer Nike to the other brands and will pay a bit more for Nike. Other people prefer some other brand and will buy Nike only if its price is low enough. Buyers have brand preferences, but they will switch brands if price differences are large enough. So the higher the price of a Nike shoe, the prices of the other brands remaining the same, the smaller is the quantity of Nike shoes demanded.
Understanding real world markets. Students have no difficulty seeing oligopoly in the world around them. Again, emphasize that the work they’ve just done understanding the models of perfect competition and monopoly are not wasted because the real-world situation of oligopoly can be better understood by building on some of the features of competition and monopoly. Again, some of what they learned in each of the two previous chapters survives and operates in oligopoly. Traditional oligopoly models. Many instructors today want to skip the traditional models of oligopoly. Others want to teach only these models and skip the game theory approach. Your choice! This chapter is written in self-contained sections so that you can skip either approach.