MANAGERIAL th Edition ECONOMICS 11

By Mark Hirschey

Monopolistic Competition and Oligopoly

Chapter 13

Chapter 13 OVERVIEW

Contrast Between Monopolistic Competition and Oligopoly Monopolistic Competition Monopolistic Competition Process Oligopoly Cartels and Collusion Oligopoly Output-Setting Models Oligopoly Price-Setting Models Market Structure Measurement Census Measures of Market Concentration

Chapter 13 KEY CONCEPTS

monopolistic competition oligopoly high-price/low-output equilibrium low-price/high-output equilibrium cartel collusion Cournot model output-reaction curve Stackelberg model first-mover advantage price signaling price leadership

barometric price leadership Bertrand model price-reaction curve contestable markets theory Sweezy model kinked demand curve oligopoly theory economic census North American Industry Classification System (NAICS) concentration ratios Herfindahl-Hirschmann Index (HHI)

Contrast Between Monopolistic Competition and Oligopoly

Monopolistic Competition

Large number of sellers that offer differentiated products. Normal profit opportunity in long-run equilibrium.
Few sellers. Economic profits are possible in long-run equilibrium. Timely market structure information is required for managerial investment decisions

Oligopoly

Dynamic Nature of Competition

Monopolistic Competition

Monopolistic Competition Characteristics Many buyers and sellers. Product heterogeneity. Free entry and exit. Perfect information. Opportunity for normal profits in long-run equilibrium.

Monopolistic Competition Price/Output Decisions

Set M = MR - MC = 0 to maximize profits. MR=MC at optimal output. No durable economic profits because P=AR=AC.

Monopolistic Competition Process

Short-run Monopoly Equilibrium

Monopolistically competitive firms take full advantage of short-run monopoly.

With differentiated products, P=AC at a point above minimum LRAC. P > MR = MC.

Long-run High-price/Low-output Equilibrium

Long-run Low-price/High-output Equilibrium

With homogenous products, P=AC at minimum LRAC. This is a competitive market equilibrium with homogeneous production.

Oligopoly

Oligopoly Market Characteristics

Few sellers. Homogenous or unique products. Blockaded entry and exit. Imperfect dissemination of information. Opportunity for above-normal (economic) profits in long-run equilibrium. National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc. Local retail markets for gasoline, food, specialized services, etc.

Examples of Oligopoly

Cartels and Collusion

Overt and Covert Agreements

Cartels operate under formal agreements.

Powerful cartels function as a monopoly.

Collusion exists when firms reach secret, covert agreements. Cartels are typically rather short-lived because coordination problems often lead to cheating. Cartel subversion can be extremely profitable. Detecting the source of secret price concessions can be extremely difficult.

Enforcement Problem

Oligopoly Output-Setting Models

Cournot Oligopoly Cournot equilibrium output is found by simultaneously solving output-reaction curves for both competitors. Cournot equilibrium output exceeds monopoly output but is less than competitive output.

Stackelberg Oligopoly

Stackelberg model posits a first-mover advantage. Price wars severely undermine profitability for both leading and following firms. Price signaling can reduce uncertainty in oligopoly markets. Price leadership occurs when firms follow the industry leaders pricing policy.

Oligopoly Price-Setting Models

Bertrand Oligopoly: Identical Products

The Bertrand model focuses upon the price reactions. The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.
The Bertrand model demonstrates how price-setting oligopolists profit with differentiated products.

Bertrand Oligopoly: Differentiated Products

Sweezy Oligopoly

Sweezy model predicts sticky prices. Sweezy model explains why prices in oligopoly markets sometimes fail to respond to marginal cost change.

Oligopoly Model Comparison

Cournot model does not incorporate output reactions. Bertrand model does not incorporate price reactions. Stackelberg model explains first-mover advantages, but does not explain countermoves. Sweezy model is incomplete. Modeling behavior in oligopoly markets is difficult.

Market Structure Measurement

Economic Markets

An economic market consists of all individuals and firms willing and able to buy or sell. When cross-price elasticities are large and positive, goods are competing products.
The economic census provides a comprehensive statistical profile of the economy. Industry statistics are classified using the North American Industry Classification System (NAICS).

Economic Census

Census Measures of Market Concentration

Concentration Ratios

Group market share data are called concentration ratios. CRi = Xi, where Xi is market share of the ith leading firm.
CRi = 100 for monopoly. CRi 0 for a perfectly competitive industry.

Herfindahl-Hirschmann Index

Calculated in percentage terms, the HHI is the sum of squared market shares for all competitors. HHI = Xi2, where Xi2 is squared market share of the ith firm.

Limitations of Census Information

HHI = 10,000 for monopoly. HHI 0 for a perfectly competitive industry.

Slow reports hinder usefulness. National statistics obscure local markets.