13 Monopolistic Competition and Oligopoly McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved • • LO1 Monopolistic Competition Relatively large number of sellers • Small market shares • No collusion • Independent action • Some control over price Differentiated products • Product attributes • Service, location • Brand-names, packaging Monopolistic Competition • Easy entry and exit • Advertising • Nonprice competition LO1 Price and Output in Monopolistic Comp • Demand is more elastic than pure • LO2 monopoly because there are more rivals and substitutes Demand is less elastic than pure competition because there are fewer rivals and imperfect substitutes Monopolistic Competition: Efficiency • Inefficient • Productive inefficiency • P > ATC • Allocative inefficiency • P > MC LO2 Oligopoly • A few large producers • Homogeneous or differentiated • • • LO3 products Limited control over price • Mutual interdependence • Strategic behavior Entry barriers Mergers Oligopolistic Industries • Four-firm concentration ratio • 40% or more to be oligopoly • Shortcomings • Localized markets • Inter-industry competition • World price • Dominant firms – Herfindahl Index LO3 High Concentration Industries (1) Industry Primary copper (2) 4-Firm Concentration Ratio (3) Herfindahl Index 99 ND (1) Industry (2) 4-Firm Concentration Ratio (3) Herfindahl Index Petrochemicals 85 2662 83 1901 Cane sugar refining 99 ND Small arms ammunition Cigarettes 95 ND Motor vehicles 81 2321 80 2515 Household laundry equipment 93 ND Men’s slacks and jeans Beer 91 ND Aircraft 81 ND Electric light bulbs 89 2582 Breakfast cereals 78 2521 78 2096 Glass containers 88 2582 Household vacuum cleaners Turbines and generators 88 ND Phosphate fertilizers 78 1853 Tires 77 1807 Electronic computers 76 Alcohol distilleries 71 Household refrigerators and freezers 85 1986 Primary aluminum 85 ND LO1 2662 1609 Oligopoly Models • Kinked Demand Curve • Collusive Pricing • Price Leadership • Reasons for models • Diversity of oligopolies • Complications of interdependence LO5 Kinked Demand Curve • Criticisms • Explains inflexibility, not price • Prices are not that rigid • Price wars LO6 Overt Collusion • Collusion reduces uncertainty, • • LO6 improves control of price, profits rise, and prevents entry of firms Cartels - a group of firms or nations that collude • Formally written agreement • Sets output levels and price for members OPEC Covert Collusion • Gentleman’s agreements • Informal understandings often in social settings between firms about price and output LO6 Obstacles to Collusion • Demand and cost differences • Number of firms • Cheating • Recession • New entrants • Legal obstacles • Golden Balls LO6 Global Perspective LO6 Price Leadership Model • Price Leadership • Dominant firm initiates price • • LO6 changes • Communicates price change • Other firms follow the leader Use limit pricing to block entry of new firms Possible price war Oligopoly and Efficiency • Oligopolies are inefficient • Productively inefficient P > minATC • Allocatively inefficient P > MC • Qualifications • Increased foreign competition • Limit pricing • Technological advance LO7