Chapter 7. Section 3: Monopolist Competition & Oligopoly

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Richard Cox
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1 Chapter 7 Section 3: Monopolist Competition & Oligopoly

2 Monopolist Competition Many companies compete in an open market to sell products that are similar but not identical Each firms hold a monopoly over its own particular product

3 Differences between perfect competition & monopolistic competition arise because monopolistic competitive firms sell goods that are similar enough to be substituted for one another but are not identical

4 Monopolistic competition does not involve identical commodities Ex: Jeans, bagel shops, ice cream stand, gas stations, & retail stores Monopolistic competition is a fact of everyday life

5 Four Conditions of Monopolistic Competition 1. Many Firms As a rule, monopolistically competitive markets are not marked by economies of scale or high start-up costs, allowing more firms.

6 2. Few Artificial Barriers to Entry -do not face high barriers to entry (Patents)

7 3. Slight Control over Price - have some freedom to raise or lower prices because each firm's goods are a little different from everyone else's & some people are willing to pay more for the different product

8 4. Differentiated Products -Firms have some control over their selling price because they can differentiate, or distinguish, their goods from other products in the market. - The main difference between perfect competition & monopolistic competition is that differentiation enable a monopolistically competitive seller to profit from the difference between their products & competition s products

9 Nonprofit Competition A way to attract customers through style, service, or location, but not a lower price. Takes several different forms 1. Characteristics of Goods The simplest way for a firm to distinguish its products is to offer a new size, color, shape, texture, or taste. - Running shoes, pens, cars, & toothpaste

10 2. Location of Sale -A convenience store in the middle of the desert differentiates its product simply by selling it hundreds of miles away from the nearest competitor. - Gas stations, movie theatres, & grocery stores can succeed or fail based on their locations

11 3. Service Level Some sellers can charge higher prices because they offer customers a higher level of service. - Restaurants

12 4. Advertising Image Firms also use advertising to create apparent differences between their own offerings and other products in the marketplace. - Designer labels

13 Price, Output, & Profits Prices- will be higher than they would be in perfect competition, because firms have a small amount of power to raise prices. Number of firms & ease of entry prevent companies from raising prices as high as they would if they were a true monopoly If prices were raised too high, many consumers would buy the cheaper product

14 Output Output & price are negatively related Profits While monopolistically competitive firms can earn profits in the short run, they have to work hard to keep their product distinct enough to stay ahead of their rivals. Firms earn just enough to cover costs If a firm started to earn profits well above its costs, two market trends would work to take those profits away

15 First, fierce competition would encourage rivals to think of new ways to differentiate their products & lure customers back Rivalries Second, new firms will enter the market with slightly different products that costs a lot less than the market leaders

16 Production Costs and Variety Monopolistically competitive firms cannot produce at the lowest average price due to the number of firms in the market. Markets have many firms, each producing too little output to minimize costs & use resources efficiently Can offer a wide array of goods & services to consumers

17 Examples of Monopolistic Competition Banks Radio Stations Clothing Computers Frozen Foods Canned Goods Sporting Goods Fish and Seafood Jewelry Health Spas Apparel Stores Convenience Stores 7

18 Oligopoly Describes a market dominated by a few large, profitable firms Looks like an imperfect form of monopoly Economists usually call an industry an oligopoly if the four largest firms produce at least 70-80% of output May set prices higher & output lower than in a perfectly competitive market Ex: Air travel, cereal, & appliances

19 Barriers to Entry One can form when significant barriers to entry keep new companies from entering the market to compete with existing firms Sometimes these barriers are created by a system of government licenses or patents

20 High start up costs (machinery or advertising) can scare firms Some occur because of economies of scale

21 Cooperation & Collusion Presents a big challenge to governments because oligopolistic firms often seem to work together to form a monopoly even if they are not trying to Many government regulations try to make oligopolistic firms act more like competitive firms

22 Three practices concern governments Price leadership, Collusion, & cartels Don t always work Each tactic includes an incentive for firms to cheat & undo any benefits Sometimes the market leader in an oligopoly can start a round of price increases & cuts by making its plans clear to other firms

23 Price leaders can set prices & outputs for entire industries as long as other member firms go along with the leader s policy Disagreements can spark a price warwhen competition cuts their prices very low to win business Harmful to producers, good for consumers

24 Collusion is an agreement among members of an oligopoly to set prices & production levels. One outcome is price fixing- an agreement among firms to sell at the same or similar prices. Illegal in the US Not the only reason for identical pricing in oligopolistic industries May result from intense competition

25 A cartel is an association by producers established to coordinate prices & production. Illegal in the US Can only survive if every member keeps to its agreed output levels & no more Otherwise, prices will fall & firms will lose profits

26 Each member has a strong incentive to cheat & produce more than its quota If every cartel member cheats, too much product reaches the market & prices fall Can also collapse if some products are left out of the group & decide to lower their prices below the cartel s levels Don t usually last long

27 Comparison of Market Structures See overhead!!

Perfect Competition. Chapter 7 Section Main Menu

Perfect Competition. Chapter 7 Section Main Menu Perfect Competition What conditions must exist for perfect competition? What are barriers to entry and how do they affect the marketplace? What are prices and output like in a perfectly competitive market?