LO1 10-1 AGENDA Thurs 10/29 Regulated Monopoly (FRQ 2011 & 2012) QOD #: 29: Graphing Practice w/ Mr. Clifford Price Discriminating Monopoly Monopolistic Competition & Oligopoly CH 8/9 Results/TC & Retakes Make-ups: Thurs before school (10/29) TC: Thurs lunch, Monday lunch (10/29 & 11/2) Retakes: Tues after school (11/3) HW: Read pp 223-228 Q#6,7
LO5 10-2 Regulated Monopoly Natural monopolies Socially optimal price Set price = marginal cost Fair return price Set price = ATC
LO5 Price and Costs (Dollars) 10-3 Regulated Monopoly Monopoly Price P m Fair-Return Price P f a f Socially Optimal Price ATC P r 0 MR r b Q m Q f Q r Quantity MC D
Four Market Models Characteristics of the Four Basic Market Models Characteristic Number of firms Pure Competition A very large number Monopolistic Competition Oligopoly Monopoly Many Few One Type of product Standardized Differentiated Standardized or differentiated Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Unique; no close subs. Considerable Conditions of entry Nonprice competition LO1 Very easy, no obstacles None Relatively easy Considerable emphasis on advertising, brand names, trademarks Examples Agriculture Retail trade, dresses, shoes Significant obstacles Typically a great deal, particularly with product differentiation Steel, auto, farm implements Blocked Mostly public relation advertising Local utilities 11-4
Monopolistic Competition The Characteristics of Monopolistic Competition 1. there are many buyers and many sellers 2. firms produce and sell slightly differentiated products 3. there is easy entry into and exit from the market 4. Price searchers sell slightly different products produce Q when MR = MC sell at the highest price at which they can sell all of their output
How are Monopolistic Competitor s products different? the product itself may actually or appear to be different in some way Differ by location, service or perceived quality Location: gas station / convenience Service: Nordstrom / Supercuts Perceived quality: Hamburgers / Clothing
Competitors and Monopoly Many businesses would like to become a monopoly they advertise perceived differences Competition depends on two factors: 1. How close to unique the product is 2. How easy it is for sellers to enter the market
LO1 11-8 Monopolistic Competition Relatively large number of sellers Differentiated products Easy entry and exit Advertising
LO1 Monopolistically Competitive Industry concentration Measured by: Four-firm concentration ratios Percentage of 4 largest firms 4-Firm CR = Herfindahl index Output of four largest firms Total output in the industry Sum of squared market shares HI = (%S1)2 + (%S2)2 + (%S3)2 +. + (%Sn)2 11-9
LO2 11-10 Price and Output in Monopolistic Comp Demand is highly elastic Short run profit or loss Produce where MR=MC Long run normal profit Entry and exit Inefficient Product variety
LO2 Price and Costs 11-11 The Short Run: Profit or Loss MC ATC P 1 A 1 Economic Profit MR = MC D 1 MR 0 Q 1 Quantity
LO2 Price and Costs 11-12 The Short Run: Profit or Loss MC ATC A 2 P 2 Loss D 2 MR = MC MR 0 Q 2 Quantity
LO2 Price and Costs 11-13 The Long Run: Only a Normal Profit MC ATC P 3 = A 3 D 3 MR = MC MR 0 Q 3 Quantity
LO2 11-14 Monopolistic Competition: Efficiency Inefficient Productive inefficiency P > ATC Allocative inefficiency P > MC Excess capacity-plant and equip. that are underused BECAUSE firms are producing at less than the min.atc output. So, in the long-run, although they should be earning a normal profit where p=mc, there ends up being a deadweight acd on the graph.
LO2 Price and Costs 11-15 Monopolistic Competition: Efficiency P=MC=Min ATC for pure competition (recall) MC ATC P 3 = A 3 P 4 Price is Lower 0 MR = MC Excess Capacity at Minimum ATC Q 3 Q 4 Quantity MR Monopolistic competition is not efficient D 3
LO2 11-16 Product Variety The firm constantly manages price, product, and advertising Better product differentiation Better advertising The consumer benefits by greater array of choices and better products Types and styles Brands and quality
The Characteristics of an Oligopoly 1. there are few sellers 2. firms produce and sell either identical or slightly differentiated products 3. there are significant barriers to entry into the market 4. oligopolies are price searchers face intense competition from current sellers barriers prevent competition from new sellers
Identifying Oligopoly Industries Economist determine whether a market is an oligopoly by looking at the percentage of sales accounted for by the top four firms in the industry 6 major film studios = 90% of revenue 20 th century, Warner Brothers, Paramount, Columbia, Universal, Walt Disney Dreamworks (Viacom bought owned by Paramount) 2008 became independent again but distributed by Disney Leading Indies: Lionsgate, Summit Entertainment, MGM (former Biggie!) 4 music companies = 80% of revenue Sony, EMI, Universal, Warner 6 book publishers 3 television networks (1950-1970) ABC/Disney CBS NBC Universal 2 added since Time Warner News Corporation (FOX) Rule of 3 (markets often become an oligopoly of 3) Orwell s 1984
LO3 11-19 Oligopoly A few large producers Homogeneous or differentiated products-steel, breakfast cereal Limited control over price Mutual interdependence-dependent on the pricing and sales strategies of competitors. Strategic behavior Entry barriers-economies of scale, capital expense, ownership of raw materials Dominant firms-growth leads to oligopoly-breakfast foods-the four largest U.S. producers make up 78% of U.S. production Mergers-banking
LO3 11-20 Oligopolistic Industries Four-firm concentration ratio 40% or more of industry output to be oligopoly Shortcomings Localized markets-can exist but not a national oligopoly-two banks in a small town Inter-industry competition-aluminum v. copper World price-the U.S. concentration ratios do not take world trade into account. Dominant firms-use Herfindahl Index to get an idea if there is one or two firms that significantly dominate. 25+25+25+25 v. 60+30+5+5
LO4 11-21 Game Theory Overview Oligopolies display strategic pricing behavior Mutual interdependence Collusion Incentive to cheat Prisoner s dilemma
LO4 Uptown s Price Strategy 11-22 Game Theory Overview 2 competitors 2 price strategies Each strategy has a payoff matrix Greatest combined profit Independent actions stimulate a response High Low RareAir s Price Strategy High Low A $12 B $15 $12 $6 C $6 D $8 $15 $8
LO4 Uptown s Price Strategy 11-23 Game Theory Overview Independently lowered prices in expectation of greater profit leads to worst combined outcome Eventually low outcomes make firms return to higher prices. High Low RareAir s Price Strategy High Low A $12 B $15 $12 $6 C $6 D $8 $15 $8
LO5 11-24 Three Oligopoly Models Kinked-demand curve Collusive pricing Price leadership Reasons for 3 models Diversity of oligopolies Complications of interdependence
LO5 Price Price 11-25 Kinked-Demand Curve Rivals Ignore Price Increase P 0 f e D 2 P 0 D 2 MR 2 f e MC 1 MC 2 Rivals Match Price Decrease g MR 2 D 1 g D 1 0 Q 0 MR 1 0 Quantity Quantity Q 0 MR 1
LO6 11-26 Kinked-Demand Curve Criticisms Explains inflexibility, not pricewhere did the price come from Prices are not that rigid-i.e. recession and inflation Price wars-can occur during price reductions.
LO6 Price and Costs 11-27 Cartels and Other Collusion MC P 0 ATC A 0 Economic Profit MR=MC MR D Q 0 Quantity
LO6 11-28 Overt Collusion Cartels - a group of firms or nations that collude Formally agreeing to the price Sets output levels for members Collusion is illegal in the United States OPEC Gentlemen Agreements or tacit understandings (unspoken)-difficult to detect but collusion is still illegal.
LO6 11-29 Obstacles to Collusion Demand and cost differences-some firms would make less profit and not want to be a part of the agreement Number of firms-more firms=more difficulty Cheating-incentive to back out and lower price on your competitors Recession-lower sales, more excess capacity, higher ATC. New entrants-more supply=lower price=defeats the purpose of the collusion. Legal obstacles
LO6 11-30 Price Leadership Model Price Leadership Dominant firm initiates price changes Other firms follow the leader Use limit pricing to block entry of new firmskeeping the price below where short-term profits are maximized to keep small firms out. Possible price war-undercut the price leader, but could lead to a price war.
LO7 11-31 Oligopoly and Advertising Prevalent to compete with product development and advertising Less easily duplicated than a price change Financially able to advertise
LO7 11-32 Advertising Positive Effects Low-cost way of providing information to consumers Negative Effects Can be manipulative Enhances competition Contains misleading claims that confuse consumers Speeds up technological progress Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product Can help firms obtain economies of scale
LO7 11-33 Oligopoly and Efficiency Oligopolies are inefficient Productively inefficient P > minatc Allocatively inefficient P > MC Qualifications Increased foreign competition Limit pricing Technological advance