Monopolistic Competition and Oligopoly. Somewhere between the two extremes of monopoly and perfect competition Two forms – Monopolistic Competition –

Monopolistic Competitionand

Oligopoly

• Somewhere between the two extremes of monopoly and perfect competition

• Two forms – Monopolistic Competition– Oligopoly

• Monopolistic Competition– Many sellers, but– Product Differentiation– So face a downward sloping demand curve– Not Price Takers

• Oligopoly– Only a few seller– Offer similar or identical products

Monopolistic Competition• Key Points• Like a monopoly– Faces a downward sloping demand curve– Sets its own price– Marks up price over quantity

• But not– Not really a monopoly– Almost because it tries to make its product

different– But its not different, so can’t push the monopoly

mindset too far, because people will go to other close substitutes

• Profit in the long run?– If firms making lots of profit maybe more firms

come in with close substitutes – This would lower the firms demand and MR curve

and also profits– Could this lead then to zero LR profits?– If they haven’t sufficiently differentiated their

product, yes– But if they have, no– Because consumers might feel there are no real

substitutes– Think Athletic Shoes

Monopolistic Competition and Advertising

• If a firm is selling a differentiated product and making a profit (price > MC)

• Then there is an incentive to advertise– To attract more buyers (increase demand and MR

curve)– And to keep their product differentiated

• Is advertising bad?– Manipulates people’s tastes – Psychological, not informative– Impedes competition– Differentiating products that are really the same

(brand loyalty)• Is it good?– Gives information– Fosters competition (consumers take advantage of

price differences among similar products)– Allows new firms to enter easier

• Does it make sense that consumers buy brand names?

• Essentially the same product as store brands, but cost more, partly because they advertise

• But maybe they are higher quality, and they have an incentive to keep higher quality to defend the brand

Oligopoly• Only a few sellers• Similar or identical products• Interdependent• Game Theory– How people behave in strategic situations– If only a few, I need to consider how they’ll

respond to my actions

• Tension between cooperating and competing• Best off cooperating and acting like a

monopoly– Produce small amount– P > MC

• But each only cares about own self interest– Incentive to compete

Duopoly Example• Only two firms• Same product• Each decides quantity to sell• Price is set by the market demand• Thus the combination of both seller’s choice

of Q leads to the price and so their profits

• They could collude and act as a monopoly– Come to an agreement on price or quantity– But generally explicit collusion is illegal (but can

still act strategically)• Thus forming a Cartel– Think of OPEC

Economics of Cooperation• Prisoner’s Dilemma– A “game”– Illustrates why cooperation can be hard even if

both would benefit • Dominant Strategy– A strategy that is best for a player in a game

regardless of what others do

Confess

Confess

Don’t

Don’t

A

B

A gets 8 yrs prison

B gets 8 yrs prison

A gets 20 yrs prison

A gets 1 yrs prison

B gets 8 yrs prison

B goes free

B gets 20 yrs prison

A goes free

• Regardless of what A does it is better for B to confess– Dominant Strategy

• Regardless of what B does if is better for A to confess– Dominant Strategy

• So they both confess and both get 8 yrs instead of both getting off

• Of course this is if they can’t collude• This is similar to the situation face by two

firms in a duopoly

• Two firms in a duopoly face a similar “game”• If colluded could reach higher profits• But can’t directly collude• Becomes a strategic game

Gallons Market Price Total Revenue (Total Profit)

0 $120 $0

10 110 1,100

20 100 2,000

30 90 2,700

40 80 3,200

50 70 3,500

60 60 3,600

70 50 3,500

80 40 3,200

90 30 2,700

100 20 2,000

Demand Schedule and Profit

High Production40 Gallons

High P40 G

Low Production30 Gallons

Low P 30 G

A

B

A gets $1.6K profit

B gets $1.6K profit

A gets $1.5K profit

A gets $1.8K profit

B gets $1.8K profit

B gets $2K profit

B gets $1.5K profit

A gets $2K profit

Duopoly “Game”

Application to OPEC• Organization of Petroleum Exporting Countries• Control about ¾ of worlds oil reserves• Tries to set production limits to keep price of

oil sufficiently high (but not too high to cause long term shift in demand)

• Each country then has incentive to deviate a bit– Because still get benefit of higher price but also

get to sell more, but if all do this then price falls– Success at setting high price in 70’s and early 80’s

but since then not so much

Arms Race Example• Cold war arms race between US and Soviet

Union• Two strategies– Arm– Disarm

• Dominant Strategy– Arm

Arm

Arm

Disarm

Disarm

US

Soviet

US at risk

Soviet at risk

US at risk and weak

US safe

Soviet safe

Soviet safe and strong

Soviet at risk and weak

US safe and strong

Cold War “Game”

• Game’s implication for welfare• Noncooperative Equilibrium– Dominant Strategy– Could be good for society• Gets away from monopoly production

– Could be bad• Gets us a world full of nuclear warheads

How to Still Get Cooperation• Repeated Games– Dominant strategy is such because game only

played once• Start out at best position• Penalize players for deviating– Tit for Tat

Public Policy • Anti Trust Laws• Sherman Act, 1890– Made agreements between oligopolists a crime

• Clayton Act, 1914– Strengthened anti trust laws

• Prevent Certain Mergers• Prevent Collusion

Predatory Pricing• Selling below cost in order to drive out a

competitor• Then when competitor gone can act as a

monopoly• Illegal under anti trust policies• Deemed anticompetitive • Rockefeller strategy in oil (Cincinnati/Chicago) • Lower price in Cincinnati to drive out

competition, but raise price in Chicago where competition had already been driven out