Session+10 Monopolistic+Competition+&+Oligopoly

8/6/2019 Session+10 Monopolistic+Competition+&+Oligopoly

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Price Determination under

Monopolistic Competition & Oligopoly

Dr. Utpal ChattopadhyayAsst. Professor, NITIE

.


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Monopolistic Competition

Many firms

Differentiated products (is in general a strategic

marketing goal) products are close substitutes toeach other;

Demand curve not completely flat

Firms do not react to each others actions (because

there are so many) Easy entry and exit

Examples: shirts, candy bars, restaurants


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Behavior of monopolisticallycompetitive firms

Firms in an industry group are similar (symmetric inextreme), i.e. they have the same incentives

What happens if firm changes price alone? (dd) Same incentive for other firms to change price (DD) ----> demand is steeper in this case

In the extreme: a very small firm changing the price alone has a very flat demand curve!

Marketing is important: firms want to make theirproduct unique, in other words: Demand for their product should get more inelastic (steep) Use advertising!


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Demand curve if the firm (dd) or the

industry (DD) changes price


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Short-run equilibrium

Like a monopolist: set price where

marginal revenue = marginal cost

Profits arise ---> market entry of similar products (firms)

Each firm competes for a percentage of totaldemand, new entry means demand for the individual

firm must be lower (shifts left/down) Shift must be so far, that profits disappear

I.e. Demand curve must finally be tangential to long-run average cost curve


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Perfect Competition Vs.

Monopolistic Competition PC: price equal to long-run marginal cost, in

MonC price is always higher as marginal cost:

there are people out there who value thegood more than the marginal cost to produceit. ==> in principle production should rise

PC produces at minimum of long-run average

cost, MonC not at the minimum Trade-Off between efficiency (cost) and variety Long-run profit situation is alike, because of

entry, but how short is the short-run??


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Summary-Monopolistic

Competition

Very common market form

No interaction between firms

Firm could reduce average cost by producing more Firms try to bind their costumers to the firm:

Marketing, advertising plays a role (not in perfectcompetition)

Make the product different from the crowd


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OligopolyA. Few Sellers / Recognized

Interdependence

B. Cournot Model

Firms choose quantity

Assume that other firm does changeoutput

Example compared to PC and Monopoly


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Oligopoly - Bertrand Model Firms choose price rather than output.

With identical goods and constant MC, thenP=?

If products are differentiated. - Example


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Oligopoly - Chamberlin

(Monopolistic Competition) Criticized Bertrand and Cournot models

because they failed to recognize their

interdependence. He argued that intelligentmanagers would know where the profit-maximizing price is and would be reluctantto reduce price and leave all members of

the industry worse off.


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Oligopoly - Stackelberg Model

-Price Leadership Designate one firm as a dominant firm and all

the other's in the industry follow this firm's

cues. I.e. one firm announce price changes andall the others follow.

Examples

Automotive industry

Banking Industry


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Oligopoly - Stigler's Theory Incentive to collude is strong so as to

maximize joint profits but so is theincentive to cheat. If any member cansecretly violate the agreement, he willgain larger profits than by conforming

to it. Therefore enforcement, i.e.detecting significant deviations from theagreed-upon prices, is paramount


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Stigler example Suppose 3 identical firms with zero

costs , facing a market demand curve ofQ=180-5P. The monopoly price andquantity is $18 and 90 and the threefirms agree to each supply 30. The

$1620 industry profits are split $540 toeach.


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Oligopoly


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Oligopoly d is the demand curve when everyone knows

(everyone makes 533.33), d' is when there

are secret cuts(if offered to all his customersthen $640, if only to "new" customers -$700), d'' is secret cut that steals away otherfirms customers without the other firmreacting - $800).

Conclusion - there is a great temptation tosecretly cut prices. Key is detection andresponse.


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Oligopoly - Game Theory Prisoner's Dilemma - Two suspected

criminals A and B are arrested and put in

separate cells unable to communicate. If oneconfesses while the other does not, the onewho confesses is granted immunity and goesfree and the other goes to jail for 20 years. If

both confess they both go to jail for 5 years.If both are silent, both go to jail for only oneyear, for a lesser crime (concealed weapons).The payoff matrix looks like this:


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Oligopoly Duopolist's Dilemma

Dominant Strategy is to cut price but both firms are better offby fixing prices.

Firm A Firm B

Cut Price (Rs. 12) Fix Price (Rs. 18)

Cut Price (Rs. 12) [720,720] [1440,0]

Fix Price (Rs. 18) [0, 1440] [810,810]


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Can Collusion be beneficial? It reduces uncertainty in profit rate , demand

uncertainty in the face of production

indivisibilities Example


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Can Collusion be beneficial? Indivisibilities in production.

Other problems - large fixed and someavoidable costs with uncertain demand.

Session+10 Monopolistic+Competition+&+Oligopoly

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