ECO 106 Pace University New York Monopolistic and Oligopolistic Firms Discussion The textbook mentions that a four-firm concentration ratio of 40 percent o

ECO 106 Pace University New York Monopolistic and Oligopolistic Firms Discussion The textbook mentions that a four-firm concentration ratio of 40 percent or higher can be used to classify an industry as an oligopoly. Economists believe that competition in markets with lower concentration ratios is usually sufficient to ensure that firms do not engage in collusion or otherwise not compete with rival firms. But for oligopoly markets, how can you evaluate whether or not firms are using market power to charge high prices and avoid competition that would benefit consumers? Give an example of an oligopolistic market, including the firms in the dominant positions, that you believe is engaging in unfair or anticompetitive behavior. 1
Economics
6th edition
Chapter 13
1
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Monopolistic Competition:
The Competitive Model in a
More Realistic Setting
2
Chapter Outline
13.1 Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market
13.2 How a Monopolistically Competitive Firm Maximizes Profit in
the Short Run
13.3 What Happens to Profits in the Long Run?
13.4 Comparing Monopolistic Competition and Perfect
Competition
13.5 How Marketing Differentiates Products
13.6 What Makes a Firm Successful?
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3
Perfect Competition vs. Monopolistic
Competition
The perfectly competitive markets in the previous chapter had the
following three features:
1. Many firms
2. Firms sell identical products
3. No barriers to entry to new firms entering the industry
The first two features implied a horizontal demand curve for
individual firms, while the third implied zero long-run profit.
Monopolistically competitive firms share features 1. and 3.; but
their products are not identical to their competitors’.
So we expect monopolistically competitive firms to have zero longrun profit but not to face a horizontal demand curve.
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4
13.1 Demand and Marginal Revenue for a
Firm in a Monopolistically Competitive Market
Explain why a monopolistically competitive firm has downward-sloping demand and
marginal revenue curves.
Monopolistic competition is a market structure in which barriers
to entry are low and many firms compete by selling similar, but not
identical, products.
The key feature here is that the products that monopolistically
competitive firms sell are differentiated from one another in some
way.
Example: Chipotle sells burritos and competes in the burrito
market against other firms selling burritos; but its burritos are not
identical to its competitors’.
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5
Figure 13.1 The Downward-Sloping Demand Curve for
Burritos at Chipotle
Chipotle sells burritos;
while other firms also sell
burritos, some customers
have a preference for
Chipotle’s burritos.
So if Chipotle raises its
price, some but not all of
its customers will switch
to buying their burritos
elsewhere.
This means Chipotle
faces a downwardsloping demand curve.
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6
Table 13.1 Demand and Marginal Revenue at a Chipotle
Marginal
Revenue
??????
???? =
????
Burritos
Sold
per Week (Q)
Price (P)
Total Revenue
???? = ?? × ??
Average
Revenue
????
???? =
??
0
$10.00
$0.00
—
—
1
9.50
9.50
$9.50
$9.50
2
9.00
18.00
9.00
8.50
3
8.50
25.50
8.50
7.50
4
8.00
32.00
8.00
6.50
5
7.50
37.50
7.50
5.50
6
7.00
42.00
7.00
4.50
7
6.50
45.50
6.50
3.50
8
6.00
48.00
6.00
2.50
9
5.50
49.50
5.50
1.50
10
5.00
50.00
5.00
0.50
11
4.50
49.50
4.50
?0.50
The first two columns show the demand schedule for Chipotle.
Total revenue increases initially, then decreases; Chipotle has to
lower the price in order to sell additional burritos.
So marginal revenue is initially positive, then negative.
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Figure 13.2 How a Price Cut Affects a Firm’s Revenue (1 of 2)
When Chipotle reduces the
price of a burrito, it sells (let’s
say) 1 more burrito.
Its revenue increases
because of the extra sale;
this is the output effect
of the price reduction.
But its revenue decreases
also; to sell another burrito, it
reduces the price on all
burritos. It loses $0.50 in
revenue on each of the
burritos it would have already
sold at $7.50. This is the price
effect of the price reduction.
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7
Figure 13.2 How a Price Cut Affects a Firm’s Revenue (2 of 2)
Chipotle’s marginal
revenue for selling the extra
burrito is equal to the green
area minus the pink area:
the output effect minus the
price effect.
The output effect is equal to
the price; so marginal
revenue is lower than the
price.
For any firm with a
downward-sloping demand
curve, its marginal revenue
curve must be below its
demand curve.
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8
9
Figure 13.3 The Demand and Marginal Revenue Curves for
a Monopolistically Competitive Firm
The graph shows the
Chipotle’s demand and
marginal revenue curves
for burritos.
After the tenth burrito,
reducing the price in order
to increase sales results in
revenue decreasing
(negative marginal
revenue).
• The price effect
becomes larger than
the output effect.
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10
13.2 How a Monopolistically Competitive
Firm Maximizes Profit in the Short Run
Explain how a monopolistically competitive firm maximizes profit in the short run.
Just like a perfectly competitive firm, a monopolistically
competitive firm should not simply try to maximize revenue.
• Each additional unit of output incurs some marginal cost.
• Profit maximization requires producing until the marginal
revenue from the last unit is just equal to the marginal cost:
MC = MR.
• This same rule holds for all firms that can marginally adjust
their output.
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11
Figure 13.4 Maximizing Profit in a Monopolistically
Competitive Market (1 of 3)
Burritos
Sold per Week
(Q)
Price
(P)
Total
Revenue
(TR)
Marginal
Revenue
(MR)
Total
Cost
(TC)
Marginal
Cost
(MC)
Average
Total Cost
(ATC)
Profit
0
$10.00
$0.00
—
$6.00
—
—
–$6.00
1
9.50
9.50
$9.50
11.00
$5.00
$11.00
–1.50
2
9.00
18.00
8.50
15.50
4.50
7.75
2.50
3
8.50
25.50
7.50
19.50
4.00
6.50
6.00
4
8.00
32.00
6.50
24.50
5.00
6.13
7.50
5
7.50
37.50
5.50
30.00
5.50
6.00
7.50
6
7.00
42.00
4.50
36.00
6.00
6.00
6.00
7
6.50
45.50
3.50
42.50
6.50
6.07
3.00
8
6.00
48.00
2.50
49.50
7.00
6.19
–1.50
9
5.50
49.50
1.50
57.00
7.50
6.33
–7.50
10
5.00
50.00
0.50
65.00
8.00
6.50
–15.00
11
4.50
49.50
–0.50
73.50
8.50
6.68
–24.00
The first, second, third, and fourth burritos each increase profit:
MC < MR. The 5th does not alter profit: MC = MR. The 6th and subsequent burritos decrease profit: MC > MR.
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12
Figure 13.4 Maximizing Profit in a Monopolistically
Competitive Market (2 of 3)
Chipotle sells burritos up until MC = MR.
This selects the profit-maximizing quantity. Then the demand curve
shows the price, and the ATC curve shows the average cost.
Since Profit = (P – ATC) x Q, we can show profit on the graph with
the green rectangle.
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13
Figure 13.4 Maximizing Profit in a Monopolistically
Competitive Market (3 of 3)
To identify profit:
1. Use MC=MR to identify the profitmaximizing quantity.
2. Draw a vertical line at that quantity.
3. The vertical line will hit the demand
curve: this is the price.
4. The vertical line will also hit the ATC
curve: this is the average cost.
5. The difference between price and average
cost is the profit (or loss) per unit.
6. Show the profit or loss with the rectangle
with height (P – ATC) and length (Q* – 0),
where Q* is the optimal quantity.
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14
13.3 What Happens to Profits in the
Long Run?
Analyze the situation of a monopolistically competitive firm in the long run.
When a firm has total revenue greater than total cost, it makes an
economic profit.
• This economic profit gives entrepreneurs an incentive to enter
the market.
In our previous example, Chipotle makes an economic profit.
• We expect new firms to enter the burrito market.
• These new firms will reduce the demand for Chipotle’s burritos.
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15
Figure 13.5 How Entry of New Firms Eliminates Profits
At first (left panel), Chipotle has few competitors, so demand for
its burritos is high. It makes an economic profit.
This economic profit attracts new firms, decreasing the demand
for Chipotle’s burritos (right panel).
This continues until Chipotle no longer makes an economic profit.
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16
Table 13.2 The Short Run and the Long Run for a
Monopolistically Competitive Firm (1 of 3)
In the short run, a monopolistically competitive firm might make a
profit or a loss.
The situation where the firm is making a profit is above.
Notice that there are quantities for which demand (price) is above
ATC; this is what allows the firm to make a profit.
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17
Table 13.2 The Short Run and the Long Run for a
Monopolistically Competitive Firm (2 of 3)
Now the firm is making a loss.
Notice that there is now no quantity for which demand (price) is
above ATC; this firm must make a (short-run) economic loss, no
matter what quantity it chooses.
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18
Table 13.2 The Short Run and the Long Run for a
Monopolistically Competitive Firm (3 of 3)
In the long run, the firm must break even.
Notice that the ATC curve is just tangent to the demand curve.
The best the firm can do is to produce that quantity.
There is no quantity at which the firm can make a profit; the ATC
curve is never below the demand curve.
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19
Zero Profit in the Long Run?
Our model of monopolistic competition predicts that firms will earn
zero profit in the long run.
However firms need not passively accept this long-run outcome.
They could:
• Innovate so that their costs are lower than other firms, or
• Convince their customers that their product/experience is better
than that of other firms, either by actually making it better in
some unique way or making customers perceive that it is better,
perhaps through advertising.
Think of the long-run as “the direction of trend”; demand will
continue to fall to the zero (economic) profit level, unless the firm
is able to do something about it.
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20
Making the Connection: How Can
Chipotle Maintain Its Economic Profit?
One of Chipotle’s early marketing
strategies was to convince people
it was healthier than alternative
fast foods.
• But some reports have
suggested this is not the case.
To maintain its edge, Chipotle has
tried to appear more socially
responsible.
• It announced it would stop
using genetically modified
ingredients and publicized
buying many local ingredients.
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21
13.4 Comparing Monopolistic
Competition and Perfect Competition
Compare the efficiency of monopolistic competition and perfect competition.
Last chapter we learned that perfectly competitive firms achieved
productive and allocative efficiency.
• Productive efficiency refers to producing items at the lowest
possible cost.
• Allocative efficiency refers to producing all goods up to the
point where the marginal benefit to consumers is just equal to
the marginal cost to firms.
Monopolistic competition results in neither productive nor
allocative efficiency.
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22
Figure 13.6 Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition (1 of 2)
In panel (a), a perfectly competitive firm in long-run equilibrium
produces at QPC, where price equals marginal cost and average
total cost is at a minimum.
The perfectly competitive firm is both allocatively efficient and
productively efficient.
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23
Figure 13.6 Comparing Long-Run Equilibrium under Perfect
Competition and Monopolistic Competition (2 of 2)
Monopolistically competitive firms in panel (b) produce the
quantity where MC=MR. The marginal benefit to consumers is
given by the demand curve, so MC?MB: not allocatively efficient.
And average cost is above its minimum point: not productively
efficient.
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24
Is Monopolistic Competition Bad for
Consumers?
The lack of efficiency suggests that monopolistic competition is a
bad situation for consumers.
• But consumers might benefit from the product differentiation.
Example: If you were buying a car, would you prefer one
a. Produced and sold at the lowest possible cost but not wellsuited to your tastes and preferences; or
b. Produced and sold at a higher cost but designed to attract you
to purchasing it?
Many consumers are willing to accept a higher price for a
differentiated product. So monopolistic competition is not
necessarily bad for consumers.
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25
Making the Connection: Are All
Cupcakes the Same?
In 2002, Mia Bauer opened a
gourmet cupcake store,
Crumbs Bake Shop.
• She sold gourmet
cupcakes and was initially
very profitable, expanding
to 63 stores in 10 states.
But her brand was
insufficient to keep
competitors out of the
market, and in July 2014
Crumbs declared bankruptcy.
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26
13.5 How Marketing Differentiates
Products
Define marketing and explain how firms use marketing to differentiate their products.
Making customers believe that your product is worthwhile and
different from those of other firms is not a trivial exercise. It
typically involves some degree of marketing.
Marketing: All the activities necessary for a firm to sell a product
to a consumer.
Once a firm manages to differentiate its product, it must continue
to do so or risk heading toward the long-run outcome of zero
economic profit. The process of doing this is known as brand
management.
Brand management: The actions of a firm intended to maintain
the differentiation of a product over time.
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27
Advertising
Advertising is a critical element of marketing for monopolistically
competitive firms.
• By advertising effectively, firms can increase demand for their
products.
But they can also use advertising to differentiate their products:
effectively making the demand curve more inelastic.
• This allows firms to charge a higher price and earn more shortrun profit.
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28
Defending a Brand Name
Marketing experts and psychologists agree: a critical aspect of
marketing is creating a brand name for your product.
• A successful brand name can help to maintain product
differentiation and delay the ability of other firms to compete
away your profits.
But firms must always try to maintain the perception of their product
as better than others, making sure that, for example:
• A highly-successful name like Coke, Xerox, or Band-Aid is
uniquely associated to that product and not to generic products,
• Other firms don’t illegally use their brand name, and
• Franchisees and others legally allowed to use their brand name
maintain the level of quality and service you expect.
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29
13.6 What Makes a Firm Successful?
Identify the key factors that determine a firm’s success.
A firm’s ability to differentiate its product and to produce it at a
lower average cost than competing firms creates value for its
customers.
• Some factors that affect a firm’s profitability are not directly
under the firm’s control. Certain factors will affect all the firms in
a market.
• The factors under a firm’s control—the ability to differentiate its
product and the ability to produce it at lower cost—combine
with the factors beyond its control to determine the firm’s
profitability.
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30
Figure 13.7 What Makes a Firm Successful?
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31
Making the Connection: Is Being the
First Firm in a Market a Key to Success?
By being the first to sell a particular good, a firm may
gain a first-mover advantage, finding its name closely
associated with the good in the public’s mind.
Surprisingly, recent research has shown that the first
firm to enter a market often does not have a long-lived
advantage over later entrants.
Among dominant, but not first brands:
• Bic pens
• Apple iPod digital music player
• Hewlett Packard laser printers
In the end, providing customers with good products at a
low price is probably the best way to ensure success.
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1
Economics
6th edition
Chapter 14
1
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Oligopoly: Firms in Less
Competitive Markets
2
Chapter Outline
14.1 Oligopoly and Barriers to Entry
14.2 Game Theory and Oligopoly
14.3 Sequential Games and Business Strategy
14.4 The Five Competitive Forces Model
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3
Oligopoly: a Very Different Market
Structure
In the previous chapters, we examined perfect and monopolistic
competition.
These two market structures were similar: firms produce until their
marginal cost is equal to marginal revenue, and the low barriers to
entry would result in profit being competed away in the long run.
Oligopoly, a market structure in which a small number of
interdependent firms compete, will require completely different
tools to analyze. Why?
1. Oligopolists are large and know that their actions have an
effect on one another.
2. Barriers to entry exist, preventing firms from competing away
profits.
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4
14.1 Oligopoly and Barriers to Entry
Show how barriers to entry explain the existence of oligopolies.
Before we analyze how oligopolists behave, it is useful to know
which firms/markets we are discussing.
A useful tool for identifying the type of market structure is the fourfirm concentration ratio: the fraction of an industry’s sales
accounted for by its four largest firms.
• A four-firm concentration ratio larger than 40 percent tends to
indicate an oligopoly.
Although there are limits to how useful four-firm concentration
ratios can be, they are a useful tool in discussing the
concentration of market power within an industry.
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5
Table 14.1 Examples of Oligopolies in Retail Trade and
Manufacturing
Retail Trade
Industry
Discount department stores
(Walmart and Target)
Manufacturing
Four-Firm
Concentration
Ratio
97%
Industry
Cigarettes (Phillip
Morris and R.J.
Reynolds)
Four-Firm
Concentration
Ratio
98%
Warehouse clubs and
supercenters (Sam’s Club
and BJ’s Wholesale Club)
94%
Beer (AnheuserBusch and
MillerCoors)
90%
College bookstores (Barnes
& Noble and Follett)
75%
Computers (HewlettPackard and Dell)
87%
Hobby, toy, and game
stores (Toys“R”Us and
Michael’s)
72%
Aircraft (Boeing and
Lockheed Martin)
81%
Radio, television, and other
electronic stores (Best Buy
and Apple)
70%
Breakfast cereal
(Kellogg’s and
General Mills)
80%
Athletic footwear stores
(Footlocker and Champs)
68%
71%
Pharmacies and drugstores
(Walgreens and CVS
Caremark)
63%
Dog and cat food
(Mars and Procter &
Gamble)
Automobiles
(General
Motors and Ford)
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68%
6
Limitations of Four-Firm Concentration
Ratios
Four-firm concentration ratios are a good first look at competition
in an industry; above 40 percent indicates an oligopoly to many
economists.
But they have some weaknesses:
1. They do not include the goods and services that foreign firms
exp…
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