Chapter 10-11 Flashcards
characteristics of monopolistic competition
- many firms
- easy entry and exit
- firms compete by selling similar but differentiated products (stress product differentiation)
forms of product differentiation
- product attributes
- service
- location
- brand names and packaging
price and output decisions in monopolistic competition
firm ignores possible reactions of its many competitors because there are too many to take into account
monopolistic competition demand curve
downward sloping, but elasticity depends on how similar products are to rivals’ (flatter than the industry demand curve)
monopolistic competition short run equilibrium
output where MR = MC
monopolistic competition in the long run
positive economic profits –> firms enter market –> demand curve for each existing firm shifts left + demand curve for each existing firm flattens (less differentiation)
–> marginal cost must shift in –> entry continues until each firm earns zero profits, each firm is maximizing profits but pi=0, and each firm is selling at a p,q combination along its demand curve
trade-off between product variety and social costs of higher price/lower output
- pi=0, but not an efficient outcome since P>MC
- firms operate below cost-minimizing levels of operation - could increase production and lower ATC
- consumer gets more choice and product variety
Hotelling Boardwalk example
in monopolistic competition, product variety diminishes over time - both shift closer –> inefficient allocation (ex: radio stations, political parties)
competitive fringe
large number of other firms in industry that do not dominate
examples of oligopolies
banks, railways, oil
characteristics of oligopoly
- market dominated by few firms
- entry barriers exist
- firms are mutually interdependent
mutual interdependence
each firm must consider the possible reaction of its rivals to its price, advertising, and product development decisions
the basic dilemma of an oligopoly
- the firms in an oligopolistic industry will typically make more profits as a group if they cooperate with each other
- however, any firm making more profits for itself competes with the others while they are cooperating
types of cooperative behaviour
- explicit cooperation
2. tacit cooperation
explicit cooperation
firms ensure they will maintain their joint profit maximizing output by an explicit agreement - cartel (tends to be unstable because there is always incentive for an individual firm to cheat) - prohibited in Canada
tacit cooperation
firms recognize influence without explicit agreement to achieve the cooperative equilibrium, but each firm is interested in its own profits and can increase profits by behaving like rivals
the prisoner’s dilemma
example of game theory where equilibrium is the worst possible outcome - noncooperative equilibrium (Nash equilibrium)
Nash equilibrium
each player’s best strategy is to maintain its present behaviour given the present behaviour of the other player - best decision for each firm is worst overall (applies to output quantity, advertisement)
factors that increase incentives to cooperate
- smaller numbers of sellers than larger (due to motivation and ability)
- producers of similar products than differentiated (more direct rivalry)
- growing market rather than contracting
- nonprice rivalry is absent or limited
- when barriers to entry of new firms are greater
competition act and oligopolies
competition act applies to oligopolies too - price fixing is illegal
four firm concentration ratio
the percentage of the value of sales accounted for by the four largest firms
low concentration = high competitiveness
high concentration = low competitiveness
problems with concentration ratios
- definition of the geographic region (industry may not be concentrated at national level but a firm could have a monopoly on a specific region)
- definition of the industry (several firms operate in several industries, but classified only in one)
