Chapter 7 - Monopolistic Competition and Oligopoly

Question 1

What is monopolistic competition?

Answer 1

It lies between the extremes of pure competition and monopoly. If refers to a market where relatively large number (over 25) small producers or suppliers are offering similar but not identical products.

Question 2

What are the three characteristics of monopolistic competition?

Answer 2

1) each firm has a small market share
2) there is no collusion to restrict output and manipulate price
3) there is no feeing of mutual interdependence - they act independently

Question 3

What is product differentiation? give examples.

Answer 3

It is any tangible or intangible feature of a product sets it apart from other similar products resulting in a preference for that product among buyers. It is competition on brand, quality, service, location, promotion and packaging.

Question 4

Is it easy or difficult to enter a monopolistically competitive industry?

Answer 4

Relatively easy because of the low economies of scale required and the low set up costs.

Question 5

What is a good monopolistic competitive industry?

Answer 5

Hospitality industry - approx. 90% are small to medium players.

Question 6

What is the demand curve for a monopolistically competitive seller? and why?

Answer 6

It is highly, but not perfectly elastic. This is because:

• there are more close substitutes than a pure monopolist
• there are no perfect substitutes (as is the case with perfect competition)
• elasticity depends on - number of rivals and degree of product differentiation.

Question 7

What does the monopolistically competitive seller aim for when determining the amount to produce?

Answer 7

MR=MC

Question 8

How is a profit expressed and what does it lead to?

Answer 8

ACATC - entry of new firms

Question 9

How is a loss expressed and what does it lead to?

Answer 9

AC>AR (D) or P<ATC - exit of firms

Question 10

What is the tendency for monopolistic firms in the long run?

Answer 10

To earn a normal profit (break even). This is called the tangency solution?

Question 11

Define the tangency solution?

Answer 11

An economic proof used to show that in the long run a monopolistically competitive firm will realise only a normal profit because the profit-maximising output will occur when its demand curve is at a tangent to its ATC curve. ie. when AC=AR (D)

Question 12

Why do monopolistically competitive firms tend to break even in the long run?

Answer 12

• Profits attract new entrants

* Losses encourage exits

Question 13

What complications with monopolistically competitive firms mean we can only generalise about the break even tendency?

Answer 13

• some firms achieve a product differentiation which cannot be copied
• some entry is partially restricted due to a patent or other advantage
• some economic losses may be tolerated by firms in the long run.

Question 14

What does economic efficiency require?

Answer 14

P=MC=AC
P=MC is the equation for allocative efficiency
MC=AC is the equation for productive efficiency

Question 15

What does the application of the tangency solution suggest in relation to the long-run equilibrium for a monopolistically competitive firm?

Answer 15

That because of the productive inefficiency, there will be excess capacity?

Question 16

What is excess capacity?

Answer 16

It is when firms produce at a higher unit cost than minimum ATC at equilibrium. The firm is producing on the down-sloping section of its ATC curve.

Question 17

Why are the losses to productive efficiency accepted?

Answer 17

For increased product variety and increased levels of consumer choice.

Question 18

What is non-price competition?

Answer 18

To improve profitability and assist their long-run equilibrium position firms differentiate their product through development and advertising.

Question 19

What does product development drive?

Answer 19

Technological innovation and product improvement.

Question 20

What are the economic benefits of advertising for a monopolistically competitive firm?

Answer 20

• information and efficiency in product search for consumer
• competition reduces monopoly power
• supports national communications eg. TV & Radio

Question 21

What does the case against advertising include?

Answer 21

• it is persuasion rather than information and as such is a waste
• its concentration and promotion of a monopoly.

Question 22

What are some general comments on a monopolistic competition?

Answer 22

• it requires more complex decision making than in pure competition or a monopoly as they have to decide on price, output and promotion levels to maximise profits.
• promotion actions of rivals may need to be taken into account in order to protect a firm’s market share.

Question 23

What is an oligopoly?

Answer 23

It is a situation when the number of firms in an industry is so small that each must consider the reactions of rivals in formulating its price.

Question 24

Are there different types of oligopolies?

Answer 24

Yes they may be homogenous (standard products such as petrol, metal and rope) or differentiated (cars, biscuits, beer and cigarettes).

Question 25

What is a concentration ratio and what do they show?

Answer 25

They are ratios that show the percentage of total industry sales accounted for by a given number of the largest firms in each industry.

Question 26

What are the short comings of concentration ratios?

Answer 26

* relate to the nation as a whole, even though some are highly localised * definitions are broad & don't account for inter-industry competition * Australian data only so imports are not considered * they don't tell us about actual market behaviour.

Question 27

What are the barriers to entry for a oligopoly?

Answer 27

They are similar to a pure monopoly - * difficult to get required economies of scale * large start up and working capital may be needed * mergers that give firms more market power and allow economies of scale to be realised * other barriers, eg patents and control of inputs.

Question 28

What is a merger?

Answer 28

The combining of two or more competing firms with a resulting increase in size, market share and economic power.

Question 29

What are four factors that influence the strategical behaviour of an oligopoly?

Answer 29

* mutual interdependence - how much the fate of one company lies with the performance and decisions of another * collusion * incentives to cheat (say one thing and do another) * a maxim strategy

Question 30

What is collusion/

Answer 30

a type of formal or informal arrangement to co-ordnate pricing strategies or fix prices

Question 31

What is a maxim strategy?

Answer 31

It involves choosing the strategy or decision, that maximises the minimum expected payoff in the game.

Question 32

What will the maximum strategy result in?

Answer 32

Nash equilibrium which is for each firm to charge a low price regardless of the choice the other firm makes.

Question 33

No single model of oligopoly covers all aspects of oligopolistic behaviour. Why is this?

Answer 33

Because ologopolistic behaviour encompasses: * tight and loose oligopoly markets * different degrees of product differentiation and standardisation * illegal collusion verses independent behaviour * high verses low barriers to entry * mutual interdependence of decision making.

Question 34

What are four different price-output models for an oligopoly?

Answer 34

1) The kinked demand curve 2) Collusive pricing 3) Price leadership model 4) Cost-plus pricing

Question 35

What are the features of a kinked demand: non-collusive oligopoly model?

Answer 35

Output occurs where MR=MC Price remains stable avoiding price wars - firms ignore price increases and decreases and price stability even present when costs change.

Question 36

What are the criticisms of the kinked demand model?

Answer 36

That it does not show how the current price is set and also that prices may not be as inflexible as the model suggests.

Question 37

What assumptions is the kinked demand curve for a non-collusive oligopolist based on?

Answer 37

That rivals will match price decreases and ignore price increases. This means firms will start with one demand curve and as another under cuts it, they will match it bending the line.

Question 38

What is the collusion and cartels model?

Answer 38

That overt or covert agreements are made to fix prices, divide up or share the market or limit competition between firms. The output and price are the same as a monopolist.

Question 39

What are the two forms of collusion or covert agreements?

Answer 39

* Cartels | * Gentlemans agreements

Question 40

What are cartels?

Answer 40

They are a group(s) of firms that agree either formally or informally to set prices and output levels of particular products among members.

Question 41

What is a 'gentleman's agreement'?

Answer 41

It is a form of collusion whereby groups of firms agree verbally to set prices and output levels of particular products among members; usually made in informal settings such as a golf course.

Question 42

What are the obstacles to collusion?

Answer 42

* Demand and cost differences between firms * Number of firms * Cheating * Recession-slumping markets cause costs to rise * Legislative obstacles - trade practices law

Question 43

What is price leadership?

Answer 43

It is a type of gentleman's agreement in which oligopolists automatically follow the price initiatives of the dominant firm in an industry.

Question 44

What are factors of price leadership?

Answer 44

* Infrequent price changes by the price leader * Price announcements are often made through indirect channels such as trade publications * Price leader may choose strategies to block potential entrants, eg. limit-pricing or price blocking

Question 45

What is the cost-plus pricing model?

Answer 45

An oligopolist uses a standard formula to estimate cost per unit of output and adds a mark up to determine price. It has advantages for multi-product firms and consistent with outright collusion.

Question 46

As oligopolists dislike price competition and because some informal price collusion occurs, how can an oligopolist compete?

Answer 46

* with advertising and product development

Question 47

Why cannot oligopolists compete on price?

Answer 47

Because: * price cuts can be quickly and easily met by a firms rivals * oligopolists typically have substancial financial resources to support advertising and product development * menu cost (to alter)

Question 48

Why is allocative and productive efficiency unlikely to be achieved under most forms of oligopoly?

Answer 48

Because this reflects the fact that price will exceed marginal cost and average cost at equilibrium,

Question 49

What causes productive inefficiency?

Answer 49

* Minimum ATC is not necessarily chosen | * Under-allocation of resources

Question 50

What causes allocative inefficiency?

Answer 50

* price does not necessarily equal MC | * output is restricted

Question 51

What are the two different views about dynamic efficiency?

Answer 51

The Competitive View and the Schumpeter-Galbraith view.

Question 52

What is the competitive view?

Answer 52

This suggests that in the longer term, oligopoly is inferior to more competitive structures in promoting product improvement and innovate cost reductions.

Question 53

What is the Schumpeter-Galbraith view?

Answer 53

It is that oligopolists have both the incentive and financial and technical resources to be more technologically progressive than competitive firms.