Chapter 7 - Monopolistic Competition and Oligopoly Flashcards
What is monopolistic competition?
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.
What are the three characteristics of monopolistic competition?
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
What is product differentiation? give examples.
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.
Is it easy or difficult to enter a monopolistically competitive industry?
Relatively easy because of the low economies of scale required and the low set up costs.
What is a good monopolistic competitive industry?
Hospitality industry - approx. 90% are small to medium players.
What is the demand curve for a monopolistically competitive seller? and why?
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.
What does the monopolistically competitive seller aim for when determining the amount to produce?
MR=MC
How is a profit expressed and what does it lead to?
ACATC - entry of new firms
How is a loss expressed and what does it lead to?
AC>AR (D) or P<ATC - exit of firms
What is the tendency for monopolistic firms in the long run?
To earn a normal profit (break even). This is called the tangency solution?
Define the tangency solution?
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)
Why do monopolistically competitive firms tend to break even in the long run?
- Profits attract new entrants
* Losses encourage exits
What complications with monopolistically competitive firms mean we can only generalise about the break even tendency?
- 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.
What does economic efficiency require?
P=MC=AC
P=MC is the equation for allocative efficiency
MC=AC is the equation for productive efficiency
What does the application of the tangency solution suggest in relation to the long-run equilibrium for a monopolistically competitive firm?
That because of the productive inefficiency, there will be excess capacity?
What is excess capacity?
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.
Why are the losses to productive efficiency accepted?
For increased product variety and increased levels of consumer choice.
What is non-price competition?
To improve profitability and assist their long-run equilibrium position firms differentiate their product through development and advertising.
What does product development drive?
Technological innovation and product improvement.
What are the economic benefits of advertising for a monopolistically competitive firm?
- information and efficiency in product search for consumer
- competition reduces monopoly power
- supports national communications eg. TV & Radio
What does the case against advertising include?
- it is persuasion rather than information and as such is a waste
- its concentration and promotion of a monopoly.
What are some general comments on a monopolistic competition?
- 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.
What is an oligopoly?
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.
Are there different types of oligopolies?
Yes they may be homogenous (standard products such as petrol, metal and rope) or differentiated (cars, biscuits, beer and cigarettes).
What is a concentration ratio and what do they show?
They are ratios that show the percentage of total industry sales accounted for by a given number of the largest firms in each industry.
What are the short comings of concentration ratios?
- 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.
What are the barriers to entry for a oligopoly?
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.
What is a merger?
The combining of two or more competing firms with a resulting increase in size, market share and economic power.
What are four factors that influence the strategical behaviour of an oligopoly?
- 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
What is collusion/
a type of formal or informal arrangement to co-ordnate pricing strategies or fix prices
What is a maxim strategy?
It involves choosing the strategy or decision, that maximises the minimum expected payoff in the game.
What will the maximum strategy result in?
Nash equilibrium which is for each firm to charge a low price regardless of the choice the other firm makes.
No single model of oligopoly covers all aspects of oligopolistic behaviour. Why is this?
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.
What are four different price-output models for an oligopoly?
1) The kinked demand curve
2) Collusive pricing
3) Price leadership model
4) Cost-plus pricing
What are the features of a kinked demand: non-collusive oligopoly model?
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.
What are the criticisms of the kinked demand model?
That it does not show how the current price is set and also that prices may not be as inflexible as the model suggests.
What assumptions is the kinked demand curve for a non-collusive oligopolist based on?
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.
What is the collusion and cartels model?
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.
What are the two forms of collusion or covert agreements?
- Cartels
* Gentlemans agreements
What are cartels?
They are a group(s) of firms that agree either formally or informally to set prices and output levels of particular products among members.
What is a ‘gentleman’s agreement’?
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.
What are the obstacles to collusion?
- Demand and cost differences between firms
- Number of firms
- Cheating
- Recession-slumping markets cause costs to rise
- Legislative obstacles - trade practices law
What is price leadership?
It is a type of gentleman’s agreement in which oligopolists automatically follow the price initiatives of the dominant firm in an industry.
What are factors of price leadership?
- 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
What is the cost-plus pricing model?
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.
As oligopolists dislike price competition and because some informal price collusion occurs, how can an oligopolist compete?
- with advertising and product development
Why cannot oligopolists compete on price?
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)
Why is allocative and productive efficiency unlikely to be achieved under most forms of oligopoly?
Because this reflects the fact that price will exceed marginal cost and average cost at equilibrium,
What causes productive inefficiency?
- Minimum ATC is not necessarily chosen
* Under-allocation of resources
What causes allocative inefficiency?
- price does not necessarily equal MC
* output is restricted
What are the two different views about dynamic efficiency?
The Competitive View and the Schumpeter-Galbraith view.
What is the competitive view?
This suggests that in the longer term, oligopoly is inferior to more competitive structures in promoting product improvement and innovate cost reductions.
What is the Schumpeter-Galbraith view?
It is that oligopolists have both the incentive and financial and technical resources to be more technologically progressive than competitive firms.
