Micro economic MONOPOLISTIC COMPETITION.ppt

1、14,MONOPOLISTIC COMPETITION,The online shoe store lists athletic shooes made by 56 different producers in 40 different categories and price between$25 and $850. It offers 1,404 different types for women and 1,757 different types for men. Athletic shoe producers compete, but each has a monopoly on it

2、s own special kind of shoe. With so many different types of athletic shoes, the market isnt perfectly competitive. The model of monopolistic competition helps us to understand the competition that we see in the markets for athletic shoes and most other goods and services we buy.,Monopolistic competi

3、tion is a market structure in which A large number of firms compete. Each firm produces a differentiated product. Firms compete on product quality, price, and marketing. Firms are free to enter and exit the industry.,What Is Monopolistic Competition?,Monopolistic Competition,Large Number of Firms Th

4、e presence of a large number of firms in the market implies: Each firm has only a small market share and therefore has limited market power to influence the price of its product. Each firm is sensitive to the average market price, but no firm pays attention to the actions of others. So no one firms

5、actions directly affect the actions of others. Collusion, or conspiring to fix prices, is impossible.,Product Differentiation A firm in monopolistic competition practices product differentiation if the firm makes a product that is slightly different from the products of competing firms.,What Is Mono

6、polistic Competition?,Competing on Quality, Price, and Marketing Product differentiation enables firms to compete in three areas: quality, price, and marketing. Quality includes design, reliability, and service. Because firms produce differentiated products, the demand for each firms product is down

7、ward sloping. But there is a tradeoff between price and quality. Because products are differentiated, a firm must market its product. Marketing takes the two main forms: advertising and packaging.,What Is Monopolistic Competition?,Entry and Exit There are no barriers to entry in monopolistic competi

8、tion, so firms cannot make an economic profit in the long run. Examples of Monopolistic Competition Producers of audio and video equipment, clothing, jewelry, computers, and sporting goods operate in monopolistic competition.,Monopolistic Competition,Price and Output in Monopolistic Competition,The

9、Firms Short-Run Output and Price Decision A firm that has decided the quality of its product and its marketing program produces the profit-maximizing quantity (the quantity at which MR = MC). Price is determined from the demand for the firms product and is the highest price that the firm can charge

10、for the profit-maximizing quantity. Figure 14.1 shows a firms economic profit in the short run.,The firm in monopolistic competition operates likea single-price monopoly. The firm produces the quantity at which MR equals MC and sells that quantity for the highest possible price. It makes an economic

11、 profit (as in this example) when P ATC.,Price and Output in Monopolistic Competition,Profit Maximizing Might Be Loss Minimizing A firm might incur an economic loss in the short run. Here is an example. At the profit-maximizing quantity, P ATC and the firm incurs an economic loss.,Price and Output i

12、n Monopolistic Competition,Long Run: Zero Economic Profit In the long run, economic profit induces entry. And entry continues as long as firms in the industry earn an economic profitas long as (P ATC). In the long run, a firm in monopolistic competition maximizes its profit by producing the quantity

13、 at which its marginal revenue equals its marginal cost, MR = MC.,Price and Output in Monopolistic Competition,As firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward. The decrease in de

14、mand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity. Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.,Price and Output in Monopolistic Competition,Figure 14.3 shows a firm in monopolistic c

15、ompetition in long-run equilibrium.,Price and Output in Monopolistic Competition,Monopolistic Competition and Perfect Competition Two key differences between monopolistic competition and perfect competition are: Excess capacity Markup A firm has excess capacity if it produces less than the quantity

16、at which ATC is a minimum. A firms markup is the amount by which its price exceeds its marginal cost.,Price and Output in Monopolistic Competition,Firms in monopolistic competition operate with excess capacity in long-run equilibrium. Firms produce less than the efficient scalethe quantity at which

17、ATC is a minimum. The downward-sloping demand curve for their products drives this result.,Price and Output in Monopolistic Competition,Firms in monopolistic competition operate with positive markup. Again, the downward-sloping demand curve for their products drives this result.,Price and Output in

18、Monopolistic Competition,In contrast, firms in perfect competition have: no excess capacity and no markup. The perfectly elastic demand curve for their products drives this result.,Price and Output in Monopolistic Competition,Is Monopolistic Competition Efficient? Price equals marginal social benefi

19、t. The firms marginal cost equals marginal social cost. Price exceeds marginal cost, so marginal social benefit exceeds marginal social cost. So the firm in monopolistic competition in the long run produces less than the efficient quantity.,Price and Output in Monopolistic Competition,Making the Rel

20、evant Comparison The markup that drives a gap between price and marginal cost arises from product differentiation. People value product variety, but product variety is costly. The efficient degree of product variety is the one for which the marginal social benefit of product variety equals its margi

21、nal social cost. The loss that arises because the quantity produced is less than the efficient quantity is offset by the gain that arises from having a greater degree of product variety.,Price and Output in Monopolistic Competition,Product Development and Marketing,Innovation and Product Development

22、 Weve looked at a firms profit-maximizing output decision in the short run and in the long run, for a given product and with given marketing effort. To keep making an economic profit, a firm in monopolistic competition must be in a state of continuous product development. New product development all

23、ows a firm to gain a competitive edge, if only temporarily, before competitors imitate the innovation.,Innovation is costly, but it increases total revenue. Firms pursue product development until the marginal revenue from innovation equals the marginal cost of innovation. The amount of production de

24、velopment is efficient if the marginal social benefit of an innovation (which is the amount the consumer is willing to pay for the innovation) equals the marginal social cost that firms incur to make the innovation.,Product Development and Marketing,Advertising A firm with a differentiated product n

25、eeds to ensure that customers know that its product differs from its competitors. Firms use advertising and packaging to achieve this goal. A large proportion of the price we pay for a good covers the cost of selling it. Advertising expenditures affect the firms profit in two ways: They increase cos

26、ts, and they change demand.,Product Development and Marketing,Selling Costs and Total Costs Selling costs, like advertising expenditures, fancy retail buildings, etc. are fixed costs. Average fixed costs decrease as production increases, so selling costs increase average total costs at any given qua

27、ntity but do not affect the marginal cost of production. Selling efforts such as advertising are successful if they increase the demand for the firms product.,Product Development and Marketing,Advertising costs might lower the average total cost by increasing equilibrium output and spreading their f

28、ixed costs over the larger quantity produced. Here, with no advertising, the firm produces 25 units of output at an average total cost of $60.,Product Development and Marketing,With advertising, the firm produces 100 units of output at an average total cost of $40. Advertising expenditure shifts the

29、 ATC curve upward, but the firm operates at a larger output and lower average total cost than it would without advertising.,Product Development and Marketing,Advertising might also decrease the markup. In Figure 14.6(a), with no advertising, demand is not very elastic and the markup is large. In Fig

30、ure 14.6(b), if all firms advertise demand becomes more elastic, the quantity increases, the price falls and the markup decreases.,Product Development and Marketing,Using Advertising to Signal Quality Why do Coke and Pepsi spend millions of dollars a month advertising products that everyone knows? O

31、ne answer is that these firms use advertising to signal the high quality of their products. A signal is an action taken by an informed person or firm to send a message to uninformed people.,Product Development and Marketing,Coke is a high quality cola, and Oke is a low quality cola. If Coke spends m

32、illions on advertising, people think “Coke must be good.” If it is truly good, when they try it, they will like it and keep buying it. If Oke spends millions on advertising, people think “Oke must be good.” If it is truly bad, when they try it, they will hate it and stop buying it.,Product Developme

33、nt and Marketing,So if Oke knows its product is bad, it will not bother to waste millions on advertising it. And if Coke knows its product is good, it will spend millions on advertising it. Consumers will read the signals and get the correct message. None of the ads need mention the product. They ju

34、st need to be flashy and expensive.,Product Development and Marketing,Brand Names Why do firms spend millions of dollars to establish a brand name or image? Again, the answer is to provide information about quality and consistency. Youre more likely to overnight at a Holiday Inn than at Joes Motel b

35、ecause Holiday Inn has incurred the cost of establishing a brand name and you know what to expect if you stay there.,Product Development and Marketing,Efficiency of Advertising and Brand Names To the extent that advertising and selling costs provide consumers with information and services that they

36、value more highly than their cost, these activities are efficient.,Product Development and Marketing,15,OLIGOPOLY,In some markets, there are only a few firms compete. For example, computer chips are made by Intel and Advanced Micro Devices and each firm must pay close attention to what the other fir

37、m is doing. How does competition between just two chip makers work? When a market has only a small number of firms, do they operate in the social interest, like firms in perfect competition? Or do they restrict output to increase profit, like a monopoly? The models of perfect competition and monopol

38、y dont predict the behavior of the firms weve just described. To understand how these markets work, we need the richer models.,What Is Oligopoly?,Oligopoly is a market structure in which Natural or legal barriers prevent the entry of new firms. A small number of firms compete.,Barriers to Entry Eith

39、er natural or legal barriers to entry can create oligopoly. Figure 15.1 shows two oligopoly situations. In part (a), there is a natural duopolya market with two firms.,What Is Oligopoly?,In part (b), there is a natural oligopoly market with three firms. A legal oligopoly might arise even where the d

40、emand and costs leave room for a larger number of firms.,What Is Oligopoly?,Small Number of Firms Because an oligopoly market has only a few firms, they are interdependent and face a temptation to cooperate. Interdependence: With a small number of firms, each firms profit depends on every firms acti

41、ons. Temptation to Cooperate: Firms in oligopoly face the temptation to form a cartel. A cartel is a group of firms acting together to limit output, raise price, and increase profit. Cartels are illegal.,What Is Oligopoly?,Oligopoly Games,Game theory is a tool for studying strategic behavior, which

42、is behavior that takes into account the expected behavior of others and the mutual recognition of interdependence. All games have four common features: Rules Strategies Payoffs Outcome,The Prisoners Dilemma In the prisoners dilemma game, two prisoners (Art and Bob) have been caught committing a pett

43、y crime. Rules The rules describe the setting of the game, the actions the players may take, and the consequences of those actions. Each is held in a separate cell and cannot communicate with each other.,Oligopoly Games,Each is told that both are suspected of committing a more serious crime. If one

44、of them confesses, he will get a 1-year sentence for cooperating while his accomplice get a 10-year sentence for both crimes. If both confess to the more serious crime, each receives 3 years in jail for both crimes. If neither confesses, each receives a 2-year sentence for the minor crime only.,Olig

45、opoly Games,Strategies Strategies are all the possible actions of each player. Art and Bob each have two possible actions: 1. Confess to the larger crime. 2. Deny having committed the larger crime. With two players and two actions for each player, there are four possible outcomes: 1. Both confess. 2

46、. Both deny. 3. Art confesses and Bob denies. 4. Bob confesses and Art denies.,Oligopoly Games,Payoffs Each prisoner can work out what happens to himcan work out his payoffin each of the four possible outcomes. We can tabulate these outcomes in a payoff matrix. A payoff matrix is a table that shows

47、the payoffs for every possible action by each player for every possible action by the other player. The next slide shows the payoff matrix for this prisoners dilemma game.,Oligopoly Games,Oligopoly Games,Outcome If a player makes a rational choice in pursuit of his own best interest, he chooses the

48、action that is best for him, given any action taken by the other player. If both players are rational and choose their actions in this way, the outcome is an equilibrium called Nash equilibriumfirst proposed by John Nash. Finding the Nash Equilibrium The following slides show how to find the Nash eq

49、uilibrium.,Oligopoly Games,Bobs view of the world,Bobs view of the world,Arts view of the world,Arts view of the world,Equilibrium,Oligopoly Games,The Dilemma The dilemma arises as each prisoner contemplates the consequences of his decision and puts himself in the place of his accomplice. Each knows

50、 that it would be best if both denied. But each also knows that if he denies it is in the best interest of the other to confess. The dilemma leads to the equilibrium of the game.,Oligopoly Games,Bad Outcome For the prisoners, the equilibrium of the game is not the best outcome. If neither confesses,

51、 each gets a 2-year sentence. Can this better outcome be achieved? No, it cant because each prisoner can figure out that there is a best strategy for each of them. Each knows that it is not in his best interest to deny.,An Oligopoly Price-Fixing Game A game like the prisoners dilemma is played in du

52、opoly. A duopoly is a market in which there are only two producers that compete. Duopoly captures the essence of oligopoly. Cost and Demand Conditions Figure 15.2 on the next slide describes the cost and demand situation in a natural duopoly.,Oligopoly Games,Part (a) shows each firms cost curves. Part (b) shows the market demand curve.,Oligopoly Games,This industry is a natural duopoly. Two firms can meet the market demand at the least cost.,Oligopoly Games,How does this market work?