McConnellMicro13_Ch11.ppt

PART 3 MICROECONOMICS OF PRODUCT MARKETS Prepared by Dr. Amy Peng Ryerson University © 2013 McGraw-Hill Ryerson Ltd. List the characteristics of monopolistic competition. Explain the importance of price and output in monopolistic competition. Describe the characteristics of oligopoly. Discuss how game theory relates to oligopoly. Compare the incentives and obstacles to collusion among oligopolists. Contrast the potential positive and potential negative effects of advertising. © 2013 McGraw-Hill Ryerson Ltd. Chapter 11 * Relatively large number of sellers Differentiated products Easy entry and exit Advertising © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO1 * Industry concentration Measured by: Four-firm concentration ratios Herfindahl index : Sum of squared market shares 4-Firm CR = Output of four largest firms Total output in the industry HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2 © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO1 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO1 * Source: Statistics Canada, Industrial Organization and Concentration in Manufacturing, Mining and Logging Industries, Catalogue No. 31C0024 Demand is highly elastic Short run profit or loss Produce where MR=MC Long run normal profit Entry and exit Inefficient Product variety © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * Quantity Price and Costs MR = MC MC MR D1 ATC Economic Profit Q1 A1 P1 0 (a) Short-run profits © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * Quantity Price and Costs MC MR D2 ATC Loss Q2 A2 P2 0 MR = MC (b) Short-run losses © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * Quantity Price and Costs MC MR D3 ATC Q3 P3= A3 0 MR = MC (c) Long-run equilibrium © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * Persistent positive profits may persist if: There is continuing and significant product differentiation Entry is somewhat limited by the financial investment required to establish product differentiation Overall, we still expect the general results © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * Inefficient Productive inefficiency P > ATC Allocative inefficiency P > MC © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * P4 Q4 Price is Lower Excess Capacity at Minimum ATC © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * The firm constantly manages price, product, and advertising. Better product differentiation Better advertising The consumer benefits by greater array of choices and better products. Types and Styles Brands and Quality © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO2 * A few large producers Homogeneous or differentiated products Limited control over price Mutual interdependence Strategic behavior Entry barriers Mergers © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO3 * Four-firm concentration ratio 40% or more to be oligopoly Shortcomings Localized markets Inter-industry competition World price Dominant firms © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO3 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO3 * Source: Statistics Canada, Industrial Organization and Concentration in Manufacturing, Mining and Logging Industries. Catalogue No. 31C0024 Oligopolists must make plans in light of the actions and expected reactions of their rivals Basic concepts: Players Rules Strategies Payoffs Equilibrium © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO4 * Al’s Strategy Bill’s Strategy A B C D 4 4 12 1 1 1 1 12 Confess Confess Not Confess Not Confess 2 players 2 strategies Each strategy has a payoff matrix Independent actions stimulate a response © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO4 * RareAir’s Price Strategy Uptown’s Price Strategy A B C D $12 $12 $15 $6 $8 $8 $6 $15 High High Low Low 2 competitors 2 price strategies Each strategy has a payoff matrix Greatest combined profit Independent actions stimulate a response © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO4 * RareAir’s Price Strategy Uptown’s Price Strategy A B C D $12 $12 $15 $6 $8 $8 $6 $15 High High Low Low Independently lowered prices in expectation of greater profit leads to worst combined outcome Eventually low outcomes make firms return to higher prices. © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO4 * Two distinct pricing strategies: Collusive pricing Price leadership There is no one simple model to predict outcomes due to: Diversity of oligopolies Complications of interdependence 11.5 The Incentives and Obstacles to Collusion: Two Oligopoly Strategies © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Collusion: any agreement to fix prices, divide up the market, or otherwise restrict competition Each firm acts as if it were a monopolist © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Three identical firms Each firm finds it most profitable to charge P0, but only if its rivals do The answer: collude and agree on price P0 Cartels and Other Collusion: Cooperative Strategies © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * D MR=MC ATC MC MR P0 A0 Q0 Economic Profit © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Cartels - a group of firms or nations that collude Formally agreeing to the price Sets output levels for members Collusion is illegal in Canada OPEC © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Demand and cost differences Number of firms Cheating Recession New entrants Legal obstacles © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Price Leadership Dominant firm initiates price changes Other firms follow the leader Use limit pricing to block entry of new firms Possible price war © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO5 * Prevalent to compete with product development and advertising Less easily duplicated than a price change Financially able to advertise © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO6 * Low-cost way of providing information to consumers Enhances competition Speeds up technological progress Can help firms obtain economies of scale © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO6 * Can be manipulative Contains misleading claims that confuse consumers Consumers pay high prices for a good while forgoing a better, lower priced, unadvertised version of the product. © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO6 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO6 * Oligopolies are inefficient Productively inefficient P > minATC Allocatively inefficient P > MC Qualifications Increased foreign competition Limit pricing Technological advance © 2013 McGraw-Hill Ryerson Ltd. Chapter 11, LO6 * The beer industry is now an oligopoly. Changes in demand Change in tastes Consumed at home and mass produced Changes in supply Technological advance Economies of scale © 2013 McGraw-Hill Ryerson Ltd. Chapter 11 * 11.1 Characteristics of Monopolistic Competition 11.2 Price and Output in Monopolistic Competition 11.3 The Characteristics of Oligopoly 11.4 Oligopoly Pricing Behaviour 11.5 Two Oligopoly Strategies 11.6 Oligopoly and Advertising © 2013 McGraw-Hill Ryerson Ltd. Chapter 11 *