8th lecture mono pol is tics

8/2/2019 8th Lecture Mono Pol is Tics

http://slidepdf.com/reader/full/8th-lecture-mono-pol-is-tics 1/12

Monopolistic Competition,

Oligopoly



Theory of Monopolistic

Competition• There are many sellers

and buyers

• Each firm in theindustry produces and

sells a slightly

differentiated product

• There is easy entry and

exit.



The Nature of Monopolistic

Competition• There are substitutes for a firms product, but not

perfect substitutes.

• In perfect competition P = MC , in monopoly, P > MC .

• In perfect competition, the demand curve is sosteep it is practically horizonal; in monopolistic

competitors, the demand curve is downwardsloping

• In the monopolistic competitor P > MR.



The Monopolistic Competitive Output

and Price

The monopolistic

competitor produces that

quantity of output for which MR= MC . This is

Q1 in the exhibit. It

charges the highest priceconsistent with the

quantity , which is P1.



Will There be Profits in the Long

Run?• If firms in the industry are earning profits,

new firms will enter the industry and reduce

the demand that each firm faces.

• Eventually, competition will reduce

economic profits to zero in the long run.



Monopolistic Competition in the

Long RunBecause of easyentry into theindustry, there are

likely to be zeroeconomic profits inthe long run for amonopolistic

competitor. Inother words,P=ATC



A Comparison of Perfect

Competition and

Monopolistic Competition

The perfectly

competitive firm produces a

quantity of output

consistent with

lowest unit costs.

The monopolistic

competitor does

not. If it did, it

would either

produce qMC2,

instead of qMC1

.

The monopolistic

competitor is said

to underutilize its

plant size or to

have excessstorage capacity.



Oligopoly: Assumptions and

Real-World Behavior • There are few sellers and many buyers

• Firms produce and sell either homogeneous

or differentiated products.

• There are significant barriers to entry.

• Concentration Ratio: The percentage of

industry sales accounted for by a set

number of firms in the industry.



Price and Output under Oligopoly

• Cartel Theory: oligopolists in an industry act as if

there were only one firm in the industry.

• A Cartel is an organization of firms that reducesoutput and increases price in an effort to increase

joint profits.

• Each potential member has an incentive to be a free

rider, to stand by and take a free ride from the

actions of others.



The Benefits of Being Members

of a CartelWe assume the industryis in long-runequilibrium, producingQ1, and charging P 1.

There are no profits. Areduction in output to QC

through the formation of a cartel raises price to P C

and brings profits of CP C AB



Problems with Cartels

• High profits will provide an incentive for firmsfrom outside the industry to join the industry.

• After the cartel agreement is made, cartel membershave an incentive to cheat on the agreement.

• If a firm cheats on the cartel agreements and other firms do not, then the cheating firm can increase its

profits. Of course if all firms cheat, the cartelmembers are back where they started at: no cartelagreements and at the original price.

fi f h i i



Benefits of Cheating in a

Cartel AgreementThe situation for arepresentative firm of the cartel: in long-run

competitiveequilibrium, it producesq1 and charges P 1,

earning zero economic profits. As a

consequence of thecartel agreement, itreduces output to qC and

charges P C . Its profits

are the are CP C AB. If itcheats on the cartelagreement and othersdo not, the firm willincrease output to qCC

and reap profits of FP DE

8th lecture mono pol is tics

Documents