Week 9 A

Week 9 A - COMM 295 Nov. 2nd, 2010 Monopolistic Competition...

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COMM 295 Nov. 2 nd , 2010 Monopolistic Competition and Introduction to Game Theory
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2 Topics Overview of Monopolistic Competition Characteristics of Monopolistically Competitive Industry Model of Short-Run Monopolistic Competition Long Run Monopolistic Competition; Economic Efficiency Prisoners’ Dilemma Introduction to Game Theory
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3 Characteristics of Monopolistic Competition Monopolistic competition combines elements of monopoly and competition. Monopoly because firms sell differentiated products and have some market power Competition because there are many firms and entry/exit is easy. Entry/exit 0 profits in LR Products are differentiated because of: product characteristics (e.g. 2 food outlets in mall) location (e.g., milk sold in supermarket vs. 7-11) advertising (e.g., different brands of bottle water)
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4 Many Real-World Firms are Monopolistically Competitive Monopolistic competition helps to explain market structure for many real world firms that we observe: Restaurants Computer manufacturers Retail bike shops Accountants, lawyers, dentists, etc These firms don’t tend to interact strategically – they face a downward sloping demand and optimize – more firms means less demand for everyone
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5 Illustration of Monopolistic Competition in Short Run Profits MC ATC Demand MR P ATC Positive profits in SR Over time, profits attracts entry, and this shifts demand inward, eventually eliminating profits Cost q*
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6 Illustration of Monopolistic Competition in Long Run Demand (2) MR (3) MC ATC (1) P = ATC In the LR, the demand curve continues to shift in because entry will eventually eliminate all profits LR is characterized by: (1) MR = MC; and (2) demand is tangent to ATC zero profits, P = ATC q*(4)
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7 Illustration of Inefficiency of LR Monopolistic Competition Demand MR MC ATC P The LR outcome is more efficient than pure monopoly (profits = 0) but is less efficient than perfect competition The industry does not operate at minimum ATC because of the market power; LR price is suboptimally high and LR quantity is suboptimally low With perfect competition, price is driven down to minimum ATC and Q rises to here in the LR
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8 Example The demand curve facing the i th firm in a monopolistic competitive industry is given by q i = (105 – n) – P i where n denotes the number of firms operating in the industry. The cost function for each firm is given by C i = 5q i + 20. How many firms will operate in the long run equilibrium?
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Answer to Problem
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Prisoners’ Dilemma If profits are higher with collusion, then we should expect the collusion outcome to emerge instead of the Nash outcomes examined previously If firms attempt to collude, each firm has an incentive to cheat the other and so the collusive outcome is hard to maintain Incentive cheat is called the Prisoners’ Dilemma Prisoners’ dilemma works for both quantity and price competition We generally show PD with price competition
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Week 9 A - COMM 295 Nov. 2nd, 2010 Monopolistic Competition...

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