ECMC02-5 - Outline Monopolistic Competition ECMC02 Lecture...

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1 0 ECMC02 – Lecture 5 Oligopoly Ata Mazaheri 1 Monopolistic Competition Oligopoly - Price Competition - Competition versus Collusion: - The Prisoners’ Dilemma - Implications of the Prisoners’ Dilemma for Oligopolistic Pricing Cartels Outline 2 Monopolistic Competition and Oligopoly u monopolistic competition Market in which firms can enter freely, each producing its own brand or version of a differentiated product. u oligopoly Market in which only a few firms compete with one another, and entry by new firms is impeded. u cartel Market in which some or all firms explicitly collude, coordinating prices and output levels to maximize joint profits. 3 MONOPOLISTIC COMPETITION A monopolistically competitive market has two key characteristics: 1. Firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes. In other words, the cross-price elasticities of demand are large but not infinite. 2. There is free entry and exit: it is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their products become unprofitable. 4 MONOPOLISTIC COMPETITION • Equilibrium in the Short Run and the Long Run Because the firm is the only producer of its brand, it faces a downward-sloping demand curve. Price exceeds marginal cost and the firm has monopoly power. In the short run, described in part (a), price also exceeds average cost, and the firm earns profits shown by the yel ow- shaded rectangle. 5 MONOPOLISTIC COMPETITION • Equilibrium in the Short Run and the Long Run In the long run, these profits attract new firms with competing brands. The firm’s market share fal s, and its demand curve shifts downward. In long-run equilibrium, described in part (b), price equals average cost, so the firm earns zero profit even though it has monopoly power.
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2 6 MONOPOLISTIC COMPETITION • Monopolistic Competition and Economic Efficiency Under monopolistic competition, price exceeds marginal cost. Thus there is a deadweight loss, as shown by the yel ow- shaded area. The demand curve is downward-sloping, so the zero-profit point is to the left of the point of minimum average cost. Comparison of Monopolistically Competitive Equilibrium and Perfectly Competitive Equilibrium In both types of markets, entry occurs until profits are driven to zero. In evaluating monopolistic competition, these inefficiencies must be balanced against the gains to consumers from product diversity. 7 MONOPOLISTIC COMPETITION Elasticities of Demand for Brands of Colas and Coffee Brand Elasticity of Demand Colas Royal Crown –2.4 Coke –5.2 to –5.7 Ground coffee Folgers –6.4 Maxwell House –8.2 Chock Full o’Nuts –3.6 With the exception of Royal Crown and Chock Full o’ Nuts, all the colas and coffees are quite price elastic. With elasticities on the order of ±4 to ±8, each brand has only limited monopoly power. This is typical of monopolistic competition. 8
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This note was uploaded on 07/20/2011 for the course MGMT 2 taught by Professor Mazaheri during the Spring '11 term at University of Toronto- Toronto.

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ECMC02-5 - Outline Monopolistic Competition ECMC02 Lecture...

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