Ch12 - Monopolistic Competition and Oligopoly

9 why does price leadership sometimes evolve in

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9.  Why does price leadership sometimes evolve in oligopolistic markets?  Explain how the  price leader determines a profit-maximizing price. Since firms cannot explicitly coordinate on setting price, they use implicit means.  One form of implicit collusion is to follow a price leader. The price leader, often the  dominant firm in the industry, determines its profit-maximizing price by calculating  the demand curve it faces: it subtracts the quantity supplied at each price by all other  firms from the market demand, and the residual is its demand curve.  The leader  chooses the quantity that equates its marginal revenue with marginal cost.   The  market price is the price at which the leader’s profit-maximizing quantity sells in the  market.  At that price, the followers supply the remainder of the market. 10.   Why has the OPEC oil cartel succeeded in raising prices substantially, while the  CIPEC copper cartel has not?  What conditions are necessary for successful cartelization?  What organizational problems must a cartel overcome? Successful cartelization requires two characteristics: demand should be inelastic, and  the cartel must be able to control most of the supply.  OPEC succeeded in the short  run because the short-run demand and supply of oil were both inelastic.  CIPEC has  not   been   successful   because   both   demand   and   non-CIPEC   supply   were   highly  responsive to price.  A cartel faces two organizational problems: agreement on a price  and a division of the market among cartel members; and monitoring and enforcing  the agreement. EXERCISES 1.  Suppose all firms in a monopolistically competitive industry were merged into one large  firm.  Would that new firm produce as many different brands?  Would it produce only a  single brand?  Explain. Monopolistic competition  is defined by product  differentiation.    Each  firm  earns  economic profit by distinguishing its brand from all other brands.  This distinction  can   arise   from   underlying   differences   in   the   product   or   from   differences   in  advertising.  If these competitors merge into a single firm, the resulting monopolist  would not produce as many brands, since too much brand competition is internecine  (mutually   destructive).     However,   it   is   unlikely   that   only   one   brand   would   be  194
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Chapter  12:  Monopolistic Competition and Oligopoly produced  after the  merger.    Producing  several  brands with  different  prices and  characteristics is one method of splitting the market into sets of customers with  different price elasticities, which may also stimulate overall demand.
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