Monopolistic Competition and Oligopoly

 On one extreme is the Perfect Competition model  On the other extreme is the Monopoly Model  Monopolistic Competition & Oligopoly are competitive

scenarios that lie between these two extremes
 Therefore, competitive features of Monopolistic

Competition and Oligopoly will emulate either Perfect Competition or Monopoly
1

Characteristics of Monopolistic Competition
 Power to set prices somewhat like a monopoly  Face competition like perfect competition

*********************************************  Large number of firms -- Each firm has relatively small market share -- Each firm must be sensitive to average market price of its product -- Collusion is not possible due to the number of firms  No barriers to entry or exit 2

Characteristics of Monopolistic Competition
 Product Differentiation – Each firm makes a product that

is slightly different from the products of competing firms. -- Close substitutes but no perfect substitutes -- An attempt to increase price will normally results in a lower volume sold  Competition on Quality, Price, Marketing -- Quality is design, reliability, service provided to buyer and ease of access to product -- Price – downward sloping demand curve -- Marketing – firm must market = promotion, distribution, packaging 3

Product Differentiation
 Product differentiation is crucial to

monopolistic competition  People value variety, even if it is not material (real)  Product differentiation takes place in buyer’s mind  Americans are provided with a wide variety of products and services  Variety is valued but costly – we pay for it

The Typical Monopolistic Competitor

 The monopolistic competitor tries to set

his or her product apart from the competition  The main way of doing this is through advertising
 When this is done successfully, the demand

curve becomes more vertical or inelastic  Buyers are willing to pay more for a product or service because they believe it is much better than their other choices

Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Basis for Product Differentiation
 Physical differences  Convenience  Ambience  Reputations  Appeals to vanity  Unconscious fears and desires  Snob appeal  Customized products

Product Differences

 Product differentiation does not necessarily

mean there are any physical differences among products
 They might all be the same, but how they are sold

may make all the difference

 There are, of course, some very real

physical product differences.

 Buyers often differentiate based on real physical

differences, but differentiation is still taking place in the buyers mind, and it may or may not be based on real physical differences

Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Advertising and Branding
 What’s to be gained by pouring money into

advertising? It works! -- Continuous signals regarding product differentiation -- coca-cola vs pepsi  Brand has tremendous value -- e.g. Budweiser -- Brands tend to capture in a single name all the values a firm wants to impress upon the buyer

The Typical Monopolistic Competitor
 Tries to set his firm apart from his competition
-- New Product Development and Innovation 1. Striving to maintain an economic profit -- Advertising 1. Create consumer perception of product differentiation – real or imagined 2. Attempting to keep demand as inelastic as possible  Selling costs can be extremely high

Identifying Monopolistic Competition
 How much is the industry dominated or not dominated

by few suppliers -- geographical scope – national, regional, global An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e.g. Concrete Mixing -- Barriers to entry and exit – industries may appear concentrated but few barriers exist to prevent entry: e.g a community with only one restaurantthere is no barrier to other restaurants coming in
4

Identifying Monopolistic Competition
 The four-firm concentration ratio – The

percentage of the value of total market revenue accounted for by the four largest firms in the industry -- A low concentration ratio indicates a high degree of competition -- A high concentration ratio indicates an absence of competition

5

Identifying Monopolistic Competition
 The Herfindahl-Hirschman Index – the square of the

percentage market share of each firm summed over the largest 50 firms in the industry (or all of the firms if there is less than 50) -- In perfect competition, the HHI is small -- In monopoly, the HHI is 10,000 (100 squared) -- A popular measure with the Justice Dept in the 1980’s HHI < 1000 characterized competitive markets HHI > 1800 would bring Justice Dept challenge to proposed mergers 6

Examples of Monopolistic Competition
Banks Radio Stations Clothing Computers Frozen Foods Canned Goods Convenience Stores Sporting Goods Fish and Seafood Jewelry Health Spas Apparel Stores Soaps & Shampoos Toothpaste

7

Price Discrimination
 Question – Does price discrimination raise or

lower profit?  Price discrimination – selling the same good or service at a number of different prices. Basically an illegal activity under the Clayton Act unless there is a cost justification for the price discrimination  Answer – Price discrimination is a marketing means to increase economic profit

Price Discrimination
 Methods of price discrimination

-- Discriminate among groups of buyers works when different buying groups are willing to pay different prices (on the average) for the same good or service Example: Airline travel – prices target business travelers vs leisure time travelers -- discriminator is advance notice, shorter the notice, the higher the price

Some Examples of Price Discrimination
Doctors often charge rich patients more than

poor patients

 They may have one price for those with insurance

and another price for those without insurance

Movies in the evening cost more than those

in the early afternoon Senior citizen, youth, and student discounts New and used cars Youth fairs on airlines Evening meals in restaurants often cost more than the same meal at lunch

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Practicing Price Discrimination

 The firm that practices price

discrimination must be able to distinguish between two or more separate groups of buyers
 Price discriminators must also be able to

prevent buyers from reselling the product or service
 For example, if a fifteen-year-old could resell his

youth fare seat to an adult who could then use it, the price discrimination effort would fail

Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Motives for Price Discrimination
 In most cases, price discrimination is

basically a mechanism for rationing goods and services
 The main motivation for price discrimination

is to raise profits
 The greater the price discrimination, the greater

the profits because buyers lose some of their “consumer surplus”  If price discrimination were carried to its logical conclusion, we would have perfect price discrimination
 The buyers would lose all of their “consumer surplus”

Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Price Discrimination
 Methods of discrimination

-- Discriminate among units – firm charges the same price to all customers but there are volume discounts

 The key idea is to figure a way to charge those
incremental buyers who are willing to pay more a higher price

 Result – Consumer Surplus is converted to
Producer Surplus

Price Discrimination
 Perfect Price discrimination occurs when a firm

figures out how to extract the entire consumer surplus
 Once the firm has the entire consumer surplus,

the MR curve becomes the Demand Curve
 At that point, the firm extracts even more

economic profit by increasing production to the point where MR(D) = MC

Is the Monopolistic Competitor Inefficient?
 From a purely economic standpoint . . .Yes!  The firms do not produce at the minimum point on the ATC  There may be too many firms in most industries
 Are there too many beauty parlors? Not if you want to get

your hair done on Friday afternoon or Saturday morning  Are there too many restaurants? Not on Sunday
 There may be overdifferentiation
 Would Americans want the drab businesses that

characterize eastern Europe and the old soviet union?  Would Americans want only one brand of toothpaste or one brand and model of a car?
 In America, it would be hard to imagine a no-frills

world

Copyright ©2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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Closing Thoughts
 More than 99% of the over 23 million business

firms in the United States are monopolistic competitors
 While price competition exists, they compete

more vigorously over differentiation characteristics such as ambience, service, convenience, quality, brand awareness, etc.