| 1. |
Monopolistic competition has
several defining characteristics; this market structure is found in many industries.
- The relatively large number of sellers means that
each has a small market share
there is no collusion
and firms take actions that are
independent of each other.
- Monopolistic competition exhibits product
differentiation. This differentiation may take the form of differences in product
attributes
services to customers
location and accessibility
brand names
and packaging.
One implication of product differentiation is that monopolistically competitive firms have
some control over price.
- Entry into the industry or exit from it is
relatively easy.
- In addition to price competition
monopolistically competitive firms also use nonprice competition in the form of product
differentiation and advertising.
- Monopolistically competitive firms are found
through-out the economy
and examples include grocery stores
gasoline stations
and
restaurants.
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| 2. |
Assume that the products the firms in the
industry produce and the amounts of promotional activity in which they engage are given.
- The demand curve confronting each firm will be
highly but not perfectly price elastic because each firm has many competitors who produce
close but not perfect substitutes for the product it produces.
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- Comparing the demand curve for the monopolistic
competitor to other market structures suggests that it is not perfectly elastic
as is the
case with the pure competitor
but it is also more elastic than the demand curve of the
pure monopolist.
- The degree of elasticity
however
for each
monopolistic competitor will depend on the number of rivals and the extent of product
differentiation.
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- In the short run the individual firm will produce
the output at which marginal cost and marginal revenue are equal and charge the price at
which the output can be sold; either profits or losses may result in the short run.
- In the long run the entry and exodus of firms
will tend to change the demand for the product of the individual firm in such a way that
profits are eliminated. (Price and average costs are made equal to each other.)
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| 3. |
Monopolistic competition among firms producing
a given product and engaged in a given amount of promotional activity results in less
economic efficiency and more excess capacity than does pure competition.
- The typical monopolistically competitive firm
achieves neither allocative nor productive efficiency.
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- The average cost of each firm is equal in the
long run to its price
but the industry does not realize allocative efficiency because
output is smaller than the output at which marginal cost and price are equal.
- The industry does not realize productive
efficiency because the output is smaller than the output at which average cost is a
minimum.
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- There will be excess capacity because firms are
producing less output than would be produced at the minimum of average total cost.
Monopolistically competitive industries have many firms operating below optimal capacity.
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| 4. |
In addition to setting its price and output so
that its profit is maximized
each monopolistically competitive firm also attempts to
differentiate its product and to promote or advertise it to increase the firm’s
profit; these additional activities give rise to nonprice competition among firms.
- Product differentiation means that the
monopolistically competitive firms will offer consumers a wide range of types
style
brands
and quality variants of a product; this expansion of consumer choice may offset
the wastes of monopolistic competition.
- Product development is an attempt by firms to
improve a product
and it serves as a form of nonprice competition; to the extent that
improved products contribute to consumer welfare
this type of nonprice competition among
monopolistic firms may also offset some of the wastes of competition.
- Monopolistic competition is more complex than the
simple model presented in the chapter because the firm must constantly juggle three
factors — price
product characteristics
and advertising — in seeking to
maximize profits.
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| 5. |
Oligopoly is frequently encountered in the U.S.
economy.
- It is composed of a few firms that dominate an
industry and sell a standardized or differentiated product.
- Oligopolistic industries may produce standardized
(homogeneous) or differentiated products.
- Oligopolistic firms control price. There is also
mutual interdependence because firms must consider the reaction of rivals to any change in
price
output
product characteristic
or advertising.
- Barriers to entry such as economies of scale or
ownership and control over raw materials can explain the existence of oligopoly.
- Some industries have become oligopolistic not
from internal growth but from external factors such as mergers.
- Concentration of the industry among a few large
producers can be measured in several ways.
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- A concentration ratio gives the percentage of an
industry’s total sales provided by the largest firms. If the four largest firms
account for 40 percent or more of the industry output
the industry is considered
oligopolistic. Shortcomings of this measure include the imprecise definition of the market
area and failure to take into account interindustry competition or import competition.
- The Herfindahl index more accurately measures
concentration because it takes into account the market shares held by each firm. It is the
sum of the squared percentage market shares of all firms in the industry.
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| 6. |
Insight into the pricing behavior of
oligopolists can be gained by thinking of the oligopoly situation as a game of strategy.
This game theory overview leads to three conclusions.
- Firms in an oligopolistic industry are mutually
interdependent and must consider the actions of rivals when they make price decisions.
- Oligopoly often leads to overt or covert
collusion among the firms to fix prices or to coordinate pricing because competition among
oligopolists results in low prices and profits; collusion helps maintain higher prices and
profits.
- Collusion creates incentive to cheat among
oligopolists.
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| 7. |
The economic analysis of oligopoly is difficult
because oligopoly actually covers many different market situations and mutual
interdependence makes it difficult for an oligopolist to estimate a demand curve.
Nevertheless
two important characteristics of oligopoly are inflexible prices and
simultaneous price changes by oligopolistic firms. An analysis of three oligopoly models
helps explain the various pricing practice of oligopolists.
- In the kinked demand model there is no collusion.
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- Each firm believes that when it lowers its price
its rivals will lower their prices
and when it increases its price its rivals will not
increase their prices.
- The firm is therefore reluctant to change its
price for fear of decreasing its profits.
- The model has two shortcomings: It does not
explain how the going price gets set
and prices are not as rigid as the model implies.
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- The game theory perspective suggests that mutual
interdependence of oligopolists encourages firms to collude to maintain or to increase
prices and profits.
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- Firms that collude tend to set their prices and
joint output at the same level a pure monopolist would set them.
- Collusion may be overt
as in a cartel agreement.
The OPEC cartel is an example of effective overt collusion during the 1970s.
- The electrical equipment conspiracy of 1960 is an
example of covert collusion whereby tacit understandings between firms set price or market
share.
- Examples of overt collusion are common and have
included bid rigging on milk prices for schools or fixing worldwide prices for a livestock
feed additive.
- At least six obstacles make it difficult for
firms to collude or maintain collusive arrangements: difference in demand and cost among
firms
the number of firms in the arrangement
incentives to cheat
changing economic
conditions
potential for entry by other firms
and legal restrictions and penalties.
- Obstacles to collusion explain the decline in the
OPEC cartel during the 1980s
including such factors as new suppliers and declining
demand.
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- Price leadership is a form of covert collusion in
which one firm initiates price changes and the other firms in the industry follow the
lead. Three price leadership tactics have been observed.
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- Price adjustments tend to be made infrequently as
cost and demand conditions change to a significant degree.
- The price leader announces the price change in
various ways
through speeches
announcement
or other such activities.
- The price set may not maximize short-run profits
for the industry
especially if the industry wants to prevent entry by other firms.
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| 8. |
Oligopolistic firms often avoid price
competition but engage in nonprice competition through product development and advertising
to determine each firm’s market share for two reasons: Price cuts are easily
duplicated
but nonprice competition is more unique; and oligopolists have greater
financial resources to devote to advertising and product development.
- The potential positive effects of advertising
include providing low-cost information to consumers that reduces search time and monopoly
power
thus enhancing economic efficiency.
- The potential negative effects of advertising
include manipulating consumers to pay higher prices
serving as a barrier to entry into an
industry
and offsetting campaigns that raise product costs and prices.
- A graphical analysis using average total cost
curves shows no general conclusion about the effect of advertising on price
competition
and efficiency.
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| 9. |
To compare the efficiency of an oligopoly with
other market structures is difficult.
- Many economists think that oligopoly price and
output characteristics are similar to monopoly; oligopoly firms may set output where price
exceeds marginal cost and average total cost. It is thus neither allocatively efficient (P
5 MC) nor productively efficient (P 5 minimum ATC).
This view must be qualified because of increased foreign competition to oligopolistic
firms
the use of limit pricing that sets prices at less than the profit-maximizing price
and the technological advances arising from this market structure
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