Northern University Bangladesh

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1 Northern University Bangladesh Managerial Economics ( MBA 5208) Session # 09 Oligopoly & Monopolistic Competition Prof. Mahmudul Alam (PMA) 23 September, 2011 (Friday) 1

2 1. Monopolistic Competition & Oligopoly Monopolistic competition is an important market structure ( regime) in the real-world situation; where large number of buyers and product-differentiation are observed Oligopoly ( Greek word)- quite common market-structure in modern world; with few sellers- examples in Bangladesh drug companies of Square, Beximco,Incepta.In USA, auto companies of Ford, General Motors and Steel manufacturers 2

3 Table:11.1 Market Structure-Characteristics of Oligopoly Number and size distribution of sellers Small number of sellers. Each firm must consider the effect of its actions on other firms. Number and size distribution of buyers Product differentiation Unspecified Product may be either homogeneous or differentiated Conditions of entry and exit Entry difficult 3

4 4

5 1.Oligopoly & Monopolistic Competition- Their Characteristics ( Contd.) In the figure, we consider an oligopolist firm where it is decreasing the price not matched by other firm ( shown by more elastic demand curve); the inelastic line is the one where it is matched by other firms 5

6 6

7 1.Oligopoly & Monopolistic Competition- Their Characteristics ( Contd.) In the previous figure, there two demand curves one D t D t for the industry and the D l D l for the leading firm; similarly the marginal cost and supply curves for the leader and the small firms 7

8 Table: 11.2 Market structure characteristics of Monopolistic Competition Number and size distribution of sellers Number and size distribution of buyers Product differentiation Conditions of entry and exit Many small sellers. Actions of individual sellers go unheeded by other firms Many small buyers Slightly differentiated. Product of one firm is a fairly close substituted for that of other sellers Easy entry and exit 8

9 9

10 1.Oligopoly & Monopolistic Competition- Their Characteristics ( Contd.) Monopolistic firms to decide price and output; other two important decisions on product-differentiation and Adv. are already decided Monopolistic firms are typical with similar demand curve and cost curve ( Chamberlain s model) Short-run and long-run profitmaximization situations 10

11 11

12 2. Price-Leadership,Cartel & Collusion Some dominant firm in the industry calls the shot, other smaller firms follow suit- it may be with a view to bringing some discipline when cut-throat competition and wide pricefluctuations were the rules Two forms of price-leadership (a) dominant firm deciding the price and other smaller firms following the given price, (b) Barometric price-leadership ( rational decision taken by one firm on the basis of evolving input-output / market realities, quickly followed by other firms) 12

13 2.Price-Leadership,Cartels & Collusion ( Contd.) Cartels ( e.g. in oil industry by OPEC)- vigorous price competition drive prices down- mutually harmful for all firms; the few firms( companies/parties) tend to come to some sort of agreement and set prices at or near monopoly level. The market-shares decided among the members of cartels by a mutually agreed formula ( e.g. potential production capacity) 13

14 2.Price-Leadership,Cartels & Collusion ( Contd.) Collusion and cheating- how it takes place 14

15 15

16 3.Game Theory Game theory utilized in deriving insights into oligopolistic markets-how the rivals in the market would try to earn economic profits by outguessing its rivals. Cases of political negotiations, wagebargaining ( between management & trade unions) to be noted 16

17 3.Game Theory( Contd.) Business behavior- coin-tossing between two children; one a passive coin-tosser & the other child calling head or tail- the caller is the strategist There is a pay-off on the basis of results of the random flip of the coin Example of a two-firm pay-off matrix 17

18 Table: 11.3 Payoff Matrix (Millions) Firm 2 No Price Change Price Increase Firm 1 No Price Change Price Increase 10, , , , 35 18

19 3. Game Theory (Contd.) Nash equilibrium- it is a situation when the action of the other firm is important ( a contradiction to perfectly competitive market) in getting the payoff/economic profit for a firm A Nash equilibrium is a set of strategies none of the participants in the game can improve their pay-off, given the strategies of the other participants 19

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