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ECON 2020

Principles of Microeconomics
Chapter 13: Monopolistic Competition and Oligopoly

Hyeon Joon Shin


Assistant Professor of Economics
The Falls School of Business, Anderson University

Semester II, 2014-15

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Semester II, 2014-15

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Four Market Models


Four Market Models

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Four Market Models


Four Market Models
Characteristics of the Four Market Models (Table 10.1)

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Monopolistic Competition
Monopolistic Competition: Characteristics

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products

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Semester II, 2014-15

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

3 / 10

Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Some control over price

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

3 / 10

Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Some control over price


Each rm has some control over the price of its own product because
of product dierentiation.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

3 / 10

Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Some control over price


Each rm has some control over the price of its own product because
of product dierentiation.
The price control is limited since there are many potential substitutes
for its product.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

3 / 10

Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Some control over price


Each rm has some control over the price of its own product because
of product dierentiation.
The price control is limited since there are many potential substitutes
for its product.

Easy Entry and Exit

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

3 / 10

Monopolistic Competition
Monopolistic Competition: Characteristics
1

Many sellers (and producers)


Each rm has a comparatively small percentage of the market.
No rm dominates the market.

Dierentiated products
Firms produce products with slightly dierent physical characteristics.
Product dierentiation may be created through the use of advertising,
brand-naming, packaging and celebrity connections.

Some control over price


Each rm has some control over the price of its own product because
of product dierentiation.
The price control is limited since there are many potential substitutes
for its product.

Easy Entry and Exit


The entry and exit of rms are relatively easy compared to monopoly.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration

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Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.
The degree of concentration is the extent to which the largest rms
account for the bulk of the industrys output.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.
The degree of concentration is the extent to which the largest rms
account for the bulk of the industrys output.

Two indexes are used to measure the degree of industry of


concentration: the four-rm concentration ratio and the Herndahl
index

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

4 / 10

Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.
The degree of concentration is the extent to which the largest rms
account for the bulk of the industrys output.

Two indexes are used to measure the degree of industry of


concentration: the four-rm concentration ratio and the Herndahl
index
The four-rm concentration ratio (4CR) is
4CR =

Shin (FSB, Anderson Univ.)

Output of four largest rms


Total output in the industry

100

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.
The degree of concentration is the extent to which the largest rms
account for the bulk of the industrys output.

Two indexes are used to measure the degree of industry of


concentration: the four-rm concentration ratio and the Herndahl
index
The four-rm concentration ratio (4CR) is
4CR =

Output of four largest rms


Total output in the industry

100

When 4CR > 40%, then the industry is identied as an oliogopolistic


industry.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

4 / 10

Monopolistic Competition
Degree of Industry Concentration
Economist measure the degree of industry of concentration to identify
monopolistically competitive versus oligopolistic industries.
The degree of concentration is the extent to which the largest rms
account for the bulk of the industrys output.

Two indexes are used to measure the degree of industry of


concentration: the four-rm concentration ratio and the Herndahl
index
The four-rm concentration ratio (4CR) is
4CR =

Output of four largest rms


Total output in the industry

100

When 4CR > 40%, then the industry is identied as an oliogopolistic


industry.
When 4CR < 40%, then the industry is identied as a monopolistically
competitive industry..
Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration (contd)

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Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.


By squaring the percentage market shares of all rms, the index
purposely gives much greater weight to larger rms to smaller ones.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

5 / 10

Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.


By squaring the percentage market shares of all rms, the index
purposely gives much greater weight to larger rms to smaller ones.
In pure competition, H approaches to zero.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

5 / 10

Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.


By squaring the percentage market shares of all rms, the index
purposely gives much greater weight to larger rms to smaller ones.
In pure competition, H approaches to zero.
In monopoly, H would be its maximum of 10,000.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

5 / 10

Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.


By squaring the percentage market shares of all rms, the index
purposely gives much greater weight to larger rms to smaller ones.
In pure competition, H approaches to zero.
In monopoly, H would be its maximum of 10,000.
In general, the lower H, the greater likehood that an industry is
monopolistically competitive rather than oligopolistic.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

5 / 10

Monopolistic Competition
Degree of Industry Concentration (contd)
The Herndahl index is
H = S12 + S22 +

+ Sn2 ,

where Si is the percentage market share of rm i.


By squaring the percentage market shares of all rms, the index
purposely gives much greater weight to larger rms to smaller ones.
In pure competition, H approaches to zero.
In monopoly, H would be its maximum of 10,000.
In general, the lower H, the greater likehood that an industry is
monopolistically competitive rather than oligopolistic.

Problem
Suppose that the city of Anderson has 20 pizzerias. Their market shares in
percentage terms are as follows: 13%, 11%, 8%, 7%, 6%, 6%, 5%, 5%,
5%, 4%, 4%, 4%, 4%, 3%, 3%, 3%, 3%, 2%, 2%, and 2%. What is the
4CR? It the pizza industry in Anderson monopolistically competitive?
What is the Herndahl Index?
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Monopolistic Competition
Degree of Industry Concentration (contd)

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Monopolistic Competition

Prot Maximization in the Short-Run

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Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.
The monopolistic competitors demand is not perfectly elastic like a
pure competitive rms but more elastic than a monopolists.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

7 / 10

Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.
The monopolistic competitors demand is not perfectly elastic like a
pure competitive rms but more elastic than a monopolists.
Each pure competitors demand is perfectly elastic, because there are a
large number of rivals in the market.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

7 / 10

Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.
The monopolistic competitors demand is not perfectly elastic like a
pure competitive rms but more elastic than a monopolists.
Each pure competitors demand is perfectly elastic, because there are a
large number of rivals in the market.
A monopolists demand is comparatively inelatic, because its has no
rival at all, that is, there is no substitute for its product.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

7 / 10

Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.
The monopolistic competitors demand is not perfectly elastic like a
pure competitive rms but more elastic than a monopolists.
Each pure competitors demand is perfectly elastic, because there are a
large number of rivals in the market.
A monopolists demand is comparatively inelatic, because its has no
rival at all, that is, there is no substitute for its product.
Each monopolistic competitor has fewer rivals than than each pure
competitor does.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

7 / 10

Monopolistic Competition

Prot Maximization in the Short-Run


Each rm produces a slightly dierentiated product, thus having
control over the price of its own product.
The monopolistic competitors demand is not perfectly elastic like a
pure competitive rms but more elastic than a monopolists.
Each pure competitors demand is perfectly elastic, because there are a
large number of rivals in the market.
A monopolists demand is comparatively inelatic, because its has no
rival at all, that is, there is no substitute for its product.
Each monopolistic competitor has fewer rivals than than each pure
competitor does.

In the short run, therefore, each monopolistic competitor behaves as a


monopolist, when it determines its optimal output and price.

Shin (FSB, Anderson Univ.)

Semester II, 2014-15

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Monopolistic Competition
Prot Maximization in the Short-Run (contd)

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Monopolistic Competition
Prot Maximization in the Short-Run (contd)
Consider two dierent rms in a monopolistically competitive industry.

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Monopolistic Competition
Prot Maximization in the Short-Run (contd)
Consider two dierent rms in a monopolistically competitive industry.
Each rm determines its optimal output and price so as to maximize its
prot, given ATC.

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Semester II, 2014-15

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Monopolistic Competition
Prot Maximization in the Short-Run (contd)
Consider two dierent rms in a monopolistically competitive industry.
Each rm determines its optimal output and price so as to maximize its
prot, given ATC.
Then, whether it makes a positive or negative prot depends on the
ATC.

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Semester II, 2014-15

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Monopolistic Competition
Prot Maximization in the Short-Run (contd)
Consider two dierent rms in a monopolistically competitive industry.
Each rm determines its optimal output and price so as to maximize its
prot, given ATC.
Then, whether it makes a positive or negative prot depends on the
ATC.

Two rms in a monopolistically competitive industry (Figure 13.1):

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Monopolistic Competition
Prot Maximization in the Long-Run

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Monopolistic Competition
Prot Maximization in the Long-Run
In the long-run, some rms suering their short-run negative prots will
exit from the industry.

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Monopolistic Competition
Prot Maximization in the Long-Run
In the long-run, some rms suering their short-run negative prots will
exit from the industry.
In the long-run, new rms will easily enter into the industry to take the
existing rmspositive prots.

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Semester II, 2014-15

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Monopolistic Competition
Prot Maximization in the Long-Run
In the long-run, some rms suering their short-run negative prots will
exit from the industry.
In the long-run, new rms will easily enter into the industry to take the
existing rmspositive prots.
After such entry and exit, P = ATC at which MR = MC.

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Semester II, 2014-15

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Monopolistic Competition
Prot Maximization in the Long-Run
In the long-run, some rms suering their short-run negative prots will
exit from the industry.
In the long-run, new rms will easily enter into the industry to take the
existing rmspositive prots.
After such entry and exit, P = ATC at which MR = MC.
In the long run, therefore, each monopolistic competitors economic
prot will be zero:
mc = (Pmc

ATCmc )

Qmc = 0

because
Pmc

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ATCmc = 0

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Monopolistic Competition
Prot Maximization in the Long-Run (contd)

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