Pricing and Output Decisions: Monopolistic Competition and Oligopoly

Chapter 9
Pricing and Output

Decisions:
Monopolistic Competition
and Oligopoly
Chapter Nine 1
Overview
Monopolistic competition
Oligopoly
Pricing under oligopoly
Competing in imperfectly
competitive markets
Strategy: the challenge for firms
in imperfect competition
Chapter Nine 2
Learning objectives
contrast monopolistic competition and
oligopoly
describe the role that mutual

interdependence plays in setting prices in
oligopolistic markets
illustrate price rigidity using the ‘kinked

demand curve’
Chapter Nine 3
Learning objectives
explain how non-price factors help firms to
differentiate their products and services
understand the five forces in Porter’s

model of competition
Chapter Nine 4
Introduction
 Imperfect competition
 some market power but not absolute

market power
 firms have the ability to set prices within
the limits of certain constraints
 mutual interdependence: interaction
among competitors when making
decisions
Chapter Nine 5
Introduction
Perfect Monopoly Monopolistic Oligopoly
Competition Competition
Market power? No Yes* Yes Yes
Mutual interdependence No No No Yes

among competing
firms?
Non-price competition? No Optional Yes Yes
Easy market entry Yes No Yes No
or exit ?
* subject to government regulation
Chapter Nine 6
 Monopolistic competition:
characteristics
 many firms
 relatively easy entry
 product differentiation: can set price at
a level higher than the price established
by perfect competition
 use MR = MC rule to maximize profit
Chapter Nine 7
 If earning above-normal profits,
newcomers will enter the market
 market supply curve shifts out and to

the right
 firm’s demand curve shifts down and
to the left
 ultimately, in the long run, firms earn
only normal profit
Chapter Nine 8
Oligopoly
 Oligopoly is a market dominated by a
relatively small number of large firms
 Herfindahl-Hirschman index (HH)
measures market concentration (max HH
= 10,000; unconcentrated markets have
HH < 1,000)
n
HH  Si2
i 1
n = number of firms in the industry

Si = firm’s market share
Chapter Nine 9
Pricing in an oligopolistic
market
 Mutual interdependence: relatively few
sellers create a situation where each is
carefully watching the others as it sets its
price
Implication: kinked demand curve

model Basic assumption is that
competitor will follow a price decrease but
will not make a change in reaction to a
price increase
Chapter Nine 10
market
If reduce price and
competitors match the Competitors do not
price cut then move match price increases
along more inelastic
demand segment Di Competitors
match
If increase price and price cuts
competitors do not
follow then move along
the more elastic
segment Df
 marginal revenue
curve has kink (at A)
Chapter Nine 11
market
 Price leader: one firm in the industry
takes the lead in changing prices, and
assumes that other firms:
• will follow a price increase
• but will not go even lower in order not
to trigger a price war
 Non-price leader: firm that leads the

differentiation of products on other, non-
price attributes
Chapter Nine 12
competitive markets
 Non-price competition: any effort made
by firms in order to change the demand for
their product (other than the price)
 Non-price determinants of demand:

 tastes and preferences
 income
 prices of substitutes and complements
 number of buyers
 future expectations of buyers
 financing terms
Chapter Nine 13
competitive markets
 Examples: of efforts by managers to
influence non-price demand influences:
 advertising and promotion
 location and distribution channels
 market segmentation
 loyalty programs
 product extensions and new products
 special customer services
 product ‘lock-in’ or ‘tie-in’
 pre-emptive new product announcements
Chapter Nine 14
competitive markets
 Equalizing at the margin: economic
concept which managers can use to help
make an optimal decision
eg MR = MC is an example of
equalizing at the margin
 can be used to decide the optimal
expenditure level on a non-price factor
 may occur over a long period of time
 firm must adjust MR, MC for the time
value of money
Chapter Nine 15
competitive markets
 Examples: the reality of ‘imperfect
competition’
• auto industry
• small retailers
• global credit card issuers
Chapter Nine 16
Strategy for firms in imperfect
competition
 How does industry concentration affect the
behavior of firms competing in the
industry?
 Strategy: the means by which an

organization uses its scarce resources to
relate to the competitive environment in a
manner that is expected to achieve
superior business performance over the
long run
Chapter Nine 17
competition
 Strategy is important when firms are price
makers and are faced with price and non-
price competition as well as threats from
new entrants into the market
 More important for firms in imperfectly

competitive markets than those in
perfectly competitive markets or monopoly
markets
Chapter Nine 18
competition
 Managerial economics: the use of
economic analysis to make business
decisions involving the best use of an
organization’s scarce resources
 Industrial organization: studies the way

that firms and markets are organized and
how this organization affects the economy
from the viewpoint of social welfare
Chapter Nine 19
competition
 Structure-Conduct-Performance (S-C-P)
paradigm: says structure affects conduct
which affects performance
 structure:number of firms in industry,
conditions of entry, product differentiation
 conduct: pricing strategies, advertising,
product development, legal tactics, collusion

 performance: maximization of society’s welfare
Criticism: weak empirical evidence of

relationship between observed concentration
and profit levels
Chapter Nine 20
competition
 ‘New’ Theory of Industrial
Organization: says there is no necessary
connection between observed industry
structure and performance that uniquely
leads to maximum social welfare
 theory of contestable markets:
performance by firms is ultimately
influenced not by actual competition,
but by the threat of potential
competition
Chapter Nine 21
competition
 Porter’s Five Forces model: illustrates the
various factors that affect the ability of any firm
in the industry to earn a profit
Chapter Nine 22
competition
 Porter’s generic strategies for earning
above-average return on investment
 Differentiation approach: for a monopoly

or monopolistically competitive market
 following MR = MC rule, firm sets a
price on the demand line that is above
AC
Chapter Nine 23
competition
 Porter’s generic strategies for earning
above-average return on investment
 Cost leadership approach: for perfect

competition
 maintain cost structure low enough
so when P = MC, there is a positive
difference between P and AC
Chapter Nine 24
Global application
 Example: world beer market
 neither pure monopoly nor pure

competition
 US market leader Anheuser Busch
controls 50% of market

 mature market, with merger activity
Chapter Nine 25

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Chapter 9

Pricing and Output

describe the role that mutual

illustrate price rigidity using the ‘kinked

understand the five forces in Porter’s

 some market power but not absolute

Market power? No Yes* Yes Yes

Mutual interdependence No No No Yes

Non-price competition? No Optional Yes Yes

Easy market entry Yes No Yes No

* subject to government regulation

 market supply curve shifts out and to

n = number of firms in the industry

Implication: kinked demand curve

 Non-price leader: firm that leads the

 Non-price determinants of demand:

• global credit card issuers

 Strategy: the means by which an

 More important for firms in imperfectly

 Industrial organization: studies the way

product development, legal tactics, collusion

Criticism: weak empirical evidence of

 Differentiation approach: for a monopoly

 Cost leadership approach: for perfect

 neither pure monopoly nor pure

controls 50% of market

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