McConnell Campbell R., Brue Stanley L., Barbiero Thomas P. Microeconomics. Ninth Edition

Подождите немного. Документ загружается.

Monopolistic Competition and Efﬁciency

We know from Chapter 9 that economic efﬁciency requires the triple equality P =

MC = minimum ATC. The equality of price and minimum average total cost yields

productive efﬁciency. The good is being produced in the least costly way, and the price

is just sufﬁcient to cover average total cost, including a normal proﬁt. The equality

of price and marginal cost yields allocative efﬁciency. The right amount of output is

being produced, and thus the right amount of society’s scarce resources is being

devoted to this speciﬁc use.

How efﬁcient is monopolistic competition, as measured against this triple equality?

Neither Productive nor Allocative Efﬁciency

In monopolistic competition, neither productive nor allocative efﬁciency is achieved

in long-run equilibrium. We show this in Figure 11-3, which includes an enlarge-

ment of part of Figure 11-2(c). First note that the proﬁt-maximizing price P

slightly

exceeds the lowest average total cost, A

. Therefore, in producing the proﬁt-maxi-

mizing output Q

, the ﬁrm’s average total cost is slightly higher than optimal from

society’s perspective—productive efﬁciency is not achieved. Also note that the

proﬁt-maximizing price P

exceeds marginal cost (here M

), meaning that monopo-

listic competition causes an underallocation of resources. Society values each unit

280 Part Two • Microeconomics of Product Markets

FIGURE 11-3 THE INEFFICIENCY OF MONOPOLISTIC COMPETITION

ATC

Excess capacity

MC ATC

MR = MC

Quantity

Price and costs

In long-run equilibrium a monopolistic competitor achieves neither productive nor allocative efﬁciency. Productive efﬁciency

is not realized because production occurs where the average total cost A

exceeds the minimum average total cost A

Allocative efﬁciency is not realized because the product price P

exceeds the marginal cost M

. The result is an underalloca-

tion of resources and excess productive capacity of Q

– Q

of output between Q

and Q

more highly than the goods it would have to forgo to

produce those units. Thus, to a modest extent, monopolistic competition also fails

the allocative-efﬁciency test. Consumers pay a higher-than-competitive price and

obtain a less-than-optimal output. Indeed, monopolistic competitors must charge a

higher-than-competitive price in the long run to achieve a normal proﬁt.

Excess Capacity

In monopolistic competition, the gap between the minimum-ATC output and the

proﬁt-maximizing output identiﬁes excess capacity: plant or equipment that is

underused because ﬁrms are producing less than the minimum-ATC output. We

show this gap as the distance between Q

and Q

in Figure 11-3. If each monopolis-

tic competitor could proﬁtably produce at the minimum-ATC output, fewer ﬁrms

could produce the same total output, and the product could be sold at a lower price.

Monopolistically competitive industries thus are overcrowded with ﬁrms, each

operating below its optimal capacity. This situation is typiﬁed by many kinds of

retail establishments. For example, most cities have an abundance of small motels

and restaurants that operate well below half capacity. (Key Question 2)

The situation portrayed in Figures 11-2(c) and 11-3 is not very satisfying to monop-

olistic competitors, since it foretells only a normal proﬁt. But the proﬁt-realizing

ﬁrm of Figure 11-2(a) need not stand by and watch new competitors eliminate its

proﬁt by imitating its product, matching its customer service, and copying its adver-

tising. Each ﬁrm has a product that is distinguishable in some way from those of the

other producers. So, the ﬁrm can attempt to stay ahead of competitors and sustain

its proﬁt through further product differentiation and better advertising. By devel-

oping or improving its product, it may be able to postpone, at least for a while, the

outcome of Figure 11-2(c).

It is true that product differentiation and advertising will add to the ﬁrm’s costs,

but they can also increase the demand for its product. If demand increases by more

than enough to compensate for the added costs, the ﬁrm will have improved its

proﬁt position. As Figure 11-3 suggests, the ﬁrm has little or no prospect of increas-

ing proﬁt by price-cutting. So why not engage in nonprice competition?

Beneﬁts of Product Variety

The product variety and product improvement that accompany the drive to main-

tain economic proﬁt in monopolistic competition are a beneﬁt for society—ones that

may offset the cost of the inefﬁciency associated with monopolistic competition.

Consumers have a wide diversity of tastes: Some like regular fries, others like curly

fries; some like contemporary furniture, others like traditional furniture. If a prod-

uct is differentiated, then at any time the consumer will be offered a wide range of

types, styles, brands, and quality gradations of that product. Compared with pure

competition, this provides an advantage to the consumer. The range of choice is

widened, and producers more fully meet the wide variation in consumer tastes.

The product improvement promoted by monopolistic competition further dif-

ferentiates products and expands choices, and a successful product improvement by

one ﬁrm obligates rivals to imitate or improve on that ﬁrm’s temporary market

advantage or else lose business. So, society beneﬁts from better products.

chapter eleven • monopolistic competition and oligopoly 281

excess

capacity

Plant

or equipment that is

underused because

the ﬁrm is produc-

ing less than the

minimum-ATC

output.

Product Variety

In fact, product differentiation creates a tradeoff between consumer choice and

productive efﬁciency. The stronger the product differentiation, the greater is the

excess capacity and, hence, the greater is the productive inefﬁciency. But the greater

the product differentiation, the more likely the ﬁrms will satisfy the great diversity

of consumer tastes. The greater is the excess capacity problem, the wider the range

of consumer choice.

Further Complexity

Finally, the ability to engage in nonprice competition makes the market situation of

a monopolistic competitor more complex than Figure 11-3 indicates. That ﬁgure

assumes a given (unchanging) product and a given level of advertising expendi-

tures. But we know that, in practice, product attributes and advertising are not

ﬁxed. The monopolistically competitive ﬁrm juggles three factors—price, product,

and advertising—in seeking maximum proﬁt. It must determine what variety of

product, selling at what price, and supplemented by what level of advertising will

result in the greatest proﬁt. This complex situation is not easily expressed in a

simple, meaningful economic model. At best, we can say that each possible combi-

nation of price, product, and advertising poses a different demand and cost (pro-

duction cost plus advertising cost) situation for the ﬁrm, and that only one

combination yields the maximum proﬁt. In practice, this optimal combination can-

not be readily forecast but must be found by trial and error.

In terms of competitiveness, the spectrum of market structures reaches from pure

competition to monopolistic competition, to oligopoly, to pure monopoly (review

Table 9-1). We now direct our attention to oligopoly, a market dominated by a few

large producers of a homogeneous or differentiated product. Because of their small

number, oligopolists have considerable control over their prices, but each must

consider the possible reaction of rivals to its own pricing, output, and advertising

decisions.

A Few Large Producers

The phrase “a few large producers” is necessarily vague because the market model

of oligopoly covers much ground, ranging between pure monopoly on the one

282 Part Two • Microeconomics of Product Markets

● Monopolistic competition involves a relatively

large number of ﬁrms operating in a noncollu-

sive way and producing differentiated products,

with easy industry entry and exit.

● In the short run, a monopolistic competitor will

maximize proﬁt or minimize loss by producing

that output at which marginal revenue equals

marginal cost.

● In the long run, the easy entry and exit of ﬁrms

cause monopolistic competitors to earn only a

normal proﬁt

● A monopolistic competitor’s long-run equilibrium

output is such that price exceeds the minimum

average total cost (implying that consumers do

not get the product at the lowest price attainable)

and price exceeds marginal cost (indicating that

resources are underallocated to the product).

Oligopoly

oligopoly A

market structure

dominated by a

few large producers

of homogeneous

or differentiated

products.

hand, and monopolistic competition on the other. Oligopoly encompasses the Cana-

dian steel industry, in which two ﬁrms dominate an entire national market, and the

situation in which four or ﬁve much smaller auto parts stores enjoy roughly equal

shares of the market in a medium-sized town. Generally, however, when you hear

a term such as Big Three, Big Four, or Big Six, you can be sure it refers to an oligop-

olistic industry.

Homogeneous or Differentiated Products

An oligopoly may be either a homogeneous oligopoly or a differentiated oligopoly,

depending on whether the ﬁrms in the oligopoly produce standardized or differen-

tiated products. Many industrial products (steel, zinc, copper, aluminum, lead,

cement, industrial alcohol) are virtually standardized products that are produced in

oligopolies. Alternatively, many consumer goods industries (automobiles, tires,

household appliances, electronics equipment, breakfast cereals, cigarettes, and many

sporting goods) are differentiated oligopolies. These differentiated oligopolies typi-

cally engage in considerable nonprice competition supported by heavy advertising.

Control over Price, but Mutual Interdependence

Because ﬁrms are few in oligopolistic industries, each ﬁrm is a price-maker; like the

monopolist, it can set its price and output levels to maximize its proﬁt. But unlike

the monopolist, which has no rivals, the oligopolist must consider how its rivals will

react to any change in its price, output, product characteristics, or advertising. Oli-

gopoly is thus characterized by mutual interdependence: a situation in which each

ﬁrm’s proﬁt depends not entirely on its own price and sales strategies but also on

those of its rivals. For example, in deciding whether to increase the price of its rolled

steel, Dofasco will try to predict the response of the other major producer, Stelco,

both located in Hamilton, Ontario. In deciding on its advertising strategy, Burger

King will take into consideration how McDonald’s might react.

Entry Barriers

The same barriers to entry that create pure monopoly also contribute to the creation

of oligopoly. Economies of scale are important entry barriers in a number of oli-

gopolistic industries, such as the aircraft, rubber, and cement industries. In those

industries, three or four ﬁrms might each have sufﬁcient sales to achieve economies

of scale, but new ﬁrms would have such a small market share that they could not

do so. They would then be high-cost producers, and as such they could not survive.

A closely related barrier is the large expenditure for capital—the cost of obtaining

necessary plant and equipment—required for entering certain industries. The auto-

mobile, commercial aircraft, and petroleum-reﬁning industries, for example, are all

characterized by very high capital requirements.

The ownership and control of raw materials help explain why oligopoly exists in

many mining industries, including gold, silver, and copper. In the electronics, chem-

icals, photographic equipment, ofﬁce machine, and pharmaceutical industries,

patents have served as entry barriers. Oligopolists can also preclude the entry of new

competitors through preemptive and retaliatory pricing and advertising strategies.

Mergers

Some oligopolies have emerged mainly through the growth of the dominant ﬁrms

in a given industry (breakfast cereals, chewing gum, candy bars). But for other

chapter eleven • monopolistic competition and oligopoly 283

<www.indiana.edu/

~econed/pdfﬁles/

fall99/meister.pdf>

Oligopoly: An in-class

economic game

homoge-

neous

oligopoly

oligopoly in which

the ﬁrms produce

a standardized

product.

differen-

tiated

oligopoly

oligopoly in which

the ﬁrms produce

a differentiated

product.

mutual

interde-

pendence

situation in which a

change in strategy

(usually price) by

one ﬁrm will affect

the sales and proﬁts

of other ﬁrms.

industries the route to oligopoly has been through mergers (examples: steel, in its

early history; and, more recently, airlines, banking, and entertainment). The merg-

ing, or combining, of two or more competing ﬁrms may substantially increase their

market share, which in turn may allow the new ﬁrm to achieve greater economies

of scale.

Another motive underlying the “urge to merge” is the desire for a greater degree

of monopoly power. The larger ﬁrm that results from a merger has greater control

over market supply and thus the price of its product. Also, since it is a larger buyer

of inputs, it will probably be able to demand and obtain lower prices (costs) on its

production inputs.

Measures of Industry Concentration

Several means are used to measure the degree to which oligopolistic industries are

concentrated in their largest ﬁrms. The most-often-used measures are concentration

ratios and the Herﬁndahl index.

CONCENTRATION RATIO

A concentration ratio reveals the percentage of total output produced and sold by

an industry’s largest ﬁrms. Figure 11-4 lists the four-ﬁrm concentration ratio—the

percentage of total industry sales accounted for by the four largest ﬁrms—for a

number of oligopolistic industries. For example, the four largest Canadian produc-

ers of tobacco products manufacture almost 100 percent of all cigarettes produced

in Canada.

When the largest four ﬁrms in an industry control 40 percent or more of the mar-

ket (as in Figure 11-4), that industry is considered oligopolistic. Using this bench-

mark, about one-half of all Canadian manufacturing industries are oligopolies.

Although concentration ratios provide useful insights into the competitiveness or

monopoly power of various industries, they have three shortcomings.

284 Part Two • Microeconomics of Product Markets

<distance-

ed.bcc.ctc.edu/

econ100/ksttext/

oligoply/oligoply.htm>

The arthritic hand of

oligopoly

concentra-

tion ratio

The percentage of

the total sales of an

industry produced

and sold by an

industry’s largest

ﬁrms.

FIGURE 11-4 PERCENTAGE OF OUTPUT PRODUCED BY

THE FOUR LARGEST FIRMS IN SELECTED HIGH-

CONCENTRATION INDUSTRIES*

Tobacco products

Motor vehicles

Petroleum and

coal products

Primary metals

Beverages

04020 60

Metal mining

Rubber products

80 100

Percentage of industry total

Source: Douglas West, Modern Canadian Industrial Organization, HarperCollins, 1994, p. 37.

*As measured by dollar value of shipments

ONE: LOCALIZED MARKETS

Concentration ratios pertain to the nation as a whole, whereas the markets for some

products are highly localized because of high transportation costs. For example, the

four-ﬁrm concentration ratio for concrete products is only 23 percent, suggesting a

competitive industry in Canada. But the sheer bulk of this product limits the rele-

vant market to a speciﬁc town or metropolitan area, and in such localized markets

we often ﬁnd oligopolistic concrete producers.

TWO: INTERINDUSTRY COMPETITION

Since deﬁnitions of industries are somewhat arbitrary, we must be aware of

interindustry competition—that is, competition between two products associated

with different industries. The high concentration ratio for the primary metals shown

in Figure 11-4 understates the competition in that industry, because aluminum com-

petes with copper in many applications (for example, in the market for electrical

transmission lines).

THREE: WORLD TRADE

The data in Figure 11-4 are for products produced in Canada only and may overstate

concentration because they do not account for the import competition of foreign

suppliers. The automobile industry is a good example. Although Figure 11-4 shows

that three ﬁrms produce over 90 percent of the domestic output of those goods, it

ignores the fact that a large portion of the automobiles bought in Canada are

imports. Many of the world’s largest corporations are foreign, and many of them do

business in Canada.

Herﬁndahl Index

The shortcomings of concentration ratios listed above actually apply to many meas-

ures of concentration, but one of those shortcomings can be eliminated: Suppose

that in industry X one ﬁrm produces all the market output. A second industry, Y, has

four ﬁrms, of which each has 25 percent of the market. The concentration ratio is 100

percent for both these industries. But industry X is a pure monopoly, while indus-

try Y is an oligopoly that may be facing signiﬁcant economic rivalry. Most econo-

mists would agree that monopoly power (or market power) is substantially greater

in industry X than in industry Y, a fact disguised by their identical 100 percent con-

centration ratios.

The Herﬁndahl index addresses this problem. This index is the sum of the

squared percentage market shares of all ﬁrms in the industry. In equation form:

Herﬁndahl index = (%S

)

+ (%S

)

+ (%S

)

+ … + (%S

)

where %S

is the percentage market share of ﬁrm 1, %S

is the percentage market

share of ﬁrm 2, and so on for each ﬁrm in the industry. By squaring the percentage

market shares of all ﬁrms in the industry, the Herﬁndahl index gives much greater

weight to larger, and thus more powerful, ﬁrms than to smaller ones. In the case of

the single-ﬁrm industry X, the index would be at its maximum of 100

or 10,000,

indicating an industry with complete monopoly power. For our supposed four-ﬁrm

industry Y, the index would be 25

+ 25

, or 2500, indicating much less

market power. (For a purely competitive industry, the index would approach zero,

since each ﬁrm’s market share—%S in the equation—is extremely small.) To gener-

alize, the larger the Herﬁndahl index, the greater the market power within an

industry. (Key Question 7)

chapter eleven • monopolistic competition and oligopoly 285

inter-

industry

competition

The competition

between the prod-

ucts of one industry

and the products of

another industry.

import

competition

The competition

domestic ﬁrms

encounter from

the products and

services of foreign

producers.

<reinsurance.home.

mindspring.com/

mktconc.htm>

Using the Herﬁndahl

Index to Measure

Industry Concentration

herﬁndahl

index

The sum

of the squared per-

centage market

shares of all ﬁrms

in the industry.

Oligopoly pricing behaviour has the characteristics of certain games of strategy, such

as poker, chess, and bridge. The best way to play such a game depends on the way

one’s opponent plays. Players (and oligopolists) must pattern their actions according

to the actions and expected reactions of rivals. The study of how people behave in

strategic situations is called game theory. We will use a simple game theory model to

analyze the pricing behaviour of oligopolists. We assume a duopoly, or two-ﬁrm oli-

gopoly, producing athletic shoes. Each ﬁrm—let’s call them RareAir and Uptown—

has a choice of two pricing strategies: price high or price low. The proﬁt each ﬁrm

earns will depend on the strategy it chooses and the strategy its rival chooses.

Four combinations of strategies are possible for the two ﬁrms, and a lettered cell

in Figure 11-5 represents each combination. For example, cell C represents a low-

price strategy for Uptown along with a high-price strategy for RareAir. Figure 11-5

is called a payoff matrix because each cell shows the payoff (proﬁt) to each ﬁrm that

would result from each combination of strategies. Cell C shows that if Uptown

adopts a low-price strategy and RareAir a high-price strategy, then Uptown will

earn $15 million (green portion) and RareAir will earn $6 million (orange portion).

Mutual Interdependence Revisited

The data in Figure 11-5 are hypothetical, but their relationships are typical of real sit-

uations. Recall that oligopolistic ﬁrms can increase their proﬁts, and inﬂuence their

rivals’ proﬁts, by changing their pricing strategies. Each ﬁrm’s proﬁt depends on its

own pricing strategy and that of its rivals. This mutual interdependence of oligop-

olists is the most obvious point demonstrated by Figure 11-5. If Uptown adopts a

high-price strategy, its proﬁt will be $12 million, provided that RareAir also employs

a high-price strategy (cell A). But if RareAir uses a low-price strategy against

286 Part Two • Microeconomics of Product Markets

game theory

model

A means

of analyzing the

pricing behaviour of

oligopolists using

the theory of strat-

egy associated

with games such as

chess and bridge.

FIGURE 11-5 PROFIT PAYOFF (IN MILLIONS) FOR A TWO-FIRM

OLIGOPOLY

Uptown's price strategy

High

$12

Low

$12

$15

High Low

RareAir's price strategy

A B

Each ﬁrm has two

possible pricing

strategies. RareAir’s

strategies are shown

in the top margin, and

Uptown’s in the left

margin. Each lettered

cell of this four-cell

payoff matrix repre-

sents one combina-

tion of a RareAir

strategy and an

Uptown strategy and

shows the proﬁt that

combination would

earn for each ﬁrm.

Oligopoly Pricing Behaviour:

A Game Theory Overview

Uptown’s high-price strategy (cell B), RareAir will increase its market share and

boost its proﬁt from $12 to $15 million. RareAir’s higher proﬁt will come at the

expense of Uptown, whose proﬁt will fall from $12 to $6 million. Uptown’s high-

price strategy is a good strategy only if RareAir also employs a high-price strategy.

Collusive Tendencies

Figure 11-5 also suggests that oligopolists often can beneﬁt from collusion—that is,

cooperation with rivals. To see the beneﬁts of collusion, ﬁrst suppose that both ﬁrms

in Figure 11-5 are acting independently and following high-price strategies. Each

realizes a $12 million proﬁt (cell A).

Note that either RareAir or Uptown could increase its proﬁt by switching to a low-

price strategy (cell B or C). The low-price ﬁrm would increase its proﬁt to $15 million,

and the high-price ﬁrm’s proﬁt would fall to $6 million. The high-price ﬁrm would be

better off if it, too, adopted a low-price policy, Doing so would increase its proﬁt from

$6 million to $8 million (cell D). The effect of all this independent strategy shifting

would be to reduce both ﬁrms’ proﬁts from $12 million (cell A) to $ 8 million (cell D).

In real situations, too, independent action by oligopolists may lead to mutual

competitive low-price strategies: Independent oligopolists compete with respect to

price, which leads to lower prices and lower proﬁts. This is clearly beneﬁcial to con-

sumers but not to the oligopolists whose proﬁts decrease.

How could oligopolists avoid the low-proﬁt outcome of cell D? The answer is that

they could collude, rather than establish prices competitively or independently. In

our example, the two ﬁrms could agree to establish and maintain a high-price pol-

icy. Each ﬁrm will increase its proﬁt from $8 million (cell D) to $12 million (cell A).

Incentive to Cheat

The payoff matrix also explains why an oligopolist might be strongly tempted to

cheat on a collusive agreement. Suppose Uptown and RareAir agree to maintain

high-price policies, with each earning $12 million in proﬁt (cell A). Both are tempted

to cheat on this collusive pricing agreement, because either ﬁrm can increase its

proﬁt to $15 million by lowering its price. If Uptown secretly cheats on the agree-

ment by charging low prices, the payoff moves from cell A to cell C. Uptown’s proﬁt

rises to $15 million, and RareAir’s falls to $6 million. If RareAir cheats, the payoff

moves from cell A to cell B, and RareAir gets the $15 million. (Key Question 8)

chapter eleven • monopolistic competition and oligopoly 287

collusion

A situation in which

ﬁrms act together

and in agreement

to ﬁx prices, divide

a market, or

otherwise restrict

competition.

●

An oligopoly is made up of relatively few ﬁrms

producing either homogeneous or differentiated

products; these ﬁrms are mutually interdependent.

● Barriers to entry such as scale economies, con-

trol of patents or strategic resources, or the abil-

ity to engage in retaliatory pricing characterize

oligopolies. Oligopolies may result from inter-

nal growth of ﬁrms, mergers, or both.

● The four-ﬁrm concentration ratio shows the per-

centage of an industry’s sales accounted for

by its four largest ﬁrms; the Herﬁndahl index

measures the degree of market power in an

industry by summing the squares of the per-

centage market shares held by the individual

ﬁrms in the industry.

● Game theory reveals that (1) oligopolies are

mutually interdependent in their pricing poli-

cies, (2) collusion enhances oligopoly proﬁts,

and (3) there is a temptation for oligopolists to

cheat on a collusive agreement.

To gain further insight into oligopolistic pricing and output behaviour, we will

examine three distinct pricing models: (1) the kinked-demand curve, (2) collusive

pricing, and (3) price leadership.

Why not a single model as in our discussions of the other market structures?

There are two reasons:

1. Diversity of oligopolies Oligopoly encompasses a greater range and diversity

of market situations than other market structures, including the tight oligopoly,

in which two or three ﬁrms dominate an entire market, and the loose oligopoly,

in which six or seven ﬁrms share, say, 70 or 80 percent of a market while a com-

petitive fringe of ﬁrms shares the remainder. Oligopoly includes both differenti-

ated and standardized products. It includes cases in which ﬁrms act in collusion

and those in which they act independently. It embodies situations in which bar-

riers to entry are very strong and situations in which they are not quite so strong.

In short, the diversity of oligopoly does not allow us to explain all oligopolistic

behaviours with a single market model.

2. Complications of interdependence The mutual interdependence of oligopolis-

tic ﬁrms complicates matters signiﬁcantly. Because ﬁrms cannot predict the reac-

tions of their rivals with certainty, they cannot estimate their own demand and

marginal-revenue data. Without such data, ﬁrms cannot determine their proﬁt-

maximizing price and output, even in theory, as we will see.

Despite these analytical difﬁculties, two interrelated characteristics of oligopolistic

pricing have been observed. First, if the macroeconomy is generally stable, oligop-

olistic prices are typically inﬂexible (or rigid or sticky). Prices change less fre-

quently under oligopoly than under pure competition, monopolistic competition,

and, in some instances, pure monopoly. Second, when oligopolistic prices do

change, ﬁrms are likely to change their prices together, suggesting a tendency to act

in concert, or collusively, in setting and changing prices (as we mentioned in the pre-

ceding section). The diversity of oligopolies and the presence of mutual interde-

pendence are reﬂected in the models that follow.

Kinked-Demand Theory: Noncollusive Oligopoly

Imagine an oligopolistic industry made up of three ﬁrms, Arch, King, and Dave’s,

each having about one-third of the total market for a differentiated product. Assume

that the ﬁrms are independent, meaning that they do not engage in collusive price

practices. Assume, too, that the going price for Arch’s product is P

and its current

sales are Q

, as shown in Figure 11-6(a) (Key Graph).

Now the question is, “What does the ﬁrm’s demand curve look like?” Mutual

interdependence and the uncertainty about rivals’ reactions make this question hard

to answer. The location and shape of an oligopolist’s demand curve depend on how

the ﬁrm’s rivals will react to a price change introduced by Arch. Two plausible

assumptions can be made about the reactions of Arch’s rivals:

● Match price changes One possibility is that King and Dave’s will exactly

match any price change initiated by Arch. In this case, Arch’s demand and

marginal-revenue curves will look like the straight lines labelled D

and MR

in Figure 11-6(a). Why are they so steep? If Arch cuts its price, its sales will

increase only modestly, because its two rivals will also cut their prices to pre-

vent Arch from gaining an advantage over them. The small increase in sales

288 Part Two • Microeconomics of Product Markets

Three Oligopoly Models

chapter eleven • monopolistic competition and oligopoly 289

Rivals match

price decrease

Rivals ignore

price increase

Quantity

(a)

Quantity

Price and costs

(b)

Price

Panel (a): The slope of a noncollusive oligopolist’s demand and marginal-revenue curves depends on whether the ﬁrm’s

rivals match (straight lines D

and MR

) or ignore (straight lines D

and MR

) any price changes that it may initiate from

the current price P

. Panel (b): In all likelihood an oligopolist’s rivals will ignore a price increase but follow a price cut.

This reaction causes the oligopolist’s demand curve to be kinked (D

) and the marginal-revenue curve to have a verti-

cal break, or gap (fg). Because any shift in marginal costs between MC

and MC

will cut the vertical (dashed) segment

of the marginal-revenue curve, no change in either price P

or output Q

will result from such a shift.

FIGURE 11-6 THE KINKED-DEMAND CURVE

Key Graph

Quick Quiz

1. Suppose Q

in this ﬁgure represents annual sales of ﬁve million units for

this ﬁrm. The other two ﬁrms in this three-ﬁrm industry sell three mil-

lion and two million units. The Herﬁndahl index for this industry is

a. 100 percent. c. 10.

b. 400. d. 3800.

2. The D

e segment of the demand curve D

in graph (b) implies that

a. this ﬁrm’s total revenue will fall if it increases its price above P

b. other ﬁrms will match a price increase above P

c. the ﬁrm’s relevant marginal-revenue curve will be MR

for price increases

above P

d. the product in this industry is necessarily standardized.

3. By matching a price cut, this ﬁrm’s rivals can

a. increase their market shares.

b. increase their marginal revenues.

c. maintain their market shares.

d. lower their total costs.

4. A shift of the marginal-cost curve from MC

to MC

in graph (b) would

a. increase the going price above P

b. leave price at P

but reduce this ﬁrm’s total proﬁt.

c. leave price at P

but reduce this ﬁrm’s total revenue.

d. make this ﬁrm’s demand curve more elastic.

Answers

1. d; 2. a; 3. c; 4. b