Summary

This chapter extends the study of market structure to monopolistic competition and oligopoly. These models describe the behavior of competitors in imperfectly competitive markets across a broad spectrum of our economy in which both price competition and a wide variety of methods of nonprice competition are observed.

• Monopolistic competition is similar to perfect competition in that it entails vigorous price competition among a large number of firms and individuals. The major difference is that consumers perceive important differences among the products offered by monopolistically competitive firms, whereas the output of perfectly competitive firms is homogeneous.

• In an industry characterized by oligopoly, only a few large rivals are responsible for the bulk of industry output. High to very high barriers to entry are typical, and the price/output decisions of firms are interrelated in the sense that direct reactions from rivals can be expected. This "competition among the few" involves a wide variety of price and nonprice methods of rivalry.

• A group of competitors operating under a formal overt agreement is called a cartel. If an informal covert agreement is reached, the firms are said to be operating in collusion. Both practices are generally illegal in the United States. However, cartels are legal in many parts of the world, and multinational corporations often become involved with them in foreign markets.

• Price leadership results when one firm establishes itself as the industry leader and all other firms accept its pricing policy. This leadership may result from the size and strength of the leading firm, from cost efficiency, or as a result of the recognized ability of the leader to forecast market conditions accurately and to establish prices that produce satisfactory profits for all firms in the industry. Under a second type of price leadership, barometric price leadership, the price leader is not necessarily the largest or dominant firm in the industry. The price leader must only be accurate in reading the prevailing industry view of the need for price adjustment.

• An often-noted characteristic of oligopoly markets is "sticky" prices. Once a general price level has been established, whether through cartel agreement or some less formal arrangement, it tends to remain fixed for an extended period. Such rigid prices are often explained by what is referred to as the kinked demand curve theory of oligopoly prices. A kinked demand curve is a firm demand curve that has different slopes for price increases versus price decreases.

• Game theory is a general framework to help decision making when firm payoffs depend on actions taken by other firms. In a simultaneous-move game, each decision maker makes choices without specific knowledge of competitor counter moves. In a sequential-move game, decision makers make their move after observing competitor moves. In a one-shot game, the underlying interaction between competitors occurs only once; in a repeat game, there is an ongoing interaction between competitors.

• The so-called Prisoner's Dilemma is a classic conflict-of-interest situation. A dominant strategy gives the best result for either party regardless of the action taken by the other. A secure strategy guarantees the best possible outcome given the worst possible scenario. In a Nash equilibrium, neither player can improve its own payoff by unilaterally changing its own strategy. In a Nash bargaining game, two competitors or players "bargain" over some item of value. When competitors interact on a continuous basis, they are said to be involved in repeat games. Like any written guarantee or insurance policy, repeat transactions in the marketplace give consumers confidence that they'll get what they pay for.

• The economic census provides a comprehensive statistical profile of the national economy. They are taken at 5-year intervals during years ending with the digits 2 and 7—for example, 1992,1997, 2002, and so on. The North American Industry Classification System (NAICS) categorizes establishments by the principal economic activity in which they are engaged. Below the 2-digit major group or sector level, the NAICS system proceeds to desegregated levels of increasingly narrowly defined activity.

• Concentration ratios measure the percentage market share held by (concentrated in) a group of top firms. When concentration ratios are low, industries tend to be made up of many firms, and competition tends to be vigorous. When concentration ratios are high, leading firms dominate and sometimes have the potential for pricing flexibility and economic profits. The Herfindahl Hirschmann Index (HHI) is a measure of competitor size inequality that reflects size differences among both large and small firms. Calculated in percentage terms, the HHI is the sum of the squared market shares for all n industry competitors:

• An effective competitive strategy in imperfectly competitive markets must be founded on the firm's competitive advantage. A competitive advantage is a unique or rare ability to create, distribute, or service products valued by customers. It is the business-world analog to what economists call comparative advantage, or when one nation or region of the country is better suited to the production of one product than to the production of some other product.

Public and private sources offer valuable service through their regular collection and publication of market structure data on the number and size distribution of competitors, market size, growth, capital intensity, investment, and so on. All of this information is useful to the process of managerial decision making and provides a useful starting point for the development of successful competitive strategy.

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