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Imperfect Competition

Imperfect Competition. Imperfect Competition. Monopolistic Competition. Monopolistic competition. Assumptions of monopolistic competition many or several firms free entry differentiated product Equilibrium of the firm short run MR = MC.

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Imperfect Competition

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  1. Imperfect Competition

  2. Imperfect Competition Monopolistic Competition

  3. Monopolistic competition • Assumptions of monopolistic competition • many or several firms • free entry • differentiated product • Equilibrium of the firm • short run • MR = MC

  4. Short-run equilibrium of the firmunder monopolistic competition MC AC AR =D MR £ Ps ACs O Qs Q

  5. Monopolistic competition • Assumptions of monopolistic competition • many or several firms • free entry • differentiated product • Equilibrium of the firm • short run • MR = MC • long run • MR = MC; AR = AC

  6. Long-run equilibrium of the firmunder monopolistic competition LRMC LRAC ARL=DL MRL £ New firms entering the industry reduce demand for each individual firm. Price falls to PL PL O QL Q

  7. Monopolistic competition • Assumptions of monopolistic competition • many or several firms • free entry • differentiated product • Equilibrium of the firm • short run • MR = MC • long run • MR = MC; AR = AC • under-utilisation of capacity in long run

  8. Under-utilisation of capacity in the long run £ LRAC DLunder monopolistic competition O Q1 Q2 Q

  9. Monopolistic competition • Limitations of the model • imperfect information • difficulty in identifying industry demand curve • entry may not be totally free • indivisibilities • importance of non-price competition • The public interest • comparison with perfect competition

  10. Long run equilibrium of the firm under perfectand monopolistic competition P2 DLunder perfect competition £ Higher price and lower output (excess capacity) under monopolistic competition LRAC P1 DLunder monopolistic competition O Q1 Q2 Q

  11. Monopolistic competition • Limitations of the model • imperfect information • difficulty in identifying industry demand curve • entry may not be totally free • indivisibilities • importance of non-price competition • The public interest • comparison with perfect competition • comparison with monopoly

  12. Imperfect Competition Oligopoly

  13. Oligopoly • Key features of oligopoly • barriers to entry • interdependence of firms • incentives to compete or to collude? • Factors favouring collusion • few firms, open with each other • similar production methods; similar products • significant entry barriers • stable market • collusion is legal

  14. Oligopoly • Collusive oligopoly: cartels • equilibrium of the industry

  15. Profit-maximising cartel Industry D = AR £ O Q

  16. Profit-maximising cartel Industry MC £ Industry profit maximised at Q1 and P1. P1 Members must agree to restrict total output to Q1. Industry D = AR Industry MR Q1 O Q

  17. Oligopoly • Collusive oligopoly: cartels • equilibrium of the industry • allocating and enforcing quotas

  18. Oil prices Recovery falters Banking turmoil and onset of recession Continuing worries about supply and rapid growth in demand from China and India Invasionof Iraq OPEC’s first quotas Iraq invades Kuwait Worldwide slowdown Iraq invades Iran New OPEC quotas Cease-fire in Iran-Iraq war Start ofglobal recovery Recession in Far East Revolution in Iran Worldwide recovery Yom Kippur War: Arab oil embargo First oil from North Sea

  19. Oil prices Recovery falters Banking turmoil and onset of recession Continuing worries about supply and rapid growth in demand from China and India Invasionof Iraq OPEC’s first quotas Iraq invades Kuwait Worldwide slowdown Iraq invades Iran New OPEC quotas Cease-fire in Iran-Iraq war Start ofglobal recovery Recession in Far East Revolution in Iran Worldwide recovery Yom Kippur War: Arab oil embargo First oil from North Sea

  20. Oligopoly • Tacit collusion • price leadership • dominant firm

  21. Dominant firm price leadership Sall other firms a Dmarket Dleader b £ Leader’s demand curve = market demand minus followers’ supply P1 P2 O Q Division of the market between leader and followers

  22. Dominant firm price leadership MCleader l f t MRleader £ Sall other firms Leader maximises profit at QL, PL. At PL, followers supply QF. PL Dmarket Dleader O QT QF QL Q Determination of price and output

  23. AR = Dmarket AR = Dleader MRleader Price leader aiming to maximise profits for a given market share £ Assume constant market share for leader O Q

  24. l t PL QL QT Price leader aiming to maximise profits for a given market share £ MC AR = Dmarket Leader maximises profit at QLand thus sets price of PL. AR = Dleader MRleader O Q

  25. Oligopoly • Tacit collusion • price leadership • dominant firm • barometric • rules of thumb • Collusion and the law • the role of the Competition Commission in the UK • The breakdown of collusion

  26. The incentive for a firm to produce more than its quota, or undercut the cartel’s price MC AR MR £ £10 is the cartel’s profit-maximising price. 12 10 8 6 4 2 3000 2000 1000 Q The Industry

  27. The incentive for a firm to produce more than its quota, or undercut the cartel’s price Firm is tempted to increase output to 600. Cartel Price (= MR if price remains fixed) £ MC 12 10 8 6 AR 4 2 MR 400 800 600 200 Q Firm A

  28. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour • The Cournot model of duopoly • assumption that rival will produce a given quantity

  29. The Cournot model of duopoly MCA DM DA1 QB1 £ Firm A believes that firm B will produce QB1. O Quantity (a) Firm A’s profit-maximising position

  30. The Cournot model of duopoly PA1 MRA1 QA1 £ MCA Firm A’s profit-maximising output and price are QA1 and PA. DM DA1 O QB1 Quantity (a) Firm A’s profit-maximising position

  31. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour • The Cournot model of duopoly • assumption that rival will produce a given quantity • profit-maximising price and output for firm A • reaction functions of firms A and B

  32. The Cournot model of duopoly Firm A’s reaction function for each assumed output of B RA Firm B’s reaction function for each assumed output of A x QB1 RB QA1 £ MCA Firm B’s output PA1 DM DA1 MRA1 O QA1 O QB1 Firm A’s output Quantity (b) The two firms’ reaction functions (a) Firm A’s profit-maximising position

  33. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour • The Cournot model of duopoly • assumption that rival will produce a given quantity • profit-maximising price and output for firm A • reaction functions of firms A and B • Cournot equilibrium

  34. The Cournot model of duopoly e QBe RB QAe Equilibrium at point e, where the two reaction functions cross £ RA MCA Firm B’s output PA1 x QB1 DM DA1 MRA1 QA1 O QA1 O QB1 Firm A’s output Quantity (b) The two firms’ reaction functions (a) Firm A’s profit-maximising position

  35. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) • The Bertrand model of duopoly • assumption that rival sets a particular price • equilibrium: price cutting until all supernormal profits are competed away • Nash Equilibrium in the Cournot and Bertrand models

  36. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) • The kinked demand curve theory • assumptions of the model • the shape of the demand and MR curves

  37. Kinked demand for a firm under oligopoly Current price and quantity give one point on demand curve. P1 Q1 £ Q O

  38. Kinked demand for a firm under oligopoly £ Assumption 1 If the firm raises its price, rivals will not Assumption 2 If the firm reduces its price, rivals will feel forced to lower theirs too. D P1 D Q O Q1

  39. Stable price under conditions of a kinked demand curve a b MR £ MR is discontinuous between a and b. P1 D = AR Q O Q1

  40. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) • The kinked demand curve theory • assumptions of the model • the shape of the demand and MR curves • effect of a change in costs

  41. Stable price under conditions of a kinked demand curve MC2 MC1 a b MR £ If MC is anywhere between MC1 and MC2, profit is maximised at Q1. P1 D = AR Q O Q1

  42. Oligopoly • Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) • The kinked demand curve theory • assumptions of the model • the shape of the demand and MR curves • effect of a change in costs • stable prices • limitations of the model

  43. Oligopoly • Oligopoly and the public interest • advantages • disadvantages • difficulties in drawing general conclusions • Advertising and the public interest • Oligopoly and contestable markets

  44. Imperfect Competition Game Theory

  45. Game Theory • Single move or normal-form games • alternative strategies: maximax and maximin • single dominant strategy games

  46. Profits for firms A and B at different prices X’s price £2.00 £1.80 B A £5m for Y £12m for X £2.00 £10m each Y’s price D C £12m for Y £5m for X £1.80 £8m each

  47. Game theory • Single move or normal-form games • alternative strategies: maximax and maximin • single dominant strategy games • the prisoners’ dilemma

  48. The prisoners’ dilemma Amanda's alternatives Not confess Confess B A Nigel gets 10 years Amanda gets 3 months Not confess Each gets 1 year Nigel's alternatives D C Nigel gets 3 months Amanda gets 10 years Each gets 3 years Confess

  49. Game Theory • Single move or normal-form games • alternative strategies: maximax and maximin • single dominant strategy games • the prisoners’ dilemma • Nash equilibrium • non-dominant strategy games

  50. Profit possibilities for firm X

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