Chapter 11 The World of Imperfect Competition
1. MONOPOLISTIC COMPETITION: COMPETITION AMONG MANY Learning Objectives • Explain the main characteristics of a monopolistically competitive industry, describing both its similarities and differences from the models of perfect competition and monopoly. • Explain and illustrate both short-run equilibrium and long-run equilibrium for a monopolistically competitive firm. • Explain what it means to say that a firm operating under monopolistic competition has excess capacity in the long run and discuss the implications of this conclusion.. • Imperfect competition refers to a market structure with more than one firm in an industry in which at least one firm is a price setter. • Monopolistic competition refers to a model characterized by many firms producing similar but differentiated products in a market with easy entry and exit.
1.1 Profit Maximization 18.25 ATC MC 10.40 9.20 2,150 D1 MR1
1.1 Profit Maximization 18.25 ATC 17.50 MC A MR2 D1 MR1 D2
1.2 Excess Capacity: The Price of Variety • Excess capacity refers to a situation in which a firm operates to the left of the lowest point on its average total cost curve.
2. OLIGOPOLY: COMPETITION AMONG THE FEW • Learning Objectives • Explain the main characteristics of an oligopoly, differentiating it from other types of market structures. • Explain the measures that are used to determine the degree of concentration in an industry. • Explain and illustrate the collusion model of oligopoly. • Discuss how game theory can be used to understand the behavior of firms in an oligopoly. • Oligopoly refers to a situation in which a market is dominated by a few firms, each of which recognizes that its own actions will produce a response from its rivals and that those responses will affect it.
2.1 Measuring Concentration in Oligopoly • Concentration ratio is the percentage of output accounted for by the largest firms in an industry. • Herfindahl-Hirschman Indexis an alternative measure of concentration found by squaring the percentage share (stated as a whole number) of each firm in an industry, then summing these squared market shares.
2.2 The Collusion Model • Duopoly is an industry that has only two firms. • Overt collusionis when firms openly agree on price, output, and other decision aimed at achieving monopoly profits. • A Cartel consists of firms that coordinate their activities through overt collusion and by forming collusive coordinating mechanisms. • Tacit collusion is an unwritten, unspoken understanding through which firms agree to limit their competition.
Monopoly through Collusion PM MC PC C B A MRfirm Dfirm = MRcombined Dcombined 1/2QM QM QC
2.3 Game Theory and Oligopoly Behavior • Strategic choice is a choice based on the recognition that the actions of others will affect the outcome of the choice and that takes these possible actions into account. • Game theoryis an analytical approach through which strategic choices can be assessed. • A payoff is the outcome of a strategic decision. • A Dominant strategy is when a player’s best strategy is the same regardless of the action of the other player. • A Dominant strategy equilibrium is a game in which there is a dominant strategy for each player.
Repeated Oligopoly Games • A tit-for-tat strategy is a situation in which a firm responds to cheating by cheating, and responds to cooperative behavior by cooperating. • A trigger strategyis a situation in which a firm makes clear that it is willing and able to respond to cheating by permanently revoking an agreement.
3. EXTENSIONS OF IMPERFECT COMPETITION: ADVERTISING AND PRICE DISCRIMINIATION • Learning Objectives • Discuss the possible effects of advertising on competition, price, and output. • Define price discrimination, list the conditions that make it possible, and explain the relationship between the price charged and price elasticity of demand.
3.1 Advertising • Firms use advertising when they expect it to increase their profits. • Advertising could lead to higher prices for consumer by: • Increased costs shift supply • Demand shifts • Advertising and information • Advertising and competition
3.2 Price Discrimination • Price discrimination refers to a situation in which a firm changes different prices for the same good or service to different consumers, even though there is no difference in the cost to the firm of supplying these consumers. • E.g. student and senior discounts on city buses, children’s admission price at movie theater, physicians charging wealthy patients more than they charge poor patients. • For price discrimination monopoly power is one of three conditions which must be met. The others include: • A price-setting firm • Distinguishable customers • Prevention of resale