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Market Equilibrium and Market Demand: Imperfect Competition PowerPoint Presentation
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Market Equilibrium and Market Demand: Imperfect Competition

Market Equilibrium and Market Demand: Imperfect Competition

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Market Equilibrium and Market Demand: Imperfect Competition

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  1. MarketEquilibrium and Market Demand:Imperfect Competition Chapter 9

  2. Market Structure Characteristics We characterize an industry by • No. of firms and size dist. • Product differentiation • Unique products? • Barriers to entry • The picture to the right concerned with two markets: • No. 2 yellow corn: many producers and sellers (Perfect Competition) • Farm equipment: few manufacturers and sellers (Oligopoly) 2 Pages 145-148

  3. Perfect Competition • We have been assuming the firm and market reflect conditions of perfect competition • Not a bad assumption for many agric. subsectors • A large number of small firms • 2 million farms • A homogeneous product • No. 2 yellow corn • Freely mobile resources • No barriers to entry caused by patents, etc. or barriers to exit (???) • Perfect knowledge of market conditions • Quality outlook information from government, university and private sources • Dramatic reduction in costs of obtaining information and increase the speed of information acquisition 3

  4. Imperfect Competition • Many markets in which farmers buy inputs and sell their products however do notreflect perfect competition conditions • Chapter 9 focuses on specific types of imperfect competitors in the farm input market • These firms are capable of setting prices farmers must pay for specific inputs 4

  5. Imperfect Competition in Selling 5

  6. Measures of Concentration • Quantitative measures of the degree of competition in a market • Concentration Ratio (CR) • % of the total market revenue accounted for by 2 (CR2), 4 (CR4), 8 (CR8), 20 (CR20), etc. largest firms in the industry • Low CR values→ a high degree of competition • High CR values → an absence of competition 6 Page 148-151

  7. Measures of Concentration • Quantitative measures of competition • Herfindahl-Hirschman Index (HHI) • The square of % market share of each firm summed over the largest 50 firms or all firms if there are < 50 firms in the industry • Perfect competition, HHI is small • Only 1 firm, HHI is 10,000 = (1002) • U.S. Justice Department • HHI < 1,000 competitive markets • HHI > 1,800 could be considered concentrated industry worthy of Justice Dept. examination of any purchases of other firms in the industry 7 Page 148-151

  8. Measures of Concentration • Whether an industry is concentrated depends on how narrowly it is defined • In terms of the product it produces • Extent of the geographic area it serves 8 Page 148-151

  9. Consolidation in the U.S. Dairy Industry 9 Page 165

  10. Measures of Concentration 10 Page 148-151

  11. Measures of Concentration Cooperative CR Values of Total U.S. Milk Marketed 11 Page 148-151

  12. Measures of Concentration 12 Page 148-151

  13. Topics for Discussion • Monopolistic Competition • Definition • Production and Pricing Decisions • Oligopolies • Definition/Examples • Production and Pricing Decisions • Monopolies • Definition/Examples • Production and Pricing Decisions • Comparison of Market Structures Pages 106-107 13

  14. Imperfect Competition in Selling • At the firm level, unlike perfect competitors who face a perfectly elastic (horizontal) demand curve • Imperfect competitors selling a differentiated product have a downward sloping demand curve $ $ Firm’s demand curve under P.C. Firm’s demand curve under imperfect competition A A B B Q Q 14

  15. Table 9-1 Imperfect Competition Firm faces a downward sloping demand curve → MR ≤ AR 2 20 Marginal Revenue (MR) : Change in revenue from the sale of the last unit of output (ΔTR÷ΔQ) Average Revenue (AR): Total Revenue/Total output (TR÷Q) Note: Price = Average Revenue 15 Page 149

  16. Imperfect Competition in Selling Marginal Revenue (MR): Change in revenue from the sale of the last unit of output 16 Page 150

  17. Imperfect Competition in Selling Maximum Total Revenue • Marginal revenue in this instance is also downward sloping • MR=0 at the point where TR is at a maximum Page 150 17

  18. Types of Imperfect Competitors in Input Markets • Monopolistic Competition • Oligopoly • Monopoly Let’s start here… 18

  19. Monopolistic Competitors • Many sellers • Each firm has relatively small market share • Power to set prices somewhat like a monopoly • Face competition like perfect competition • Collusion is not possible given number of firms in the industry • No barriers to entry or exit 19 Page 148-151

  20. Monopolistic Competitors • Product Differentiation: Each firm makes a product that is slightly different from the products of competing firms • Close substitutes but not perfect substitutes • An attempt to ↑ price will normally results in a ↓ in volume sold • Competition on Quality, Price, and Marketing • Quality in design, reliability, service provided to buyer and ease of access to product • The firm faces a downward sloping demand curve • Firm must market intensively: promotions, distribution, packaging, etc. 20 Page 148-151

  21. Monopolistic Competitors • Product differentiation does not necessarily mean there are any physical differences among products • They might all be the same, but how they are sold may make all the difference 21 Page 148-151

  22. Monopolistic Competitors • The monopolistic competitor tries to set his/her product apart from the competition • Main method is via advertising • When this is done successfully, the demand curve becomes more vertical or inelastic • Buyers are willing to pay more because they believe it is much better than their other choices • Basis for product differentiation • Physical differences Convenience • Ambience Reputation • Appeals to vanity Snob appeal 22 Page 148-151

  23. Monopolistic Competitors • Typical Monopolistic Competitor • Tries to set firm apart from competition • New Product Development and Innovation • Advertising • Create consumer perception of product differentiation – real or imagined • Attempt to keep demand as inelastic as possible • Selling costs can be extremely high 23 Page 148-151

  24. Monopolistic Competitors Short run profits can exist but long run profits are reduced to 0 with industry entrants Fast food industry is a good example All services basically the same Extensive use of marketing to differentiate products/services across firms Striving to produce more products and services 24 Page 148-151

  25. Monopolistic Competitors How much of the product does this firm produce? Determine output level where MC = MR (Why does this make sense?) What price should the firm charge for this product? Locate on the downward sloping demand curve where above quantity intersects Associated price on this demand curve 25 Page 148-151

  26. Monopolistic Competitors $/unit Short run profits exist if: PSR > ATCSR at QSR MC ATC PSR Profits ATCSR Firm Demand E MR Q QSR • The firm produces QSR where MR=MC at E • Prices its products at PSR by reading off the demand curve at quantity QSR • Represents consumer’s willingness to pay for QSR Page 150 26

  27. Monopolistic Competitors $/unit ATC MC ATCSR Loss PSR Firm Demand E MR Q QSR • Short run loss • At QSR, PSR < ATCSR Page 150 27

  28. Monopolistic Competitors $/unit ATC MC ATCLR = PLR Firm Demand E MR Q QLR • In the Long Run (LR) • Profits are bid away as more firms enter the market • Losses will no longer exist as firms leave the market • At QLR the remaining firms are just breaking even Page 150 28

  29. Monopolistic Competitors • How much is the industry dominated or not dominated by few suppliers • Depends on the geographical scope – national, regional, global • An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e.g. local farm supply cooperative • Depends on the existence of barriers to entry and exit • Industries may appear concentrated but few barriers exist to prevent entry which implies less ability to dominate market 29 Page 148-151

  30. Oligopolies • A few number of sellers • Each can impact market price and quantities • Interdependent in their decision making • A firm will consider how other firms will react to pricing, promotional and other actions • Key component in marketing strategies and pricing behavior 30 Pages 152-155

  31. Oligopolies • Rival oligopolists will match price cuts but not price increases in the short run as they want to capture larger market share • If there are differences in prices they are the result of successful product differentiation • Non-price competition between oligopolistsused to uniquely identify products • Tend to have stable prices • Changes in production and other costs not easily passed on and may have to be absorbed 31 Pages 152-155

  32. Oligopolies • Price leadership strategy • A particular firm dominates the market • Controls the largest share of the market • Other industry firms more efficient in operation, marketing, etc. • The dominant firm first sets its price to maximize profit • Remaining firms set their prices based on the dominant firms pricing • The price set by the oligopolist seller is higher then under perfect competition • Quantity produced is lower then perfect comp. 32 Pages 152-155

  33. Oligopolies • The dominant firm may be efficient enough to set a lower price • Eventually drive the other firms out of the market 33 Pages 152-155

  34. Oligopolies • Examples of Oligopolies • Auto manufacturers • 2007 CR4 value of 73.7 • Aircraft manufacturing • 2007 CR4 value of 81.3 • Farm machinery and equipment • John Deere, J.I.Case and New Holland • 80% of 2-wheel drive tractors • close to 90% of combines sold in the U.S. • Cattle slaughtering • CR4 value increased from 39 to 67 over the 1985-1995 period • 2007 CR4 value of 59.4 34 Pages 152-155

  35. Oligopolies • Demand curve DD • All oligopolists move prices together and share market • Original demand curve dd • A singlefirm changes its price • Curve DD is more inelastic • Below point A, other firms match price cut • This leads to a kinked demand curve dAD • Leads to a discontinuous marginal revenue curve, dBCE D d A d B D C E Remember oligopolists account for the reaction of other firms so there is no single demand curve 35 Pages 152-155

  36. Oligopolies • Meeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share D MC d A B D C E 36 Pages 152-155

  37. Oligopolies D MC d • Shifting MC curve to MC* reflecting technological advances will not affect PE and QE • It does impact profits as MC drops A PE B D C MC* E QE 37 Pages 152-155

  38. Monopolies • One seller in the market • Firm and market demand curve are the same • Entry of other firms restricted by patents, etc. (i.e., barrier to entry) • Firm has absolute power over setting market price • Produces a unique product • It can have economic profits in the long run because it can set price without competition 38 Page 155-156

  39. Monopolies $/unit • Total revenue = area 0PECQE • Monopolist produces quantity where MC=MR (pt A), QE • Uses the demand curve (pt C) when setting price PE ATC MC AVC C PE B M A N Demand= AR TVC MR Quantity 0 QE 39 Page 155-156

  40. Monopolies $/unit ATC MC AVC • Total variable costs for the monopolist is equal to area 0NAQE, (green box) • =AVC x QE = 0N x QE C PE B M A N Demand= AR TVC MR Quantity 0 QE 40 Page 155-156

  41. Monopolies $/unit ATC MC AVC C PE • Total fixed costs equals NMBA (orange box) • =(ATC-AVC) x QE B M TFC A N Demand= AR MR Quantity 0 QE 41 Page 155-156

  42. Monopolies $/unit ATC MC AVC • Total cost is area 0MBQE (green box + orange box) • = area ONAQE + area NMBA C PE B M TFC N A Demand= AR TVC MR Quantity 0 QE 42 Page 155-156

  43. Monopolies $/unit Economic Profit ATC MC AVC C • Monopoly economic profit = area MPECB • = Total Revenue (yellow box) – Total Costs (green box + orange box) PE B M TFC A N Demand= AR TVC MR Quantity 0 QE 43 Page 155-156

  44. Monopolies $/unit ATC MC AVC C PE Economic Profit • Total fixed costs equals NMBA (orange box) • =(ATC-AVC) x QE B M TFC A N Demand= AR TVC MR Quantity 0 QE 44 Page 155-156

  45. Comparison of Structure Results • Lets compare the results we have obtained from the alternative market structures 45

  46. Perfect Competition $/unit Supply Consumer surplus = sum of areas 1, 4, 5, 8 and 9 (Pink triangle) 9 8 Producer surplus = sum of areas 2, 3, 6 and 7 (green triangle) 5 4 1 PPC 3 2 6 Total economic surplus = sum of blue and green triangles = sum of areas 1 – 9 7 Demand MR Quantity 0 QPC 46 Page 157

  47. Monopoly Case $/unit Consumer surplus = sum of areas 8 and 9 (Pink triangle) Supply 9 8 • Compared to P.C., consumers would be economically worse-off by areas 1, 4 and 5 • Paying a higher price, PM • Purchasing a smaller quantity, QM PM 5 4 1 PPC 3 2 6 7 Demand MR Quantity 0 QPC QM 47 Page 157

  48. Monopoly Case $/unit PS = to sum of areas 3, 4, 5, 6 and 7 (green area) Supply • Compared to P.C. producers lose area 2 but gain areas 4 + 5 • Producers economically better-off than perfect competition 9 8 PM 5 4 1 PPC 3 2 6 7 Demand MR Quantity 0 QPC QM 48 Page 157

  49. Monopoly Case $/unit Supply • Purple triangle is total economic surplus under perfect competition • Orange triangle is total economic surplus under monopoly • Society as a whole economically worse-off by areas 1 + 2 (Green triangle) • Known as the dead weight loss • Reflects the fact that less resources in this market are used to provide products to consumers PM 1 PPC 2 Demand MR Quantity 0 QPC QM 49 Page 157

  50. Summary of Impacts of Alternative Market Structures from a Selling Perspective Page 157 50