10) Imperfect Competition

What is market Power

Market Power is a firms ability to influence the price of a market, rather than being a price-taker

Sources of Market Power

Key sources include:

• Barriers to Entry within the market (the harder to enter, the more power)

• Level of product differentiation (the more unique, the more power)

• Level of Competition (Less competition, more power)

• Control of Key resources

• Economies of Scale

Key Barriers to Entry

Key Barriers include:

• Consumer loyalty

• Government / Legal policies (patents, regulations, etc)

• Set up costs (Trying to create a new airline)

Market Power Impact on Business Curves

The degree of market power a business has impacts:

• Its individual demand curve (elasticity falls with market power)

• Marginal Revenue curve

• Optimal output / price

Market Conditions and the Demand Curve

Perfect Competition

• Perfectly elastic demand (horizontal)

• Firms can not change price (No market power)

Imperfect Competition (Monopolistic Competition and Oligopoly)

• Downward sloping, but elastic demand

• Limited Market Power

Monopoly

• Downward Sloping, inelastic Demand

• Firm demand is market demand

  • Max Market Power

Four Main Market Structures

Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

Monopolistic Competition Market

Key Features

• Many firms

• Low Barriers to Entry

• Existent, but Low Market Power

• Downward sloping, elastic demand

• MR < D

• Moves toward zero profit in the long term

Oligopoly

Features

• Small number of dominant Firms

• Significant market power, but not maximum

• Firms are interdependent (impact each other)

• MR < D

• Potential for long-term profit

Short-Run Profit in Imperfect competition

Anything is possible within the short-run

Long-Run Profit in Imperfect Competition

Approaches Zero Profit in Monopolistic Competition

• As economic profit is available, more firms join until it reaches zero

Potential for long-term profit in Oligopoly

• Due to barriers to entry, profit can be sustained

• So can losses however, if barriers to exit are also high

Allocative Efficiency in Imperfect Competition

With higher market power, price tends to be higher than if it were perfect competition

Output does also tend to be lower

Product differentiation to create market power does however give consumers choice

Welfare within Imperfect Competition

Market power gives firms a degree of monopsony power

Higher prices raise producer surplus, lower consumer surplus and create Deadweight loss

Powerful firms may also impact other markets if they manipulate their suppliers

Productive Efficiency within Imperfect Competition

It is ambiguous and dependant on the situation

Monopolies and oligopolies may benefit from significant economies of scale

They often also tend to have excess capacity, producing beneath the optimal efficiency rate

Dynamic Efficiency within Imperfect Competition

Dependant on the size/resources of firms (typically Oligopoly and Monopolies)

Typically only larger firms have the excess to spend on R&D, hence the trade in allocative efficiency for Dynamic efficiency

Competition Policy

Competition is typically bad for business, but better for society

Hence the government has strong anti-collusion policies, advocating for competition

Firms colluding can create a pseudo monopoly, separate companies but working as a monopoly

Business Demand Strategies

In competitive but differentiated markets, it is key to convince consumers your product is better

This can involve:

• Advertising Campaigns (raises costs and MB, also Increases Customer loyalty)

• Make brand switching harder (Difficulty to switch operating systems)

• Network effects (where more users makes a product better)

• Product Differentiation (convincing customers your product is different)

Supply-side Strategies

Firms can save / increase profit through unique cost-advantages

• Having unique insights / experience

• Economies of Scale

• Research and Development

• Bargaining with suppliers

• Holding key access to inputs

Entry Deterant Strategies

By increasing the barriers to entry a business builds market power, through:

• Cost advantages (Supply-side strategies)

• Brand Awareness / Recognition

• Increasing Brand Loyalty / making brand switching harder

• Regulatory Services

Graphing Changes

Start From Zero-Economic Profit State

Graph the Immediate Changes (Cost of an Advertising Campaign)

Graph the Long-Run Changes (Increased Demand from Advertising)

Graphing: Cost Advantages (Fixed and Variable)

Fixed Cost Reduction:

• Lowers the ATC curve

Variable Cost Reduction:

• Lowers the ATC, AVC and MC curves

Graphing: Increasing Consumer Demand

Shift the firms demand curve to the right

Graphing: Increasing Real / Perceived Value

Shifts the Demand Curve to the Right

Makes the Demand Curve less Elastic

Graphing: Detered Entry

Firms can hold profit into the long run

Less elastic Demand Curve