AP Micro Unit 4 - Imperfect Competition

Monopoly

* A kind of a market where only one firm that dominates the industry and sells a very unique product

Oligopoly

* A kind of market where there are a few, large firms that dominate the industry (usually less than 10)

Monopolistically Competitive Market

* A kind of market where a large number of sellers offer differentiated products

Characteristics of Imperfectly Competitive Firms

• Fewer, larger firms in the industry

• Firms are “price makers” - firms have some or total control over the price they choose to sell their goods at

• Higher barriers to entry, meaning firms cannot enter as easily

• Firms earn long run profits (except for monopolistic competition - it breaks even in the long run)

• Products sold are differentiated

• Non-price competition is used - tools like advertising to promote products

• Firms are inefficient in the long run

• Demand is greater than Marginal Revenue

Example Barriers to Entry

• Geography

  • If location is close to resources

  • Firms is the only one selling product in the area

• Government (US)

  • Issues patents and other protections

• Common Use

  • Brand name and reputation

• Economies of Scale

  • Availability of firms to mass produce at a low-cost

• High Fixed Costs

  • Firms may not have the financial resources to pay the upfront costs of entering the market

Monopoly

• A market structure where an individual firm has sufficient control over a market or industry

• They determine the terms of access to other firms

Natural Monopoly

• Occurs when an individual firm comes to dominate an industry by producing goods and services at the lowest possible production cost that other firms cannot compete with

• They’re beneficial to society as they charge low prices and promote productive efficiency

Characteristics of Monopolies

• One, large firm

• Firms are “price makers”

• High barriers to entry

• Firms earn long-run profits

• Products sold are unique

• Non-price competition is used

• Firms are inefficient if left unregulated - overcharge and underproduce

Monopoly Graph

Profit in a Monopoly (graph)

Loss in a Monopoly (graph)

Monopoly with Consumer Surplus, Producer Surplus, and Dead Weight Loss

Monopoly Graph

Profit Maximizing Price and Output

(Loss-Minimizing)

* MR = MC

Monopoly Graph

Socially Optimal Price and Output

• P = MC

• Allocatively Efficient

Monopoly Graph

Fair-return Price and Output

* P = ATC

Monopoly Graph

Maximized Total Revenue Price and Output

* MR = 0

Key Points on Monopoly Graph

• Profit Maximizing - MR = MC

• Socially Optimal - P = MC

• Fair-Return - P = ATC

• Maximized TR - MR = 0

Elasticity in Monopoly

• Unit Elastic Point - point on the demand curve where a horizontal line intersects MR = 0

• Elastic Region - any point above the MR = 0 intersecting line

• Inelastic Region - any point below the MR = 0 intersecting line

• Can also be determined with a TR curve, where the peak matches MR = 0

Price Discrimination

* Practice where specific products are sold to different buyers at the highest price they are willing and able to pay

Conditions required to practice price descrimination

• Monopoly Power

• Able to segregate the market

• Consumers cannot easily re-sell the product

Characteristics of a Price Discriminating Monopoly

• D = MR

• Allocatively Efficient but Productively Inefficient

• Larger long-run economic profits

• Zero consumer surplus

Characteristics of a Pure Monopoly

• D > MR

• Allocatively and Productively Efficient

• Smaller long-run economic profits

• Some consumer surplus

Perfect Price Discrimination

• AKA 1st degree price discrimination

• Demand exactly equals MR

• Three curves: MC, D = MR, and ATC

Characteristics of Monopolistic Competition

• Many, various sized firms

• Firms are “price makers”

• Low barriers to entry

• Firms break even in the long-run

• Products are differentiated

• Non-price competition is used

• Firms are inefficient if left unregulated

• Firms experience excess capacity - they are productively inefficient

Non-Price Competition

• Ways that firms seek to increase sales and attract consumers through methods other than price

• Examples: Brand names and packaging, product attributes and service, advertising

Monopolistic Competition Graph

• Demand and MR are more elastic

• (Missing ATC)

Monopolistic Competition Earning a Profit

Monopolistic Competition Earning a Loss

Monopolistic Competition in the Long Run

• ATC will be tangent to the demand curve in the downward sloping region (economies of scale region)

• Productively and Allocatively Inefficient

Monopolistic Competition

Short Run to Long Run

• Firms earn short-run profits, so more firms enter the market

  • More substitutes are created, so there is less market share for existing firms, so demand and MR curves shift left together until demand is tangent to ATC

• Firms earn short-run losses, so firms exit the market

  • There is more market share for existing firms, so demand and MR curves shift right together until demand is tangent to ATC

Excess Capacity

* The difference between a firm’s current inefficient level of production and the productively efficient level of output
* If there is productive efficiency, there is no excess capacity, but Monopolistically Competitive Firms are Productively Inefficient in the long-run

Oligopoly

• An imperfect market structure where the industry is dominated by a few, large firms

• Two kinds:

  • Colluding Oligopolies

    • AKA cartels

    • Firms communicate with each other and act in one unit

  • Non-Colluding Oligopolies

    • Firms compete and do not work together

Characteristics of Oligopoly

• Few, large firms

• Firms are “price makers”

• High barriers to entry

• Firms earn long-run profits

• Products are differentiated

• Non-price competition is used

• Firms are inefficient if left unregulated

Game Theory

* The study of how people behave in strategic situations

What is a game (in economics)?

* Any set of circumstances that has a result dependent on the actions of two or more decision-makers

Payoff Matrix

* A chart that shows the actions of two firms and the payoffs of each combination of choices

Dominant Strategy

• A strategy a firm should take no matter what the other firm does

• Sometimes a firm doesn’t have a dominant strategy because their actions should differ based on the other firm’s actions

Nash Equilibrium

• A point at which there is a stable state in the game in which no participant can unliterally improve their position

• It’s a point where the game equilibrates because neither player can improve their position without the other player moving

• You can find this point by determining the best option for either player, and if there are two circles in one box, that is the equilibrium point

Price Leadership

• Model of oligopoly where the dominant firm will initiate a price change in the industry

• We can model the change with a kinked demand curve

• If the dominant firm raises prices, the other firms can either match those prices or ignore those prices and get more consumers - elastic

• if the dominant firm lowers prices, the other firms will usually match your prices and the market will stay relatively similar - inelastic

• Note: Not necessary for the AP, but can help show how the market is influenced by interdependence