Micro Chapter 14 - Imperfect Competition

Monopolistic Competition

not perfect substitutes but close, degree of substitutability will determine how closely the industry resembles perfect competition, can enter and exit freely

Imperfect Competition

firms that have market power and face competitors

Types of imperfect competition

monopolistic and oligopoly

Oligopoly

market in which few firms compete and entry is impeded. Firms compete and behave strategically eg. cell phone service

Monopolistic and perfect competition similarities

many firms serve the market, free entry and exit, zero economic profit in the long run

Monopolistic and perfect competition differences

firms sell a differentiated good eg. different brands, styles, locations

The Chamberlin Model

assumption of a clearly defined industry group which consists of a large number of producers of products that are close but not perfect substitutes, 1930s by Edward Chamberlin and Joan Robinson

Implications of Chamberlin Model

downward sloping demand curves, firms act as if their own price and quantity decision have no effect on the behaviour of other firms, demand schedule is highly elastic

Symmetry between firms

all firms assumed to have the same demand curve so if it makes sense for one firm to alter prices, it would also make sense for the others too

2 demand curves to face

1.describing what happens when it alone changes price. 2. describing what happens when all prices change in unison. more elastic in 1 than 2.

Optimal Price and Quantity

Point at which MC = MR on the individual demand curve, this should also be P* and Q* for the market demand

Long Run Equilibrium

entry shifts demand to left, equal proportional reduction in quantity as equal shares in the industry. after shift, readjust to match new profit-maximising level

Equilibrium position on graph

when MC = MR, the individual demand curve is tangent to both the long and short run ATC, at this point zero economic profit and at any other output level, AC > AR so economic profit would be 0

Factors that influence demand

price, availability, location, variation in product characteristics

Perfect vs Monopolistic Competition

allocative efficiency, P and MC relationship and long run profitability

PC vs CMC, Allocative efficiency

PC meets allocative efficiency, CMC doesn't. In PC, P=MC -> no unexploited possibilities for mutual gains through exchange. CMC P>MC so there exists people who value an additional unit of output more highly than the value of resources required to produce

PC vs CMC, P and MC relationship

In PC, P=MC -> firm should react with an indifference to an opportunity to fill a new order at the current market. In CMC, P>MC -> firms should greet a new order at the current market price with enthusiasm

PC vs CMC, Long run profitability

both exactly the same, freedom on entry -> economic profit at zero and freedom of exit -> no long run economic losses

Criticisms of Chamberlin Model

1. defining industry group, 2. operational boundaries, 3. perfect competition theory, 4. fairness to attract

1. Defining an 'industry group'

meaning a group of products that are different from each other in an unspecified way, yet likely to appeal to any given buyer

2. Operational boundaries

where is the boundary? if coke and pepsi are substitutes but pepsi and milk is too? gets highly unrelated

3. Perfect Competition theory

both predict economic profit will attract entry which reduces prices and eliminates profit in the long run

4. Fairness in attracting

assumes each firm has an equal chance to attract buyers in an industry which seems too similar to perfect competition

Optimal Number of Locations

trade-off between fixed costs and start up costs of new locations on one hand then savings from lower transportation on the other. Decision between locational convenience and lower costs

Optimum Degree of Product Diversity

Greater diversity is expected with greater population density and higher transportation costs (measure willingness to pay for desired products). OPD is negatively related to the start-up costs of adding new product characteristics or locations

Hotelling Model

example- hot dog stand. better off to be closer to the competition and the market is unlikely to provide the product the consumers desire. With 3 hot dog vendors, no stable equilibrium

Strategic Oligopoly Theories

1. Cournot, 2. Bernard, 3. Stackleberg

Oligopoly Behaviour

takes into account what the rivals are doing, any decisions made will include a prediction on how they will react, fewer firms in the markets so easier to take into account actions, profit maximisation doesn't only depend on individual MC and MR but rival curves too

Strategic Actions to Deter entry

threaten to decrease price against new competitors by keeping excess capacity

Nash Equilibrium

each firm is doing the best they can, given what its competitors are doing

Duopoly

just 2 firms competing in the market

Cournot

happens simultaneously and is static. Assumes rivals continue to produce at current level and takes Q as a given. A weak form of interdependence

Reaction Function of Cournot

a curve that tells the profit-maximising level of output for one oligopolist for each amount supplied by another

Bertrand

happens simultaneously and is static. Each firm assumes that rivals charge current prices so take prices as a given

Cournot vs Bernard

C is quantities, B is prices, C yields a slightly lower price and a slightly higher quantity then if firms collude to achieve monopoly outcome, B leads to essentially the same outcome as perfect competition

Stackleberg

Sequential, a leader and a follower firm where leader strategically manipulates quantity decisions of rival. One firm assumes its rival will continue current output while other assumes producing on cournot function.

How to work out Stackelberg

Use backward induction, 1. Check follower first (followers reaction function will be the same), 2. Move onto the leader, 3. Substitute the followers reaction function (take into account for TR), 4. Find new MR and equate to MC

Stackelberg, leader or follower?

leading firm receive same profit as if they were a cartel so they have the benefit

Duopoly Overall Profit Level

the shared monopoly model would have the higher overall combined profit level

Duopoly Equilibrium on a graph

static game - where best response functions intersect and stackelberg - leader has advantage on best response function of follower

Highest to Lowest Profit

Monopoly, Oligopoly, Perfect Competition (zero economic profit)

Highest to Lowest Ouput

Perfect Competition, Oligopoly, Monopoly

Collusion

incentives to collude to have monopoly outcome, incentives are similar to Prisoners' Dilemma. Hard to hold cartels together as dominant strategy for both is to cheat- tit-for-tat. Repeated interactions between small numbers can support collusive behaviour

Dominant Strategy

strategy in a game that produced the best result irrespective of the strategy chosen by one's opponent

Tit-for-tat

first time, cooperate then do what the previous person did in every other interaction. *Mustn't be a known end of interactions

In the long run, firms will not increase prices uniformly as

they can then increase their profits by cutting prices

The number of outlets increase when

population density and transportation costs increase

If P > MC a firm can capture…

the whole of the market by undercutting its rival's price

an incumbent firm may fight entry to

make higher profits later and maintain its profits

Most to least equilibrium price of models of oligopoly

Cournot > Stackelberg > Bertrand

most to least equilibrium quantity of models of oligopoly

Bertrand > Stackelberg > Cournot

a natural monopolist will deter potential entrants as it enjoys…

increasing returns

ways of collusion

price fixing, promise to transfer profits, imposing quotas to limit supply

Why do big firms buy out their viable competitors

To preserve their market power and to prevent them to make their own acquisitions in the future

Collusion can be sustained in repeated games by playing

tit-for-tat or grim trigger strategies

tacit collusion

activity that results in firms coming to a mutual price understanding without ever actually discussing the matter between them -> legal unless evidence of collusion/ communication

Price discrimination can increase efficiency and profits when the market is

a cournot duopoly, a stackelberg duopoly or a monopoly

If a monopolistic firm's demand shifts outward due to increased brand awareness ->

results in a redistribution in industry sales and if increased product awareness -> boost in industry sales

Galbraith revised sequence

producers decide which products are cheapest and most convenient to be produced and then use advertising and other devices to create demand for these products. The quality was not considered

Traditional Sequence

Producers are agents of consumers

Traditional Sequence vs Galbraith

traditional sequence is more plausible than the revised Galbraith