Notes on Imperfect Competition

Imperfect Competition

Introduction

  • Most markets are not perfectly competitive but imperfectly competitive.
  • Types of Imperfectly Competitive Markets:
    • Monopoly: One business dominates the entire market.
    • Oligopoly: A few large firms dominate the market.
    • Monopolistic Competition: Many businesses differentiate their products and have lots of competition.

Monopolistic Competition

  • Many sellers within this market.
  • Low barriers to entry: Relatively easy to enter or exit this market.
  • Firms earn zero economic profit in the long run, similar to perfectly competitive firms.
    • Economic profit attracts firms to enter, competing the profit away.
    • Economic losses cause firms to exit, leading to firms breaking even or earning zero economic profit (normal profit) in the long run.
  • Products are differentiated rather than identical (unlike perfect competition).
  • Example: Shoes; products are differentiated but highly substitutable.
  • Differentiation gives firms some pricing power; they are price seekers rather than price takers.

Oligopoly

  • A few sellers dominate the market.
  • High barriers to entry make it difficult for firms to enter and compete.
    • Barriers include high startup costs, government regulations, and established customer loyalty.
  • High barriers to entry give firms pricing power.

Monopoly

  • One seller dominates the market.
  • Barriers to entry are so high that it is impossible for any firms to enter and compete.
  • If a competitor enters, the market becomes an oligopoly.
  • The product is unique, with no close substitutes.
  • High barriers to entry and the uniqueness of the good give the firm pricing power (monopoly power).

Demand Curves

  • Perfectly Competitive Firms:
    • Price takers: Market supply and demand set the equilibrium price.
    • Horizontal demand and marginal revenue curve.
    • If a firm increases the price above equilibrium, it sells zero units.
    • If a firm lowers the price below equilibrium, it loses profit.
  • Imperfectly Competitive Firms:
    • Price seekers: Have a typical downward-sloping demand curve.
    • As price increases, sales decrease; as price decreases, sales increase.
    • To sell more units, a firm must lower the price.
Demand Curve and Marginal Revenue

\begin{array}{|c|c|c|c|} \hline \text{Output} & \text{Price} & \text{Total Revenue} & \text{Marginal Revenue} \ \hline 1 & $10 & $10 & 10 \ \hline 2 & 9 & $18 & 8 \ \hline 3 & 8 & $24 & $6 \ \hline \end{array}

  • Marginal revenue is below the price.
  • Marginal revenue curve is below the demand curve on a graph.
  • The marginal revenue curve is technically twice the slope as the demand curve.

Efficiency

  • Perfectly Competitive Firms:
    • Price at marginal cost.
    • Produce where MR=MCMR = MC, and at that quantity, P=MCP = MC.
    • Allocatively efficient: Producing where marginal cost equals marginal benefit (demand curve).
  • Imperfectly Competitive Firms:
    • Produce where MR=MCMR = MC.
    • Price up at the demand curve.
    • Since P > MC, the firm is not allocatively efficient.
    • Underproducing and overcharging.
    • The allocatively efficient quantity is where the marginal cost intersects the demand curve.
    • Deadweight loss occurs because the allocatively efficient quantity is not produced.