Transcript 7 2015-7 Monopolistic Competition and

Monopolistic Competition and
Olgipoly
The perfectly competitive solution is considered the socially optimum solution
to market supply issues but it is the lure of profits that generates excitement of
being in business.
The monopolist has the best chance of making a profit but in so doing is readily
identified for government action.
In markets where there are a few competitors but a downward sloping demand
curve the possibility of profit does exist.
If the market has persistent over supply it is characterized by monopolistic
competition.
If the market has consistent profit it is characterized as an oligopoly.
In both cases the markets are contestable amongst the competitors and some
win and some loose.
The Over Supply Case
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In a monopolistic competitive market all profits are short run and in the long run the competition
amongst sellers leads to a case where the ATD is equal to the demand curve and profit
disappears but funds can be carried over as a proxy and can be used to subsidize further
business activity.
The timing in the market is often set by the firms themselves and does not necessarily respond to
any natural pressures.
May be heavily government regulated in service of non economic objectives of government such
as environmental concerns, health and safety issues, local ownership considerations, or treaty
obligations.
In these markets there are :
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Few competitors
High barriers to entry
A highly substitutable product
Significant supplier opportunities.
Imperfect information which enables price discrimination.
High advertising expenditures that lead to “trends” in product design and appearance.
Relatively high technology that is changing continuously and appears to “push” out the demand curve.
No Long Run Deadweight Loss
Analytics of Monopolistic
Competition
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The market has chronic Over Supply.
Short Run Marginal Cost =
Long Run Marginal Cost
Long Run
Average Total Cost
Price
Short Run
Average Total Cost
Short Run
Price Received
Long Run
Price Received=
Cost Incurred
Demand
Short Run
Cost Incurred
Marginal
Revenue
Short Run
Quantity Sold
Long Run
Quantity Sold
“Perceived” Shortage
Actual Over Supply
Quantity
Oligopoly : 3 Views
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Oligopolists may operate from one of three theoretical perspectives:
There may be a “Kinked Demand Curve” which argues that there is a point at which a linear
demand curve becomes more steep due to various external factors and as a result there is so
much discord in the market that profits must be maintained in order to secure continuity of the
industry. This is common in areas where there are a fixed number of outputs that will expire and
the last units will be more valuable outside of the market than inside of it. The mission of the firm
will be to capture these potential benefits inside the market.
There may be a Cartel of Sellers who agree to fix prices at a specific level in order to extract
the maximum profit from the market and then divide this up amongst each other.
There may also be a Contested Market in which firms attempt to drive each other out of
business and in the end undercut to a perfectly competitive solution.
In all three cases there are
– Few competitors
– High barriers to entry
– A highly substitutable product
– Significant supplier opportunities.
– Imperfect information which enables market differentiation
– Relatively low technology
– No Long Run Deadweight Loss
“Kinked Demand Curve”
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Firms attempt to capture as much surplus “inside” the market as possible, but there is a pricing “range.” which
seems to be ineffective in selling and the firm will stop and accept an unsold inventory. However outside of the
firm there is an apparent external marginal cost at which an arbitrager will still sell the same product at a higher
price and take up the slack quantity .
Marginal Cost
Demand
Price
Internal
Projected Demand
facing an
Arbitrager
Marginal Cost
External
Kink
Price Received
Average Total Cost
Cost Incurred High
Pricing Range
Marginal
Revenue
Cost Incurred Low
Quantity Sold
Internal
Quantity Sold
External
Quantity
Cartel of Sellers
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The industry participants decide to work together as if they were one monopolist and attempt to
earn a long term profit under the guise of competition. The cartel will work unless one party
decides that it wants a bigger share. Q^ = 2 Q* : P^ = P* : C^ = C*
Price
Price
MC
Price
MC
P*
ATC
Profit
MC
P*
P^
ATC
Profit
C*
MR
AR C*
MR
Quantity
Q*
Firm 1
ATC
Combined
Profit
AR
C^
MR
Quantity
Q*
Firm 2
AR
Quantity
Q^
Industry
Contested Market
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Each firm reacts to the other in order to drive the other out of business by undercutting the costs
of the other below the break even point. P=C” This works only if there is a true “advantage” to
Firm 1
Price
Price
MC
Price
MC
P*
MC
P*
P^
ATC
Profit
ATC
Profit
C*
MR
AR
ATC
Combined
Profit
C*
MR
AR
C^
MR
AR
P=C”
Quantity
Q*
Firm 1
Quantity
Q*
Firm 2
Quantity
Q^
Industry
The problems with Monopolistic
Competition and Oligopoly
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Accuracy of market projections cannot be set with confidence and in industries
where cost structures are moved by exogenous factors such as the weather, it may
not be possible to avoid overproduction.
Market control is also difficult to establish and maintain over a long term and the
presence of arbitragers may force any kinks in the demand curve to increase costs in
order to maintain its market control.
Cooperation in markets is difficult to maintain as each firm in the industry has the
allure of profits to tempt it to change its behavior and take markets away from the
others. Legal parameters have been set up to ensure that competition is free and fair
through consumer protection legislation ,but that is also costly and can if proven to be
unnecessary result in a deadweight loss of its own. Any cost incurred policing a
non-problem is a waste of resources and hence a deadweight loss.
As a result markets which are in turmoil trend to have very high advertising
expenditures and also very high degrees of mergers and acquisitions.
Accuracy
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Each competitor will attempt to understand the nature of the activity that each competitor will most
likely undertake in a given situation. This can take the form of industrial espionage, bidding
employees away from a competitor, conducting major charitable campaigns in order to raise
public approval ratings, and also funding primary research into consumer attitudes including focus
groups and roundtable forums.
Each approach attempts to find out what the market will bear and the responses that may be
expected from competitors.
There is a tendency for market projections to lead financial and human resource decisions in firms
that face imperfectly competitive markets.
Generally market projections have a five percent confidence interval based on a normal
distribution of expected results but in markets where margins are relatively low (less than 1.5 %)
and social trends dominate the motivation of the consumer , the statistical probability of success
may not be assuring.
As a result management decisions are likely to favor overproduction as a method of preserving
market share by following down any drop in prices from inventory where costs are known with
certainty, by lagging the market by a long enough lag that production can be restarted with
minimum disruption, and by following and perhaps even advocating for certain favorable trends.
Market Control
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Controlling the market is difficult to establish as products that can be stored by the
consumer, that can be resold by third parties and which carry with them the
information that is needed to use them effectively.
Technology changes continuously and therefore how the product may be used will
depend on the technology background or social climate and the “relative” value of
patents and copyrights.
Products have a “life cycle” and from invention to becoming dated is increasingly
shorter . There are few models that are produced continuously of anything and often
production “runs” are one time occurrences with the manufacturer often dissolving
before repeat orders are placed.
As a result management decision about control are likely to look to government
regulation as a method of securing the future for the “status quo” which can lead to
stability and influence beyond a particular market at any point in time or space.
Cooperation
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There is an inherent drive to cheating when the future is unstable .
This is known as the “prisoners dilemma” wherein two individuals, who are each
accused of a crime, are promised a minimal sentence if they confess to the crime but
a serious punishment if they do not. The result is that when the penalties have a wide
dispersion there will most assuredly be a confession. There may also be an
inducement to implicate the other in this scenario.
Given this tendency it is quite difficult to maintain cooperation over an extended
period of time as any variability in market outcomes will lead to the temptation to
break the agreement and leads to an outcome that is less than optimal for all parties.
This is called a Nash Equilibrium after John Nash. “A Beautiful Mind”.
Moreover there is a trend in large cartels to assume that anyone who would break
away from the cartel would have also caused the instability in the market, which can
lead to severe market retaliations.
Imperfections Persist
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Imperfect competition models seem to be increasing dismissed by
economists as being only temporary, but the fact that markets produce
outcomes that suggest either monopolistic competition or some form of
oligopoly is still present and if only temporary may still have profound
impacts on welfare allocations.
The reactions to imperfect competition fill a great deal of public policy and
the enforcement of these regulations is a costly element in many industries.
The nature of these expenditures may outweigh the potential losses and
may in and of themselves reduce welfare.