Transcript Monopolistic Competition

Imperfect Competition
Economics 101
Imperfect Competition
 Imperfect competition refers to those market
structures that fall between perfect
competition and pure monopoly.
 Imperfect competition includes industries in
which firms have competitors but do not
face so much competition that they are price
takers.
Types
 Types of Imperfectly Competitive Markets
Monopolistic Competition
 Many firms selling products that are similar but not
identical.
Oligopoly
 Only a few sellers, each offering a similar or identical
product to the others.
Monopolistic Competition
Definition
Monopolistic Competition
 Many firms selling products that are similar but not
identical.
Markets that have some features of competition
and some features of monopoly.
Attributes
 Attributes of Monopolistic Competition
Many sellers
Product differentiation
Free entry and exit
Attribute 1
 Many Sellers
There are many firms competing for the same
group of customers.
 Product examples include books, CDs, movies,
computer games, restaurants, piano lessons, cookies,
furniture, etc.
Attribute 2
 Product Differentiation
Each firm produces a product that is at least
slightly different from those of other firms.
Rather than being a price taker, each firm faces
a downward-sloping demand curve.
Attribute 3
 Free Entry or Exit
 Firms can enter or exit the market without
restriction.
 The number of firms in the market adjusts
until economic profits are zero.
Short-Run Economic Profits
 The Monopolistically Competitive Firm in the Short
Run
 Short-run economic profits encourage new firms to enter
the market. This:
 Increases the number of products offered.
 Reduces demand faced by firms already in the market.
 Incumbent firms’ demand curves shift to the left.
 Demand for the incumbent firms’ products fall, and their profits
decline.
(a) Firm Makes Profit
Price
MC
ATC
Price
Average
total cost
Demand
Profit
MR
0
Profitmaximizing
quantity
Quantity
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Short-Run Economic Losses
 The Monopolistically Competitive Firm in the Short
Run
 Short-run economic losses encourage firms to exit the
market. This:
 Decreases the number of products offered.
 Increases demand faced by the remaining firms.
 Shifts the remaining firms’ demand curves to the right.
 Increases the remaining firms’ profits.
(b) Firm Makes Losses
Price
MC
ATC
Losses
Average
total cost
Price
MR
0
Lossminimizing
quantity
Demand
Quantity
Copyright©2003 Southwestern/Thomson Learning
Long-Run Equilibrium
 Firms will enter and exit until the firms are
making exactly zero economic profits.
Price
MC
ATC
P = ATC
Demand
MR
0
Profit-maximizing
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
Characteristics of Long-Run
Equilibrium
 Two Characteristics
 As in a monopoly, price exceeds marginal cost.
 Profit maximization requires marginal revenue to equal marginal
cost.
 The downward-sloping demand curve makes marginal revenue
less than price.
 As in a competitive market, price equals average total
cost.
 Free entry and exit drive economic profit to zero.
Monopolistic versus Perfect
Competition
 There are two noteworthy differences
between monopolistic and perfect
competition—excess capacity and markup.
Excess Capacity
 Excess Capacity
 There is no excess capacity in perfect competition in the
long run.
 Free entry results in competitive firms producing at the
point where average total cost is minimized, which is the
efficient scale of the firm.
 There is excess capacity in monopolistic competition in
the long run.
 In monopolistic competition, output is less than the
efficient scale of perfect competition.
(a) Monopolistically Competitive Firm
Price
(b) Perfectly Competitive Firm
Price
MC
MC
ATC
ATC
P
P = MC
MR
0
Quantity
produced
Efficient
scale
P = MR
(demand
curve)
Demand
Quantity
0
Quantity produced =
Efficient scale
Quantity
Copyright©2003 Southwestern/Thomson Learning
Markup
 Markup Over Marginal Cost
For a competitive firm, price equals marginal
cost.
For a monopolistically competitive firm, price
exceeds marginal cost.
Because price exceeds marginal cost, an extra
unit sold at the posted price means more profit
for the monopolistically competitive firm.
(a) Monopolistically Competitive Firm
Price
(b) Perfectly Competitive Firm
Price
MC
MC
ATC
ATC
Markup
P
P = MC
P = MR
(demand
curve)
Marginal
cost
MR
0
Quantity
produced
Demand
Quantity
0
Quantity produced
Quantity
Copyright©2003 Southwestern/Thomson Learning
(a) Monopolistically Competitive Firm
Price
(b) Perfectly Competitive Firm
Price
MC
MC
ATC
ATC
Markup
P
P = MC
P = MR
(demand
curve)
Marginal
cost
MR
0
Quantity
produced
Efficient
scale
Demand
Quantity
0
Quantity produced =
Efficient scale
Quantity
Excess capacity
Copyright©2003 Southwestern/Thomson Learning
Monopolistic Competition and
Welfare of Society
 Monopolistic competition does not have all
the desirable properties of perfect
competition.
 There is the normal deadweight loss of
monopoly pricing in monopolistic
competition caused by the markup of price
over marginal cost.
Monopolistic Competition and
Welfare of Society
 However, the administrative burden of regulating
the pricing of all firms that produce differentiated
products would be overwhelming.
 Another way in which monopolistic competition
may be socially inefficient is that the number of
firms in the market may not be the “ideal” one.
There may be too much or too little entry.
Advertising
 When firms
Sell differentiated products
At price above marginal cost
 Then, they have incentive to advertise
To attract more buyers
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Oligopoly and Game Theory
Key Feature
 Because of the few sellers, the key feature
of oligopoly is the tension between
cooperation and self-interest.
Characteristics
 Characteristics of an Oligopoly Market
Few sellers offering similar or identical products
Interdependent firms
Best off cooperating and acting like a
monopolist by producing a small quantity of
output and charging a price above marginal cost
Simple Type: Duopoly
 A duopoly is an oligopoly with only two
members. It is the simplest type of oligopoly.
 Duopoly
Oligopoly with only two members
Decide quantity to sell
Price – determined on the market
 By demand
The Demand Schedule for Water
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Production Decisions
 For a perfectly competitive firm
Price = marginal cost
Quantity = efficient
 For a monopoly
Price > marginal cost
Quantity < efficient quantity
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Markets with a few Sellers
 Duopoly
Collude and form a cartel
 Act as a monopoly
Total level of production
Quantity produced by each member
Don’t collude – self-interest
 Difficult to agree; Antitrust laws
 Higher quantity; lower price; lower profit
Not competitive allocation
 Nash equilibrium
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Collusion and Cartel
 The duopolists may agree on a monopoly
outcome.
Collusion
 An agreement among firms in a market about
quantities to produce or prices to charge.
Cartel
 A group of firms acting in unison.
Is Cartel Possible?
 Although oligopolists would like to form
cartels and earn monopoly profits, often that
is not possible. Antitrust laws prohibit
explicit agreements among oligopolists as a
matter of public policy.
The Equilibrium for an Oligopoly
 A Nash equilibrium is a situation in which
economic actors interacting with one
another each choose their best strategy
given the strategies that all the others have
chosen.
The equilibrium for an Oligopoly
 When firms in an oligopoly individually choose
production to maximize profit, they produce
quantity of output greater than the level produced
by monopoly and less than the level produced by
competition.
 The oligopoly price is less than the monopoly price
but greater than the competitive price (which
equals marginal cost).
Size of an Oligopoly
 How increasing the number of sellers affects
the price and quantity:
The output effect: Because price is above
marginal cost, selling more at the going price
raises profits.
The price effect: Raising production will
increase the amount sold, which will lower the
price and the profit per unit on all units sold.
Size of an Oligopoly
 As the number of sellers in an oligopoly
grows larger, an oligopolistic market looks
more and more like a competitive market.
 The price approaches marginal cost, and
the quantity produced approaches the
socially efficient level.
Strategic Action
 Because the number of firms in an
oligopolistic market is small, each firm must
act strategically.
 Each firm knows that its profit depends not
only on how much it produces but also on
how much the other firms produce.
Game Theory
 Game theory is the study of how people
behave in strategic situations.
 Strategic decisions are those in which each
person, in deciding what actions to take,
must consider how others might respond to
that action.
Prisoners’ Dilemma
 The prisoners’ dilemma provides insight into the
difficulty in maintaining cooperation.
 Often people (firms) fail to cooperate with one
another even when cooperation would make
them better off.
 The prisoners’ dilemma is a particular “game”
between two captured prisoners that illustrates
why cooperation is difficult to maintain even when
it is mutually beneficial.
Bonnie’ s Decision
Confess
Bonnie gets 8 years
Remain Silent
Bonnie gets 20 years
Confess
Clyde gets 8 years
Clyde’s
Decision
Bonnie goes free
Clyde goes free
Bonnie gets 1 year
Remain
Silent
Clyde gets 20 years
Clyde gets 1 year
Copyright©2003 Southwestern/Thomson Learning
Dominant Strategy
 The dominant strategy is the best strategy for a
player to follow regardless of the strategies
chosen by the other players.
 Dominant strategies in Prisoners’ dilemma:
_ Clyde: Confess
_ Bonnie: Confess
Nash Equilibrium & Best
Outcome
 Nash Equilibrium (self-interest):
_ Clyde: Confess & Bonnie: Confess
 Best Outcome (cooperation):
_ Clyde: Silent & Bonnie: Silent
 Cooperation is difficult to maintain, because
cooperation is not in the best interest of the
individual player.
Game Example: OPEC
 Iraq and Iran: Members of OPEC
 Their decisions on oil production.
 Decisions: High Production or Low
Production
Iraq’s Decision
High Production
Iraq gets $40 billion
Low Production
Iraq gets $30 billion
High
Production
Iran’s
Decision
Iran gets $40 billion
Iraq gets $60 billion
Iran gets $60 billion
Iraq gets $50 billion
Low
Production
Iran gets $30 billion
Iran gets $50 billion
Copyright©2003 Southwestern/Thomson Learning
Nash Equilibrium
 Dominant strategies:
_ Iran: High Production
_ Iraq: High Production
 Nash Equilibrium (self-interest):
_ Iran: High Production & Iraq: High Production
 Best Outcome (cooperation):
_ Iran: low production & Iraq: low production
Game Example: Where to
Advertise?
 Players: Competitor.com or We.com
 Decisions: NBA and NHL
Where to advertise?
Competitor.com
NBA
We.com
NHL
NBA
W: 4,
C: 3
W: 3,
C: 4
NHL
W: 3,
C: 4
W: 4,
C: 3
No Nash equilibrium in pure strategies
No Nash Equilibrium
 Dominant strategies:
_ We.com: none
_ Competitor.com: none
Nash Equilibrium (self-interest):
_ We.com: none
_ Competitor.com: none
Game Example: Evening News
 Players: ATV and TVB
 Decisions: 7:30 pm or 8:00 pm
Evening News:
TVB
7:30pm
7:30pm A: 1,
ATV 8:0pm
B: 1
A: 4,
B: 3
8:0pm
A: 3,
B: 4
A: 2.5,
B: 2.5
Nash Equilibrium
 Dominant strategies:
_ ATV: none
_ TVB: none
Two Nash Equilibria (self-interest):
_ ATV: 7:30pm & TVB: 8:00pm
or
_ ATV: 8:00pm & TVB: 7:30pm
Why People Sometimes
Cooperate
 Firms that care about future profits will
cooperate in repeated games rather than
cheating in a single game to achieve a onetime gain.
 Repeated prisoners’ dilemma
Encourage cooperation
 Penalty for not cooperating
Better strategy
 Return to cooperative outcome after a period of
noncooperation
Best strategy: tit-for-tat
 Player - start by cooperating
Then do whatever the other player did last time
 Starts out friendly
 Penalizes unfriendly players
 Forgives them if warranted
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Public Policy Toward
Oligopolies
 Controversies over antitrust policies
Most commentators agree that price-fixing
agreements among firms should be illegal. Yet
the antitrust laws have been used to condemn
some business practices whose effects are not
obvious. There are three examples of
controversial business practice:
 Resale price maintenance
 Predatory pricing
 Tying
Resale price maintenance
 Resale price maintenance (fair trade)
Require retailers to charge customers a given
price
Might seem anticompetitive
 Prevents the retailers from competing on price
Defenders:
 Not aimed at reducing competition
 Legitimate goal: Prevent from free rider problem
Example
 Superduper sells disc players to retailers for $100.
 Require retailers to charge customers a given price, say
$150.
 Might seem anticompetitive
 Prevents the retailers from charging less than $150
 Defenders:
 Superduper would be worse off if its retailers were a
cartel, so it is not aimed at reducing competition.
 Legitimate goal of resale price maintenance
Without resale price maintenance, some
customers would take advantage of one store’s
service, and then buy the item at a discount
retailer. Resale price maintenance prevents from
free rider problem.
Public Policy Toward
Oligopolies
 Predatory pricing
Charge prices that are too low
 Anticompetitive
 Price cuts may be intended to drive other firms out of
the market
Skeptics
 Predatory pricing – not a profitable strategy
 Price war - to drive out a rival
Prices - driven below cost
Example
 Coyote Air has a monopoly on some route. Roadrunner




Express enters and takes 20% of the market.
Coyote’s anticompetitive move: slashing its fare.
The price cut (predatory pricing) of Coyote intends to drive
Roadrunner out of the market. Prices have to be driven
below cost.
Coyote sells cheap tickets at a loss, and low fares attract
more customers. Therefore, Coyote had better be ready to
fly more planes. Meanwhile, Roadrunner can respond to
Coyote’s predatory pricing by cutting back on flights. As a
result, Coyote ends up bearing more losses.
The predator suffers more than the prey.
Public Policy Toward
Oligopolies
 Tying
Offer two goods together at a single price
 Expand market power
 Skeptics
 Cannot increase market power by binding two goods
together
Form of price discrimination
 Tying may increase profit
Example






Makemoney Movie produces two films. It offers theaters the two films
(Film A is a blockbuster, and Film B is art film) together at a single
price.
Makemoney uses tying as a mechanism for expanding its market
power.
Skeptical: forcing a theater to accept a worthless movie as part of the
deal does not increase the theater’s willingness to pay. Makemoney
cannot increase its market power simply by using tying.
Tying exists because it is a form of price discrimination. Suppose there
are two theaters. Theater 1 is willing to pay $15000 for film A and
$5000 for film B. Theater 2 is willing to pay $5000 for film A and
$15000 for film B.
Pricing strategy for each film: $15000; Tying strategy for two films
:$20000
Tying allows Makemoney to increase profit by charging a combined
price.