Unit 9: Imperfect Competition

Imperfect Competition
Chapter 8

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Imperfect Competition
Two Types of Imperfect Competition
Monopolistic Competition Oligopoly

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Determinants
Number of Firms Goods being produced
Product Differentiation

Barriers to Entry

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Product Differentiation
Output from rival firms are not perfect substitutes
Genuine Differences Perceived Differences (i.e. Branding) Location / Convenience Quality of a good Imperfect Information (search costs) Switching costs Reputation

As a result, consumers cannot easily switch suppliers, so suppliers have a degree of market power they face downward sloping demand
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Barriers to Entry
If Barriers to Entry are High, there will only be a few firms in the industry (oligopoly) If Barriers to Entry are Low, there will be many firms in the industry (Monopolistic Competition)

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Barriers to Entry
1. Government Policy
Government Patents, Licenses

2. Single or Limited Ownership of a Resource 3. Information 4. Economies of Scale 5. Marketing Strategies

ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Advertising
Advertising can be a barrier to entry If a firm has a strong brand, it may be difficult for new firms to draw consumers away from the incumbent Brand value can carry over. If the firm develops a reputation from one successful product, it can use that reputation to market other products In some cases, firms may produce so many different varieties of a product, that they satisfy many different types of consumer preferences and crowd the market thus preventing new firms from becoming established
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Monopolistic Competition
Free Entry (just like Perfect Competition) Firms Sell Differentiated Products, but there are so many competitors that a firm can (for the most part) ignore the reaction of competitors when setting a price and quantity

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Demand
The Firm faces a downward sloping demand curve
i.e. it can raise its price without losing all its customers

Marginal Revenue is downward sloping so Price is greater than Marginal Revenue For a Linear Demand Curve, you can find Marginal Revenue by doubling the slope (just like for the Monopolist)
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Quantity
The Firm chooses its quantity so that MR = MC If Price > MR then

P > MC

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Monopolistic Competition
A monopolistically competitive firms quantity

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Profits in Monopolistic Competition

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Profits
If a Firm sells at a Price greater than Average Cost, it would earn Economic Profits If investors see an industry earning Economic Profits, new firms will enter With new entry, the Firm will face lower demand for its product as new competitors capture market share The Firms demand curve will shift inward until we reach the point where P = AC
i.e.

NO MORE Profits
Prof. Colin Mang, 2012

ECON 1006: Introduction to Microeconomics

Unit 9: Imperfect Competition

Monopolistic Competition
Under Monopolistic Competition

P = AC > MC
Capital Allocation is efficient because there are Zero Economic Profits Production is NOT efficient because P > MC
The Consumer and the Firm value the final good sold differently
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Monopolistic Competition
Firms with different demand curves and different Average Costs will charge different prices Output will be lower than under Perfect Competition, but higher than under a Monopoly

QPC > QMC > QMonopoly

ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Monopolistic Competition
Monopolistic Competition is very common Examples
Small Retail Stores Gas Stations in Large Markets Restaurants (especially Fast Food) Barber Shops

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Oligopoly
An Oligopoly is a market with few firms Barriers to entry prevent new competitors from entering, so the number of firms is relatively stable The market may have a few very large firms surrounded by many smaller ones, or it may be composed of several equivalently sized firms The distinguishing feature between Oligopoly and Monopolistic Competition is that firms will actively monitor their rivals behaviour (easy because there are few rivals to keep track of)
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Entry Costs
High Entry Costs can deter or prevent new entrants from entering; these costs will necessitate an Oligopoly market structure so that firms can have sufficient scale to reduce Average Cost
High Capital Costs
Ex. Auto manufacturing Ex. Oil Refining Ex. Jet manufacturing

High Research Costs

Ex. Pharmaceuticals Ex. Electronics
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Oligopoly
In the extreme case there are only two firms called a Duopoly; though most oligopolies have more Because there is no further entry, Firms can set P > AC, i.e. they COULD earn Economic Profits

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Oligopoly
Because there are so few firms, a Firm has to consider how its competitors will react when setting Price and Quantity If the Firm wants to sell more output, it must lower its price lowering price may entice its customers to buy more, as well as lure customers from other firms BUT its competitors may choose to lower their prices as well, thus dampening the effect
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Oligopoly Strategies
Oligopoly Firms have two main strategies:
Collude (Cooperate) Compete

If they Collude
The firms agree to act as a single monopoly, producing the monopoly quantity, and thus charging the monopoly price

If they Compete
The outcome will depend on the nature of the competition
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Collusion
The Firms in an industry set up a Cartel and restrict output (raising price) to the Monopoly level which will generate the largest industry-wide profit margin Western Countries have Anti-Trust Laws which forbid Cartel operations (since we know that Monopolies are inherently inefficient and harm consumers)

ECON 1006: Introduction to Microeconomics

Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Collusion
Cartels are unstable because each firm has an incentive to cheat its partners Remember that monopolies operate in the elastic portion of the demand curve (i.e. cutting price will increase revenue); so each firm in the Cartel has an incentive to produce extra output it will lower price slightly but generate extra revenue for the offending firm but any firm that didnt increase output would now be stuck with the same quantity but a lower price, thus having lower revenues
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012

Unit 9: Imperfect Competition

Oligopoly Competition
Since the Firms will compete, they must think strategically Firms may or may not set MR = MC Firms may seek short run profits or they might accept short run losses if it means long run profits We need a system to analyze Strategic Behaviour and Decision Making We can use Game Theory
ECON 1006: Introduction to Microeconomics Prof. Colin Mang, 2012