Chapter 11 - Notes PDF

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ECON 1580 Chapter 11 The World of Imperfect Competition I.

Imperfect competition A. The spectrum of business enterprise ranges from perfectly competitive rms to monopoly. B. Imperfect competition is a market structure with more than one rm in an industry in which at least one rm is a price setter. C. An imperfectly competitive rm has a degree of monopoly power, either: 1. based on product differentiation that leads to a downward-sloping demand curve 2. or resulting from the interaction of rival rms in an industry with only a few rms D. There are two broad categories of imperfectly competitive markets: 1. one in which many rms compete, each offering a slightly different product 2. one in which the industry is dominated by a few rms a) Important features of both kinds of markets are advertising and price discrimination.

II.

Monopolistic Competition: Competition Among Many A. The model of monopolistic competition assumes: 1. a large number of rms 2. easy entry and exit B. This model differs from the model of perfect competition in one key respect: 1. the goods and services produced by rms are differentiated C. Product differentiation gives rms producing a particular product some degree of price-setting or monopoly power. D. Monopolistic competition is a model characterized by many rms producing similar but differentiated products in a market with easy entry and exit. E. In the short run, the model of monopolistic competition looks exactly like the model of monopoly. F. In monopolistic competition, entry will eliminate any economic prots in the long run.

III.

Profit Maximization A. Differentiated markets imply that the notion of a single “market price” is meaningless. B. Because products in a monopolistically competitive industry are differentiated, rms face downward-sloping demand curves. C. The Short Run 1. Because a monopolistically competitive rm faces a downward-sloping demand curve, its marginal revenue curve is a downward-sloping line that lies below the demand curve, as in the monopoly model.

D. The Long Run 1. Any shift in a demand curve shifts the marginal revenue curve as well. 2. The existence of economic prots in a monopolistically competitive industry will induce entry in the long run. 3. Because entry and exit are easy, favorable economic conditions in the industry encourage start-ups. IV.

Excess Capacity: The Price of Variety A. The long-run equilibrium solution in monopolistic competition always produces zero economic prot at a point to the left of the minimum of the average total cost curve. B. A rm that operates to the left of the lowest point on its average total cost curve has excess capacity. C. Because monopolistically competitive rms charge prices that exceed marginal cost, monopolistic competition is inefficient. D. One can criticize a monopolistically competitive industry for falling short of the efficiency standards of perfect competition. E. Monopolistic competition is inefficient because of product differentiation. F. The inefficiency of monopolistic competition may be a small price to pay for a wide range of product choices.

V.

KEY TAKEAWAYS A. A monopolistically competitive industry features some of the same characteristics as perfect competition. B. The characteristic that distinguishes monopolistic competition from perfect competition is differentiated products. 1. Each rm is a price setter and thus faces a downward-sloping demand curve. C. Short-run equilibrium for a monopolistically competitive rm is identical to that of a monopoly rm. 1. The rm produces an output at which marginal revenue equals marginal cost and sets its price according to its demand curve. D. In the long run in monopolistic competition any economic prots or losses will be eliminated by entry or exit, leaving rms with zero economic prot. E. A monopolistically competitive industry will have some excess capacity; this may be viewed as the cost of the product diversity that this market structure produces.

VI.

Oligopoly: Competition Among The Few A. In an oligopoly, the market is dominated by a few rms, each of which recognizes that its own actions will produce a response from its rivals and that those responses will affect it. B. The rms that dominate an oligopoly recognize that they are interdependent. C. Some oligopoly industries make standardized products: steel, aluminum, wire, and industrial tools. D. Others make differentiated products: cigarettes, automobiles, computers, ready-to-eat breakfast cereal, and soft drinks.

VII.

Measuring Concentration in Oligopoly A. Oligopoly means that a few rms dominate an industry. B. One way to measure the degree to which output in an industry is concentrated among a few rms is to use a concentration ratio, which reports the percentage of output accounted for by the largest rms in an industry. 1. The higher the concentration ratio, the more the rms in the industry take into account their rivals’ behavior. 2. The lower the concentration ratio, the more the industry reects the characteristics of monopolistic competition or perfect competition. C. Two measures of industry concentration are reported by the Census Bureau: 1. concentration ratios 2. Herndahl–Hirschman Index (HHI) D. An alternative measure of concentration is found by squaring the percentage share (stated as a whole number) of each rm in an industry, then summing these squared market shares to derive a Herndahl–Hirschman Index (HHI). 1. The largest HHI possible is the case of monopoly, where one rmhas 100% of the market. E. One problem is that industry categories may be too broad to capture signicant cases of industry dominance.

VIII.

The Collusion Model A. There is no single model of prot-maximizing oligopoly behavior that corresponds to economists’ models of perfect competition, monopoly, and monopolistic competition. B. Economists have devised a variety of models that deal with the uncertain nature of rivals’ responses in different ways. C. Firms in any industry could achieve the maximum prot attainable if they all agreed to select the monopoly price and output and to share the prots. D. A duopoly is an industry with two rms. E. In overt collusion, rms openly agree on price, output, and other decisions aimed at achieving monopoly prots. F. Firms that coordinate their activities through overt collusion and by forming collusive coordinating mechanisms make up a cartel. 1. Firms form a cartel to gain monopoly power. G. An alternative to overt collusion is tacit collusion, an unwritten, unspoken understanding through which rms agree to limit their competition.

IX.

Game Theory and Oligopoly Behavior A. Oligopoly presents a problem in which decision makers must select strategies by taking into account the responses of their rivals, which they cannot know for sure in advance. B. A choice based on the recognition that the actions of others will affect the outcome of the choice and that takes these possible actions into account is called a strategic choice. C. Game theory is an analytical approach through which strategic choices can be assessed. D. Among the strategic choices available to an oligopoly rm are:

E. F.

G.

H.

1. pricing choices 2. marketing strategies 3. product-development efforts The outcome of a strategic decision is called a payo . Two applications to examine the basic concepts of game theory: 1. The rst examines a classic game theory problem called the prisoners’ dilemma. 2. The second deals with strategic choices by two rms in a duopoly. The Prisoners’ Dilemma 1. When a player’s best strategy is the same regardless of the action of the other player, that strategy is said to be a dominant strategy. 2. A game in which there is a dominant strategy for each player is called a dominant strategy equilibrium. 3. The outcome of the game depends on the way the payoff matrix is structured. Repeated Oligopoly Games 1. Overt collusion is one device through which the monopoly outcome may be maintained, but that is illegal. 2. In a tit-for-tat strategy a rm responds to cheating by cheating, and it responds to cooperative behavior by cooperating. 3. Another way rms may seek to force rivals to behave cooperatively rather than competitively is to use a trigger strategy, in which a rm makes clear that it is willing and able to respond to cheating by permanently revoking an agreement. 4. Game theory has proved to be an enormously fruitful approach to the analysis of a wide range of problems. 5. Any situation in which rivals make strategic choices to which competitors will respond can be assessed using game theory analysis.

X.

KEY TAKEAWAYS A. The key characteristics of oligopoly are a recognition that the actions of one rm will produce a response from rivals and that these responses will affect it. Each rm is uncertain what its rivals’ responses might be. B. The degree to which a few rms dominate an industry can be measured using a concentration ratio or a Herndahl–Hirschman Index. C. One way to avoid the uncertainty rms face in oligopoly is through collusion. D. Collusion may be overt, as in the case of a cartel, or tacit, as in the case of price leadership. E. Game theory is a tool that can be used to understand strategic choices by rms. F. Firms can use tit-for-tat and trigger strategies to encourage cooperative behavior by rivals.

XI.

Extensions Of Imperfect Competition: Advertising And Price Discrimination A. The models of monopoly and of imperfectly competitive markets allow us to explain two commonly observed features of many markets: 1. Advertising 2. Price discrimination

XII.

XIII.

Advertising A. Firms in monopoly, monopolistic competition, and oligopoly use advertising when they expect it to increase their prots. B. There are two ways in which advertising could lead to higher prices for consumers: 1. the advertising itself is costly 2. rms may be able to use advertising to manipulate demand and create barriers to entry C. Advertising has its defenders. 1. They argue that advertising provides consumers with useful information and encourages price competition. D. Advertising and Information 1. Advertising an inferior product is likely to have little payoff. 2. The fact that the product is advertised, regardless of the content of that advertising, signals consumers that at least its producer is condent that the product will satisfy them. E. Advertising and Competition 1. If advertising creates consumer loyalty to a particular brand, then that loyalty may serve as a barrier to entry to other rms. 2. There is a positive relationship between the degree of concentration of market power and the fraction of total costs devoted to advertising. 3. To the extent that advertising increases industry concentration, it is likely to result in higher prices to consumers and lower levels of output. 4. Advertising may encourage competition as well. 5. Advertising may also allow more entry by new rms. 6. A world with advertising is more competitive than a world without advertising would be. Price Discrimination A. FIrms can charge different prices to different consumers. B. When a rm charges different prices for the same good or service to different consumers, even though there is no difference in the cost to the rm of supplying these consumers, the rm is engaging in price discrimination. C. Price discrimination is generally legal. D. The potential for price discrimination exists in all market structures except perfect competition. E. Three conditions that must be met for a firm to engage in price discrimination: 1. A Price-Setting Firm 2. Distinguishable Customers 3. Prevention of Resale F. Price differentials based on differences in production costs are not examples of price discrimination. G. price-discrimination strategies are based on differences in price elasticity of demand among groups of customers and the differences in marginal revenue that result. H. It is always in the interest of a rm to discriminate.

XIV.

KEY TAKEAWAYS A. If advertising reduces competition, it tends to raise prices and reduce quantities produced. If it enhances competition, it tends to lower prices and increase quantities produced. B. In order to engage in price discrimination, a rm must: 1. be a price setter 2. be able to identify consumers whose elasticities differ 3. be able to prevent resale of the good or service among consumers C. The price-discriminating rm will adjust its prices so that customers with more elastic demand pay lower prices than customers with less elastic demand....