lecture notes prepared by anton ljutic. © 2004 mcgraw–hill ryerson limited imperfect competition...

Lecture notesPrepared by Anton

Ljutic

© 2004 McGraw–Hill Ryerson Limited

Imperfect Competition

CHAPTER ELEVEN


This Chapter Will Enable You to:

• Understand the importance and effects of product differentiation

• Argue the pros and cons of advertising• Understand the differences between two types of

imperfect competition• Explain why monopolistically-competitive firms

tend to have excess capacity and are unlikely to earn long-run economic profits

• Understand why oligopoly firms often do not engage in competitive pricing

• Understand why large firms are often tempted to collude and form cartels


Imperfect Competition

• A market structure in which producers are identifiable and have some control over price

• Product differentiation - the attempt by a firm to distinguish its product from that of its competitors by:– Developing a recognized brand name, product logo, or

packaging– Securing a superior location or developing a reputation

for exceptional service– Engaging in product redevelopment and improvement– Developing an effective advertising strategy


Benefits of Advertising

• Provides the consumer with vital information

• Enhances competition between firms

• Lowers the price of products

• Finances magazines and television shows


Critiques of Advertising

• It is mostly non-informative and wasteful

• Encourages concentration within industries

• Raises prices to the detriment of the consumer


Two Types of Market Structures

• Monopolistic competition– A market in which there are many firms who sell a

differentiated product and have some control over the price of the products they sell

• Oligopoly– A market dominated by a few large firms

• Concentration ratios– A measurement of the percentage of an industry’s total

sales that is controlled by the largest few firms


• Many small firms

• Freedom of entry

• Some control over price

• Differentiated products

Monopolistic Competition


Costs,revenue

Quantity

MR

D

AC

MC

Economicprofit

•Equilibrium is whereMR = MC •Price = P1and Q = Q1• Total profitis:(P1 – AC) x Q1.

•Equilibrium is whereMR = MC •Price = P1and Q = Q1• Total profitis:(P1 – AC) x Q1.

Q1

Monopolistically Competitive Firm in Short-Run Equilibrium

P1

C1

Figure 11.2


Costs,revenue

Quantity

MR

D

AC

MC•Equilibrium is whereMR = MC •Price = P2and Q = Q1• Total Revenue = Total Cost and there are no economic profits

•Equilibrium is whereMR = MC •Price = P2and Q = Q1• Total Revenue = Total Cost and there are no economic profits

Q1

The Long-Run Equilibrium for the Firm

P2

Figure 11.3


Costs,revenue

Quantity

MR

D

ACMC

•Equilibrium is whereMR = MC •Price = P2and Q = Q3• Total Revenue < Total Cost and there are economic losses

•Equilibrium is whereMR = MC •Price = P2and Q = Q3• Total Revenue < Total Cost and there are economic losses

Q3

The Effect of Too Much Entry

P2

Figure 11.3

C3

Economicloss


Costs,revenue

MR2

D2

ACMC

QMC

Excess Capacity

PPC

Figure 11.3

PMC ab

cD1=MR1

QPC

Excess

•Long-run equilibrium for a perfectly comp. firm is a•For a monopolistically comp. firm it is b

•Long-run equilibrium for a perfectly comp. firm is a•For a monopolistically comp. firm it is b


Advantages to Franchising

• Bulk purchasing

• National advertising

• Brand identification

• It allows individuals to own their own business without having to accumulate the large sums of money it would take to get started on a national level


Characteristics of Oligopoly Industry

• It is dominated by a few large firms• Entry by new firms is difficult• Non-price competition between firms is widely

practiced• Each firm has significant control over its price• Mutual interdependence exists between firms

– Mutual interdependence: The condition in which a firm’s action depends on part, on the reactions of rival firms


Advantages of Collusion

• It reduces the intensity of competition

• It enhances the profitability of firms

• It greatly reduces the risks and uncertainty firms face

• Colluding firms are better able to block any possible entry by new firms


The Cartel

• It is a formal agreement of cooperation among firms

• It assumes the presence of collusion• It is illegal in Canada and in the United States• OPEC is a classic example of a cartel• Cartels work to the advantage of their members

only if there is no cheating between the participants


OPEC’s Effects on World Oil Market

S2

S1

P

D

Q

$2

$8

3024


Price Leadership

• To avoid price wars, firms often practice price leadership

• Firms in an industry concede the role of price leader to a single firm, usually the largest or most efficient firm

• The leader then monitors its cost and revenue with the long view in mind

• When conditions change sufficiently that a price increase seems urgent, the leader will balance the advantages of a large increase with the risks of new entry into the industry


The Kinked Demand Curve

Price

Quantity

D

P1

Q1

•If this firm increases price, rivals will not follow, resulting in an elastic demand above the prevailing price.

•If this firm decreases price, rivals will follow, resulting in an inelastic demand below the prevailing price.

•If this firm increases price, rivals will not follow, resulting in an elastic demand above the prevailing price.

•If this firm decreases price, rivals will follow, resulting in an inelastic demand below the prevailing price.

Elastic D

Inelastic D

Figure 11.8


Kinked Demand and Marginal Revenue

Price

Quantity

D

P1

Q1

•The discontinuity in the MR curve is the result of the kink in the demand curve. •An increase in MC to MC2 results in no change in equilibrium price or quantity.

•The discontinuity in the MR curve is the result of the kink in the demand curve. •An increase in MC to MC2 results in no change in equilibrium price or quantity.

MR

MC1

MC2

Figure 11.9


Are Oligopolies Efficient?

• There is no agreement in this area

• Some believe that oligopolies are too powerful and produce inefficiently

• Others take the view that oligopolies are at the cutting edge of new technology development and, in the long-run, push the average costs of production down


Pricing Strategies for Firms with Market Power (I)

• Peak-load pricing– the seller charges a higher price when demand for its

product peaks, and a lower price at other times

• Inter-temporal price discrimination– consumers are separated into different groups with

different elasticities of demand– those with lower elasticities are sold first, at higher

price– some time later the price is reduced in order to appeal

to those with higher demand elasticities


Pricing Strategies for Firms with Market Power (II)

• Two-part tariff– an up-front fee for the right to buy a product is charged

• Mixed bundling– restaurant owners usually bundle certain products for a

specific price

• Coupons and rebates– sellers of products offer more price sensitive customers

a lower price than those who simply can’t be bothered with clipping the coupons or mailing in the rebate requests


Are Firms Profit Maximizers?

• J.K.Galbraith: when management and ownership are divorced, profit-maximization not the only objective

• Other possible objectives:– Obtaining autonomy of decision-making– Developing state-of-the-art technology– High rates of growth– Social goals


Chapter Summary: What to Study and Remember

• the importance and effects of product differentiation

• the pros and cons of advertising• the differences between two types of imperfect

competition• why monopolistically-competitive firms tend to

have excess capacity and are unlikely to earn long-run economic profits

• why oligopoly firms often do not engage in competitive pricing

• why large firms are often tempted to collude and form cartels

lecture notes prepared by anton ljutic. © 2004 mcgraw–hill ryerson limited imperfect competition...

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