market equilibrium and market demand: imperfect competition

MarketEquilibrium and Market Demand:

Imperfect Competition

Chapter 9

Market Structure CharacteristicsWe characterize an

industry byThe number of firms and

their size distributionProduct differentiationBarriers to entryThe picture to the right

concerned with two markets:No. 2 yellow corn: many

producers/sellers (Perfect Competition)

Farm equipment: few manufacturers/sellers (Oligopoly)

Pages 145-1482

Perfect CompetitionUp to now we have been assuming the firm

and market reflect conditions of perfect competitionNot a bad assumption for many agricultural

subsectorsA large number of small firms: 2 million

farmsA homogeneous product: No. 2 yellow cornFreely mobile resources: No barriers to entry

caused by patents, etc. or barriers to exit (???)Perfect knowledge of market conditions:

Quality outlook information from government, university and private sources

3

Imperfect CompetitionMany markets in which farmers buy

inputs and sell their products however do not reflect perfect competition conditions

Chapter 9 focuses on specific types of imperfect competitors in the farm input marketThese firms are capable of setting prices

farmers must pay for specific inputs

4

Imperfect Competition in Selling

5

Topics for Nov 3rd

Monopolistic Competition Definition Production and Pricing Decisions

Oligopolies Definition/Examples Production and Pricing Decisions

Monopolies Definition/Examples Production and Pricing Decisions

Comparison of Market StructuresPages 106-1076

7

Imperfect Competition in SellingUnlike perfect competitors who face a

perfectly elastic (horizontal) demand curveImperfect competitors selling a

differentiated product have a downward sloping demand curve

A

B

Firm’s demand curve underimperfect competition

A B

Firm’s demand curveunder P.C.

QQ

$$

8 Page 149

Price Quantity Total Rev. Avg. Revenue Marginal Revenue15 0 0 -------- -----14 2 28 14 1413 4 52 13 1212 6 72 12 1011 8 88 11 810 10 100 10 6

9 12 108 9 48 14 112 8 27 16 112 7 06 18 108 6 -25 20 100 5 -44 22 88 4 -63 24 72 3 -8

2 26 52 2 -101 28 28 1 -120 30 0 ----- -14

Table 9-1 ImperfectCompetition

Marginal Revenue (MR) : Change in revenue from the sale of the last unit of output (ΔTR÷ΔQ)

Average Revenue (AR): Total Revenue/Total output (TR÷Q)

20

Note: Price = Average Revenue

Firm faces a downward sloping demand curve → MR ≤ AR2

Imperfect Competition in Selling

Marginal Revenue: Change in revenue from the sale of the last unit of output

Marginal revenue in this instance is also downward sloping

MR=0 at the point where TR is at a maximum10

Imperfect Competition in SellingMaximum Total Revenue

Types of Imperfect Competitors in Input Markets

Monopolistic Competition Oligopoly Monopoly

11

Let’s start here…

Monopolistic CompetitorsMany sellers

Each firm has relatively small market share

Power to set prices somewhat like a monopoly

Face competition like perfect competition

Collusion is not possible given number of firms in the industry

No barriers to entry or exit

Page 148-15112

Monopolistic Competitors

Page 148-15113

Product Differentiation: Each firm makes a product that is slightly different from the products of competing firmsClose substitutes but no perfect substitutesAn attempt to ↑ price will normally results in a ↓ in volume sold

Competition on Quality, Price, MarketingQuality is design, reliability, service provided to buyer and ease

of access to productThe firm faces a downward sloping demand curveFirm must market intensively: promotions, distribution,

packaging, etc.


8-15114

Product differentiation does not necessarily mean there are any physical differences among productsThey might all be the same, but how they are sold

may make all the difference


Page 148-15115

The monopolistic competitor tries to set his/her product apart from the competitionMain method is via advertisingWhen this is done successfully, the demand curve

becomes more vertical or inelastic Buyers are willing to pay more because they believe it is much

better than their other choices

Basis for product differentiationPhysical differences ConvenienceAmbience ReputationsAppeals to vanity Snob appea


Page 148-15116

Typical Monopolistic CompetitorTries to set firm apart from competition

New Product Development and Innovation Advertising

o Create consumer perception of product differentiation – real or imagined

o Attempt to keep demand as inelastic as possibleSelling costs can be extremely high

Monopolistic CompetitorsShort run profits can exist but long run

profits are reduced to 0 with industry entrants

Fast food industry is a good example All services basically the same Extensive use of marketing to

differentiate products/services across firms

Striving to produce more products and services

Page 148-15117

Monopolistic CompetitorsProduction Decision:

Determine output level where MC=MR (Why does this make sense?)

Pricing Decision: Determine where above quantity

intersects the downward sloping demand curve

Page 148-15118

Short run profitsThe firm produces QSR where MR=MC at E Prices its products at PSR by reading off the demand

curve at quantity QSR

Represents consumer’s willingness to pay for QSR

MonopolisticCompetition

Short run profits exist if: PSR > ATCSR at QSR

20


Page 150

Short run loss At QSR, PSR < ATCSR

In the Long Run (LR)Profits are bid away as more

firms enter the market Losses will no longer exist as

firms leave the market At QLR the remaining firms

are just breaking even

Page 15121

PLR = ATCLR



Page 148-15122

How much is the industry dominated or not dominated by few suppliersGeographical scope – national, regional, global

An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e.g. Feed Retailing

Barriers to entry and exit: industries may appear concentrated but few barriers exist to prevent entry


Page 148-15123

Quantitative measures of competitionConcentration Ratio (CR): 2,4, 8, 20, etc

% of the value of total market revenue accounted for by 2, 4, 8, 20, etc. largest firms in the industry

Low CR values→ a high degree of competition High CR values → an absence of competition


Page 148-15124

Quantitative measures of competitionHerfindahl-Hirschman Index (HHI): The

square of the % market share of each firm summed over the largest 50 firms in an industry or all firms if < 50 in industry Perfect competition, HHI is small Only 1 firm, HHI is 10,000 = (1002) U.S. Justice Department

o HHI < 1,000 competitive marketso HHI > 1,800 could be considered concentrated industry

worthy of Justice Dept. examination of any purchases

OligopoliesA few number of sellers

Each can impact market price & quantities

Interdependent in their decision making Key component in marketing strategies and

pricing behavior Match price cuts but not price increases by

fellow oligopolists Do this to maintain market share

Non-price competition between oligopolists to uniquely identify products

Pages 152-15525

OligopoliesRival oligopolists will match price cuts but

not price increases in the short run because they want to capture a larger market share

If there are differences in prices they are the result of successful product differentiation

Tend to have stable prices Changes in production and other costs not easily

passed on and may have to be absorbed

Pages 152-15526

OligopoliesPrice leadership strategy

A particular firm dominates the market Controls the largest share of the market Other industry firms more efficient in operation,

marketing, etc. The dominant firm first sets its price to

maximize profit Remaining firms set their prices based on the

dominant firms pricing

The price set by the oligopolist seller is higher under perfect competition Quantity produced is lower then perfect comp.

Pages 152-15527

OligopoliesThe dominant firm may be efficient

enough to set a lower price Eventually drive the other firms out of

the market

Pages 152-15528

OligopoliesExamples of Oligopolies

Auto manufacturers 1997 CR4 value of 97.4

Aircraft manufacturing Farm machinery and equipment

John Deere, J.I.Case and New Holland 80% of 2-wheel drive tractors close to 90% of combines sold in the U.S.

Cattle slaughtering CR4 value increased from 39% to 67% over

the 1985-1995 period

Pages 152-15529

Demand curve DD All oligopolists move prices

together and share market

30

Demand curve ddA single firm changes

its price Curve DD is more

inelasticBelow point 1, firms

match price cutThis leads to a kinked

demand curve d1D Leads to a

discontinuous marginal revenue curve, d256

6

Remember oligopolists account for the reaction of other firms so there is no single demand curve

Meeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share

Shifting MC curves reflecting technological advances will not affect PE and QE

It does impact profits as MC drops from pt 3 to pt 4

MonopoliesOne seller in the marketEntry of other firms restricted by

patents, etc. (i.e., barrier to entry)Firm has absolute power over

setting market priceProduces a unique productIt can have economic profits in the

long run because it can set price without competition

Page 155-15633

Monopolies

Page 155-15634

MC ATCAVC

Demand= ARMR

TVC

0

N

M

PEC

B

A

QE

Total revenue = area 0PECQE

Monopolist produces quantity where MC=MR (pt A), QE

Uses the demand curve (pt C) when setting price PE

$/unit

Quantity

Monopolies

Page 155-15635

MC ATCAVC

Demand= ARMR

TVC

0

N

M

PEC

B

A

QE

$/unit

Quantity

Total variable costs for the monopolist is equal to area 0NAQE, (green box) =AVC x QE

= 0N x QE

Monopolies

Page 155-15636

MC ATCAVC

Demand= ARMR

TFC

0

N

M

PEC

B

A

QE

$/unit

Quantity

Total fixed costs equals NMBA (orange box)=(ATC-AVC) x QE

Monopolies

Page 155-15637

MC ATCAVC

Demand= ARMR

TFC

TVC

0

N

M

PEC

B

A

QE

$/unit

Quantity

Total cost is area 0MBQE (green box + orange box)

= area ONAQE + area NMBA

Monopolies

Page 155-15638

MC ATCAVC

Demand= ARMR

TFC

TVC

0

N

M

PE

EconomicProfit

C

B

A

QE

$/unit

Quantity

Monopoly economic profit = area MPECB = Total Revenue (yellow

box) – Total Costs (green box + orange box)

Monopolies

Page 155-15639

MC ATCAVC

Demand= ARMR

TFC

TVC

0

N

M

PE

EconomicProfit

C

B

A

QE

$/unit

Quantity

Total fixed costs equals NMBA (orange box)=(ATC-AVC) x QE

Comparison of Structure ResultsLets compare the results we have

obtained from the alternative market structures

40

Consumer surplus = sum of areas1, 4, 5, 8 and 9 (blue triangle)

Perfect Competition Case

41

Producer surplus = to the sum of areas 2, 3, 6 and 7 (green triangle)


42


Total economic surplus = sum of blue and green triangles =sum of areas 1 – 9

43

CS = sum of areas 8 and 9, (new blue triangle)

Compared to P.C., consumers would be economically worse-off by areas 1, 4 and 5Paying a higher

price, PM Purchasing a smaller

quantity, QM

Monopoly Case

44

PS = to sum of areas 3, 4, 5, 6 and 7 (green area)

Compared to P.C. producers lose area 2 but gain areas 4 + 5Economically

better-off than P.C.

Monopoly Case

45

Society as a whole would be economically worse-off by areas 1+2Known as the dead

weight lossReflects the fact that

less of available resources in this market are used to provide products to consumers

Monopoly Case

46

Summary of Imperfect Competitors from a Selling Perspective

Page 15747

Imperfect Competition From the Buying Perspective

48

Types of Imperfect Competitors on the Buying Side

Monopsonistic competitionOligopsonyMonopsony

Let’s start here…

49

MonopsoniesSingle buyer in the input marketFocus is on the marginal input cost

of purchasing an addition unit of resources

Will purchase input until Marginal Value Product (MVP)=Marginal Input Cost (MIC)As long as MVP>MIC, the

monopsonist makes a profit

Page 158-16050

MonopsoniesUnder perfect competition, the firm

views the input supply curve as a horizontal lineFirm can purchase as much as desired as the

going priceFirm’s purchase does not impact inputs cost

Monopsonist is the only input buyer→Faces an upward sloping input supply

curveBuying decisions impact input prices

Page 158-16051

MonopsoniesMonopsonist must consider the marginal

input cost (MIC) when purchasing inputsMIC defined as the change in the cost of an

input as more of the input is usedLets look at a simple example

Monopsonist must pay higher prices per unit if he/she wants to purchase greater amounts of the input→MIC curve is above the input supply

curvePage 158-16052

Marginal Input Cost

Page 158-160

Units of Variable Input

Price/Unit ($)

Total Input Cost

Marginal Input Cost

1 3.00 3.00 -----2 3.50 7.00 4.003 4.00 12.00 5.004 4.50 18.00 6.005 5.00 25.00 7.006 5.50 33.00 8.007 6.00 42.00 9.008 6.50 52.00 10.009 7.00 63.00 11.0010 7.5 75.00 12.00

53

Marginal Input Cost

Page 158-1601 2 3 4 5 6

1

3

2

4

5

678

9

10

11

$/U

nit

12

7 8 9 10Quantity/unit of time

Marginal Input Cost

Input Supply Curve

Data obtained from previous table

54

MonopsoniesProfit maximizing monopsonist

Use variable input to the point where Marginal Input Cost (MIC) =Marginal Revenue Product (MRP)

MRP = addition to total revenue attributed to the addition of one unit of variable input = Marginal revenue x MPP

So long as MRP>MIC, profits will increase with increased input use

If MRP<MIC, profits will ↑ by reducing the amount of input used (Why?)

Page 158-16055

MRP = MVP under perfect competition MVP=PPC x MPP

Buying Decisions by Perfect Competitors

56

Buying Decisions by a Monopsonist

57

Monopsonist makes decisions along MRP curveDiffers from MVPMRP=MIC at APurchase QM inputs

Buying Decisions by a Monopsonist

Resource useHigher Price paid

under P.C., PPC

Utilization higher under P.C., QPC

Price difference referred to as monopsonistic exploitation (i.e., PPC – PM)

58

Imperfect Competition on Both Sides

Page 160

Product Selling Perspective

Input Purchasing Perspective

Perfect Competition

Perfect Competition

Monopolistic Competition

Monopsonistic Competition

Oligopoly Oligopsony

Monopoly Monopsony

Can have any combination of the above for a particular firm Lets look at profit maximization under specific cases

59

Case #1: Monopsonist in input purchasing and Monopolist seller of product Equilibrium: MRP=MIC at Point A. Pricing off input supply curve gives QMM and PMM

60

Case #2: Perfect Competition in input purchasing and Monopoly seller Equilibrium is where MRP=Supply at C No Marginal InputCost curve → QPCM and PPCM

61

Case #3: Monopsony in input purchasing and Perfectly Competitive sellerEquilibrium: MVP=MIC at Point EPricing off supply curve → QMPC and PMPC

62

Case #4: Perfect Competition in both input purchasing and product salesEquilibrium: MVP=Supply at Point F→ QPC and PPC

63

Monopsonistic CompetitorsMany firms buying resources Ability to differentiate services to

producersDifferentiated services includes

distribution convenience and location of facilities, willingness to provide credit or technical assistance

P and Q determined same as monopsonist

Page 16164

OligopsoniesA few number of buyers of a resourceProfit earned will depend on elasticity

of supply for resource (less elastic than monopsonistic competition)

Each oligopsonist knows fellow oligopsonists will respond to changes in price or quantity it might initiate

P and Q determined same as monopsonist

Page 16165

Various segments of the livestock industryExhibit several forms of imperfect competition.

66

Governmental RegulationVarious approaches have been used to

counteract adverse effects of imperfect competition in the marketplace Legislative acts passed by Congress, including

the Sherman Antitrust and Clayton Acts Price ceilings Lump-sum Tax Minimum price or floors

Page 16267

Legislative ActsSherman Antitrust Act of 1890

Prohibited monopoly and other restrictive business practices

Packers and Stockyards Act of 1921 Reinforced Anit-trust laws regarding

livestock marketingCapper-Volstead Act of 1922

Exempted cooperatives from anti-trust lawsRobinson-Patman Act

Prohibited price discrimination practicesAgricultural Marketing Agreement Act

Established agricultural marketing ordersPage 16368

Impacts of Price CeilingsRegulatory agencies such as the Federal

Trade Commission can impact monopoly effects by instituting a maximum (ceiling) price FTC charged with investigating business

organizations and practices and carrying out anti-trust provisions

How can we model the impact of price ceilings?

Page 16369

Implications of a Price Ceiling

Without regulatory involvement the monopolist will Equate MR and MC

(point C)Produce QM and

charge price PM Earn a profit of A

′PMBD

Impacts of Price Ceilings

DA′

70

With gov’t imposed price ceiling, PMAXThe demand curve

is given by PMAXEDMR is PMAXEFGMono. produces

more (Q1>QM) at a lower price (PMAX < PM)

A′D



71

Monopolist’s profit falls to area IPMAXEH (turquoise box)A′



72

Impacts of a Lump Sum TaxA regulatory agencies can impact the

level of monopoly profits by assessing a lump-sum tax May be a license fee or one-time charge Corresponds to a fixed tax regardless of

output level

How can we model the impact of a lump sum tax?

Page 16573

Implications of Lump-Sum TaxThe monopolist

equates MC=MR (pt. F)Produces QM Charges PM

Profit of APMBC

Impacts of A Lump Sum Tax

74

Implications of Lump-Sum Tax

Impacts of A Lump Sum TaxLump-sum tax

↑ firm’s ATC from ATC1 to ATC2

↓ producer surplus from APMBC to EPMBT

Does not change output level or price

The loss in producersurplus is area AETC(blue box)75

Impacts of a Minimum PriceIn a monopsony, the gov’t could regulate

the price of a resource by imposing a minimum price that must be paid for that resource Good example is the various minimum wage

laws

How can we model the impact of a minimum price policy?

Page 16576

Implications of a Minimum Price No minimum priceMonopsonist

determines where MRP=MIC

Employ QM input unitsPays $PM/unit

Impacts of a Minimum Price

77

Implications of a Minimum Price

Impacts of a Minimum PriceMinimum price, PF,

imposed Monopsonist’s MIC

curve would be PFDCB

The firm would use more input

78

SummaryUnlike perfect competition, imperfect

competitors have ability to influence priceMonopolistic competitors try to differentiate

their productMonopolists are the only seller in their

product market. Monopsonists are the only buyer

Oligopolies are a few number of sellers while oligopsonies are a few number of buyers.

What are the economic welfare implications of imperfect competition?

79

Chapter 10 focuses on resource use in agriculture and the environment

80

market equilibrium and market demand: imperfect competition

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